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Geopolitics of Putinism

October 28, 2017

In 2016, the geopolitics of Putin will remain the defining feature of Russia at home and abroad. Deteriorating economic conditions may drive the Kremlin to a more extreme position rather than reconciliation.

Over the past year and a half, the majority of headlines covering Russia were defined by geopolitics. President Vladimir Putin’s desire to restore Russia to its former status as a great power has driven not only Moscow’s external relations, but also developments within the country itself. The resulting dynamics have shaped the changing perceptions of Russia domestically, and internationally. In the coming months, these will likely translate into more solid structural changes, suggesting that the operating environment for foreign corporations trading with – or operating in – Russia will settle into a new and uncomfortable status quo.

Geopolitics of Putinism and the New Russian Identity

Moscow’s aim to carve out its own economic and political zone of influence and to establish the new narrative of Russian national identity are the cornerstones of the geopolitics of Putinism. Both feed into Russian society’s perceived need for the restoration of Russia’s dignity as a great power. Recent developments suggest that the divide between Russia and its external interlocutors (including the United States, Europe – led by Germany – and Ukraine) will solidify in the medium-term and that deteriorating economic conditions may drive the Kremlin to a more extreme position rather than reconciliation. This means that the operating environment for multinational companies will remain difficult, since they are cast as representatives of foreign powers and are often targeted by the Kremlin in response to a deterioration of Russia’s relations with their country of origin.

Putin best described the basis of his geopolitical views in his speech to the Valdai Discussion Club, an annual gathering of international experts on Russia, in October 2014, in which he presented his vision of an emerging multipolar international structure. In such an arrangement, regional powers would create their respective economically and politically integrated blocs and set rules for their mutual interaction on a global scale.

This logic, which necessitates the creation of Moscow’s own bloc if it is not to become a periphery of somebody else’s zone, is the driving force behind the Eurasian Economic Union (EEU). In this context, Russia’s focus appears firmly fixed on what is termed the “near abroad,” the countries of the former Soviet Union. Ukraine was expected to be a key part of this bloc although Russia is unlikely to give up its efforts to include Kiev. The practical implications of Russia’s drive to construct its own exclusive bloc are not limited to its assertiveness towards Ukraine. The latest proposal that EEU countries should avoid using the U.S. dollar and the euro in trade within the bloc is another example of how the regional blocs theory translates into the real world.

To substantiate this objective, the Kremlin embarked upon a project of delimiting its boundaries by defining the identity of Russia (or a notion of “us”) as unique from everybody else. Tradition, Russian Orthodoxy, historical exceptionalism and cultural mission have become hallmarks of the new national identity narrative; the return to great power status has been its overarching message. The new identity draws a clear dividing line between Russia as an embodiment of traditional virtues on the one hand, and alien and decadent liberal Europe or aggressive and destructive U.S. on the other hand. Military posturing against NATO, where the U.S. is cast as the driver of aggressive policies and Europe as its hapless follower, is a part of the construction of a domestic image of Russia’s might – reminiscent of the days of the Soviet Union as a global superpower.

The Kremlin’s near complete control of Russian media will ensure the transmission of the government’s message as well as its consistency across all media outlets. In the past twelve months, Putin’s popularity surged due to renascent nationalist fervor. The external enemy has also been useful in creating a siege mentality, which limits the likelihood of popular unrest in response to increasing economic hardship. Given the domestic utility of the stand-off with the EU and U.S. for the Kremlin, it is unlikely that mutual relations with Russia will improve even after the crisis in Ukraine is over. For multinational companies this means a return to the pre-crisis status quo is unlikely and they may continue to be an easy target of Russian retaliation whenever relations with their countries of origin sour.

Yet, the focus on the near abroad, for as long as it lasts, will limit Russia’s appetite to be actively involved further afield. Overall, Russia will likely remain a cooperative actor on the global stage. Although Russia will continue to support and foster its traditional allies (as seen with its recent military support to Syria’s Bashar al-Assad) or seek a more secure foothold in various locations globally, it is unlikely that it would go into an open conflict with the United States or Europe over issues not related to its immediate neighborhood. In handling these issues, Russia will focus on carving space for itself at what Putin sees as the future negotiating table of large regional powers.

Beyond the Ukraine Crisis

Moscow’s military posturing has shifted the standoff over the Ukraine crisis to a new level in recent months. While in summer 2014 the issue was largely viewed as a problem related solely to Moscow’s effort to reverse Kiev’s westward trajectory, less than twelve months later, Russia is perceived as the top regional security threat in Central and Eastern Europe (CEE). Continual Russian incursions into the Baltic airspace and waters have motivated an increase in military spending in countries on the eastern edge of NATO. However, signs show that more fundamental shifts are forthcoming in 2016.

