Russia’s Impossible Choices

Jan. 19, 2016 Moscow finds itself in a familiar predicament.

|January 19, 2016

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By George Friedman

Russian Deputy Finance Minister Sergei Storchak said on Jan. 18 that Russia is considering not making any more loans to foreign governments during the current economic crisis, according to Russia’s Interfax news agency. Storchak said, “The budget is strained, more than strained. I think we are in a situation where we are forced to take a break from issuing new loans.” It is not quite clear how this will affect loans that the Russian government has promised but not yet closed. In particular, Russia has committed to a $5 billion loan to Iran, which is in the process of closing. Storchak said, “We have assumed large obligations. And not to respect obligations on the issued loans is even more shameful than not to fulfill our own obligations on the loans which we have taken.”

The reasons for this decision (I doubt that a deputy finance minister would have made an unauthorized statement on a subject so delicate) is of course oil prices. Russia is in the extraordinarily difficult position of having based its economic well-being on the price of a commodity it cannot control. At current prices, with some varieties of oil having fallen below $30 a barrel, the Russian national budget is “more than strained,” as Storchak put it. Loans to foreign governments are simply one of the many things that will have to be cut.

Storchak is aware of one vital fact: There is no reason to believe that the collapse in oil prices is temporary. Demand for oil has declined substantially, given ongoing weakness in Europe and some hints of weakness in the United States. That has meant that exporters, particularly China, have limited export capability and decreased need for oil. This situation is going to exist for several years. At the same time, the combination of new technologies and high oil prices brought new producers into the market and created an oil glut. The China bubble maintained high oil prices for a while, but there is nothing to sustain them after that has burst. So Russia is looking at a near existential crisis. It lives on oil revenues and used to brag that it could manage on $70 a barrel oil when prices were well above that. Now prices are less than half of what the Russians need to fund their budget, as well as drive the rest of their economy.

Storchak’s statement wasn’t really about foreign loans, although they are certainly at issue. It was actually an official warning, by a deputy minister so as to downplay it a bit, that the Russian economy is facing disaster. These loans are not all that expensive, and they build Russian influence. By announcing that Russia would stop offering them, the Russian government is telegraphing to its public and the world that its situation is as bad as the pessimists have said. This was the vehicle for making clear that Russia may not be near a breaking point, but is moving toward one.

Still, the decision to cut these loans should be considered in its own right. In suspending these loans, the Russians are cutting one of their major foreign policy tools. During the halcyon days when oil prices were more than $100 a barrel, the Russians used loans to shape the behavior of foreign governments. This was particularly true along Russia’s periphery, Europe to Central Asia. Such loans did not obligate foreign governments to follow Russia’s lead, but it certainly didn’t hurt to know that the Russians could solve foreign governments’ financial problems.

The weaker Russia becomes economically, the stronger it needs to appear, both for domestic and foreign audiences. Appearing weak both domestically and in foreign countries invites the vultures to feast. The Russians cannot afford to do both. Yet the situation is so bad that it must say that it is suspending these loans. The Russian aircraft in Syria, therefore, now serve a double role. First, they defend a Russian ally, Bashar al-Assad. Second, they show the world that the Russians may have economic problems, and may not be able to give loans, but they can still influence events and irritate the United States, even at low oil prices. I doubt that this was what the Russians had in mind when they intervened in Syria, but it is certainly on their minds now.

The simple formula that a strong economy creates a strong military has never really applied to Russia. Ever since Napoleon, the Russian economy has been weak. It is hard to think of a period when it was booming, save perhaps the 1950s when its boom was tied to rebuilding after the devastation of World War II. Yet in spite of the paucity of economic success, the Russians have fought appallingly expensive wars, and either fought the enemy to a bloody standstill or defeated them outright, as they did with Napoleon and Hitler.

Modern weapons are expensive to develop, but deploying precision-guided munitions is cheaper than deploying and arming many millions of men as the United States did during World War II. It is possible, within the existing budget, to create capable weapons developed by what we used to call Soviet R&D—the KGB. Today technology just behind the cutting edge is available, and the cost of fielding it is cheaper than a World War II mechanized force.

Therefore, do not assume that Russian economic weakness, while serious, precludes weapons development. The question of Ukraine is still central to Russian national security. The Ukrainians are taking advantage of the moment by cutting off supplies to Crimea. The Russians discovered during the Ukraine crisis that they were not able to launch a full scale offensive. They then went into a military development mode that we estimated would last two years. After that they would revisit the Ukrainian situation. Given the Russians’ overriding interest in Ukraine, I suspect that military development is one thing that they will not cut.

However, this is what broke the Soviet Union. First it was a massive defense budget designed to keep up with American innovation. This strained the economy enormously. Then the decline of oil prices broke the economy and collapsed the Soviet Union. It could not survive both. In this case, oil prices have declined dramatically, but Russia’s military development is nothing like it was in the 1980s. Still, the Russians have far more than loans to consider. They need to consider whether they can afford a military program designed to force a new outcome in Ukraine. If not, they need to consider whether they can afford to have Ukraine as a pro-Western force whose borders are less than 250 miles from Volgograd, the city formerly called Stalingrad. In either case they are facing impossible choices that they cannot ignore and yet cannot really make.

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