The Russian military has been flexing its muscles over a wider geographical area over the past eighteen months. There have been a record number of Russian military exercises, including drills of strategic missile forces. Searches for suspected Russian submarines have taken place in Swedish, Finnish and British territorial waters. Near misses between Russian military aircraft and commercial passenger flights have been recorded in skies over several European countries. In response, NATO stepped up its exercise activity in the region and CEE countries have increased their military spending and amended their defense policies. In addition to a series of announcements of material purchases, changes have been registered in the size and nature of military exercises, as well as in the overall structure of military forces in the region. Though perceptions of Russia as the top security threat are not necessarily shared by all European countries, the U.S. announced a commitment to a long-term military presence in the CEE in June 2015. While this was mostly a symbolic statement consistent with existing planned U.S. deployments on the ground, it signaled another step in what will likely become a structural shift in security arrangements in the region. A familiar pattern of the textbook prisoner’s dilemma is gradually emerging along the fault-line on the eastern edge of NATO.

The planned security fence on the Estonian-Russian border may become its physical manifestation, but structural shifts, which are gradually emerging on a political level, have more grave implications. NATO has created and fostered its rapid response force and prepares scenarios specifically contemplating the possibility of Russia launching a hybrid war against one of its members. Moscow halted its participation in the Treaty on Conventional Armed Forces in Europe in March 2015 and subsequently overhauled its naval doctrine, identifying NATO as the main possible adversary. These acts solidify the perceptions of new adversity and a stand-off between Russia and NATO in Europe. Once enshrined in official documents and commitments to allied countries, such perceptions are likely to become structural.

Yet, it is unlikely that Russia would take matters as far as risking open military confrontation with NATO. In fact, Moscow’s aim is to challenge NATO’s position as an effective guarantor of security to Russia’s former satellites. Russia may engage in events of non-military character (such as the abduction of an Estonian intelligence officer in September 2014), which are in essence breaches of state sovereignty and security of its neighbors, but will avoid episodes that are serious enough to trigger responses from the alliance. Such inconspicuous acts are designed to question NATO’s practical utility. The aim of Russian policy is to assert Moscow’s role as a major power and potentially force a redesign of international security structures in Europe to permit Russia a greater say in high-level discussions. This suggests that even after the Ukraine crisis is eventually over, relations between Russia and NATO countries will likely remain tense.

As a result, the operating environment for western corporations in Russia will remain more complicated than ever before. The continuation of tensions has not have triggered significant policy shifts and the securitization of international relations narratives have entrenched mutual perceptions of strategic rivalry. In addition to negative changes in the business environment, transaction and financing costs may also be adversely affected.

Economic Outlook for 2016 Remains Challenging

Oil and gas have been a consistent part of Russia’s power projection. Energy exports, which typically account for 15% of Russian GDP, are the driving force of the economy, a centerpiece of Russian budget revenues and the main source of political patronage in Putin’s years in power. Years of high oil prices masked the structural deficiencies of the Russian economy: lack of diversification, low labor productivity and reliance on technological imports, but these deficiencies have been exposed over the past twelve months as a result of low oil price environment and international sanctions.

Yet, rather than addressing structural weaknesses, the Kremlin’s policies focus on the stabilization of the status quo to the benefit of the elite. The government’s plan to ride out the recession focuses on providing financing for strategic enterprises, systemically important banks and stabilizing the ruble. The economic decline is being portrayed as a result of external forces aiming to keep Russia down and out. Placing the blame on external enemies fits well within the overall narrative of the geopolitical confrontation put forward by the Kremlin. While such a narrative deflects criticism away from the government, it does little to improve the economy’s fundamentals. The setup and motivations of the decision-making circle are unlikely to change substantially in the near future. CEOs of multinational companies operating in Russia should therefore prepare for more of the same policies in 2016. For now, Moscow has sufficient fiscal reserves and the National Welfare Fund to support both the currency and strategic enterprises until the end of next year, when Russia hopes economic growth will pick up. Meanwhile, the decline in the ruble’s value will continue to shelter the state budget from the worst effects of the fall in oil prices and buoy the commodities exporters.

The one idea that aims to induce a restructuring of the Russian economy is the drive for import substitution. This is underpinned by the fact that Russia needs to wean itself off the dependence on vital imports from countries it now considers to be adversaries. The Imports Substitution Commission launched in September 2015 under the leadership of Prime Minister Dimitri Medvedev. Defense and civil engineering will be the initial focus sectors in 2016, as Russia will look to replace key imported components with domestically produced ones.

The push for the development of domestic capacities will continue side-by-side with the food imports embargo (which expires in August 2016, but may be extended) and the occasional harassment of importers of non-sanctioned items with regulatory checks and temporary imports bans. Similarly, products or operations of U.S. and EU companies in Russia may be the target of regulatory actions for political reasons. Such events are usually in response to a deterioration of Russia’s relations with the country of origin of the given producer. While these typically only result in temporary disruptions or fines, they may lead to an increase in operational and administrative costs, or damage to brand reputation.

Sanctions Easing a Prospect for 2016

Prospects of sanctions being eased will likely improve in 2016, but the effects of their lifting would be felt in the economy with a delay. Such a move would depend on the stabilization of the security situation in eastern Ukraine. Moreover, sanctions easing on the part of the EU would likely be a function of political bargaining among the 28 countries in line with its consensual policy-making model. As a result, all sanctions may not be lifted at the same time. More likely, some sanctions (those concerning the financial and energy sectors) would be eased, while some (those concerning the defense and dual use technology sectors) would remain.

The U.S. continues to act in lock-step with the EU on sanctions against Russia. There is no obvious reason for this to change in the near future neither Brussels nor Washington are ready to hand Moscow a strategic victory by splitting their united front against Russia. Therefore, it is likely that, should the EU ease the sanctions regime, some partial easing would also be introduced in the U.S. However, the degree of easing would likely be somewhat lighter and only apply to sanctions introduced by the president’s executive order (not those passed by Congress in December 2014). Presidential sanctions to mirror the EU sanctions on financial, energy, defense and dual use technology sanctions, and coordination would therefore be relatively easy.

The lifting of sanctions would create an opportunity for first movers; although, the decision to move back into the Russian market will likely be underlined by economic conditions in the market rather than just political considerations. Putin’s economic policies are unlikely to bring substantial stimulus to the economy in the absence of an oil price recovery. Yet, the sanctions easing may only become a prospect in late 2016 if the security situation does not improve early in the year.

The longer the sanctions stay in place the more impact they will have on Russia’s geo-economic positioning. Russia’s turn toward China and other Asian neighbors may accelerate since the initial installation of sanctions on Russia, although none of the major projects Russia pitched, especially the gas pipelines to China, have come to fruition. Yet, Russia would be increasingly likely to accept Chinese and Indian participation in major projects if prolonged sanctions intensify the need for an injection of capital. The financing cushion provided by Russia’s National Welfare Fund is unlikely to last beyond 2017.

Russian Domestic Political Risks limited in 2016

Putin’s geopolitics and its negative economic consequences have raised the possibility of his ousting from power in a palace coup by economic elites or through a public process. However, Putin has so far proved adept at preventing possible challenges to his leadership. 2016 will see general elections and the Kremlin has again been managing risks in advance.

General elections will likely be held two months earlier than originally planned in September 2016 rather than in December 2016. With minimal access to nationwide media, the non-parliamentary opposition focuses its campaigning on street rallies. By rescheduling elections for September, campaigning is confined to summer months, when the likelihood of public gatherings attracting a large attendance is low. The date change is in direct contradiction to the Russian constitution, which stipulates that the parliamentary term lasts a full five years, but the Constitutional Court allowed the rescheduling regardless. This will further reduce the chances of anti-Kremlin parties entering parliament. In Russia’s proportional system, the threshold for entry into the Duma is seven percent and it is unlikely that any single non-parliamentary party will win enough votes. To redress their individual weakness, these anti-Kremlin parties joined forces under the leadership of Alexei Navalny in April and will run a joint campaign in general elections. However, even on a united platform their prospects for winning seats in the Duma are limited.

Overall, the outlook for the general elections remains unchanged: pro-Kremlin parties will likely secure almost complete control of the parliament again. Nevertheless, the government is not taking any chances, as protracted economic difficulties may gradually erode the establishment’s popularity. Besides grass-root opposition, the establishment seems to be increasingly targeting the country’s former liberal elite. The criminal case filed against Leonid Melamed (an ally of former deputy prime minister Anatoly Chubais) in summer 2015 is widely interpreted as a step to prevent the potential rise of a viable political alternative in Russia.

Widespread public protests for now appear to be a limited risk in 2016. Economic hardship may eventually motivate anti-government moods; however, the likelihood of such an event is mitigated by the government’s control of the media and the message that it transmits: that economic difficulties are a result of external forces and the government is busy mitigating the impact on the population. However, as the new nationalist narrative takes hold, it is the far-right movements that may start to represent a risk for the government. With the radicalization of public opinion, the appeal of existing far-right groups and figures may increase, especially if the economic situation worsens dramatically. In fact, the challenge in terms of the rise of a non-parliamentary political party is much more likely to come from the far-right than from liberal opposition figures. However, even this risk is low in the next twelve months.

More of the Same in 2016

The emerging dynamics within the Russian Federation and in its relations with Europe and the United States suggest that 2016 will see gradual structural changes that will solidify the geopolitical rift that opened over the Ukraine crisis. Even after the conflict in the Don- bass eventually settles, relations will remain strained and the operational environment for foreign corporations potentially difficult. Aside from the obvious implications of bans and sanctions currently in place, disruptions to operations and supply chains as a result of regulatory actions are likely. The developing concept of ‘the West’ as alien to Russian culture may impact brand perceptions of US and EU companies in the Russian market. Yet, overall, Russia will likely remain politically stable next year, despite an economic growth outlook that is far from rosy. Both at home and abroad, the geopolitics of Putinism will again remain the defining feature of Russian headlines in the coming year.