As I have warned over the past few months, Russia is being particularly badly hit by the global financial crisis. Partly this is a function of the severity of the collapse of commodity prices, especially oil and gas, which has had an exceptionally serious impact on a country where 85% of GDP relies on the extraction of raw materials. However the scale of the crisis in Russia has been hugely increased by a number of massive miscalculations by the Silovik state. Now the speed and scale of the Russian meltdown could conceivably become a threat to the stability of the Silovik regime itself.
As energy prices rose from their lows of a decade ago, the regime which took power after the resignation of Boris Yeltsin on New Years Eve 1999 made oil and gas the central plank of their economic policies. In a sense this was a natural thing to do, but from the Kremlin's point of view, it had several political advantages. Firstly, control over oil and gas was a lot simpler than controlling the complicated logistics chains of modern industry; and secondly the oil reserves could not be shifted overseas, beyond Kremlin control. However, by making oil and gas such a priority, the Russian economy suffered two unwelcome effects: firstly the strong Rouble rendered much of Russian industry uncompetitive so that it subsequently collapsed and secondly it made Russia much more vulnerable to big swings in commodity prices. In effect Russia lost more complex elements of its economy and in a sense therefore actually became less developed.
Nevertheless, the surge in energy prices, based around a global economic boom and concerns about "peak oil" dramatically improved Russia's financial position from the point where they defaulted on their debt on August 15th 1998. Russia became awash with liquidity- much of it provided by the global banking system, which was chasing yield wherever it could find it. Yet, even in these good times, there were significant problems. The increasing use of state power against certain oligarchs was greeted with concern, particularly the arrest of Mikhail Khordokovsky, the chairman of Yukos, an oil company which had gone the furthest in adapting to a Western business model and was, from the Kremlin point of view showing worrying signs of independence. However for most people, the murderous history of these so-called Oligarchs actually made the idea of the Kremlin cracking the whip against them quite popular.
The government of Vladimir Putin, it was suggested. was built upon Order. However, it was not built upon Law. The continuing high levels of corruption were only part of the problem. There was simply no recourse anywhere in the Russian constitutional or legal system. The government was not a government dependent on laws, but on the personal decisions of its occasionally capricious leaders. Without any legal order, disputes have often turned violent. The murderous habits of the Oligarchs were adopted in full by the Siloviki- the tight-knit and shadowy members of the former Soviet security services such as the KGB like Vladimir Putin himself-who often turned out to be the same people as the Oligarchs.
This lack of legal certainty meant that completely arbitrary decisions were being taken. Massive contracts involving major global companies were cancelled without warning or redress and technical skills that these companies had brought to Russia were stolen. It became quite clear that intellectual property, like every other property in Russia, could not be protected from arbitrary theft by the state. The cancellation of the Shell Sakhalin-2 consortium was a major example of this.
Then came the dispute between BP and their partners in TNK. here it was not just the technical expertise that was under threat, but the very concept of ownership at all. BP executives were forced to flee for their very lives as it became clear that even BP could not protect its own legal interests against those of the Silovik-Oligarch ruling elite. At this point, confidence in Russia was being seriously shaken, and several major investments planned by global investors in the country were abandoned.
At the same time, the power elite in the Kremlin, seemingly awash in petrodollars, had been putting forward an increasingly assertive foreign policy. Popular at home, these policies often seemed to be nothing more than doing the opposite of what Western powers wished Russia to do. Hostile rhetoric became the order of the day and the myth grew that Russia had somehow been humiliated by the West and was now simply restoring their rightful place in the world order. However the invasion of Georgia, after a series of provocations designed to lure the erratic Georgian leader, Mikheil Saakashvili into an ill advised military response, was a spectacular own goal. Although the Western political response was weak, the invasion led to a dramatic loss of investor confidence in Russia.
Since the invasion of Georgia in August, Russia has seen a spectacular market rout, which dwarfs anything seen in the West. The market value of Russian companies has fallen by over $1 trillion. The credit freeze in the West has been even more severe in Russia and the market collapse firstly triggered margin calls and then essentially bankrupted the Russian banking system. Despite the amassing of $450 billion of Russian reserves, more than a fifth of this carefully husbanded war chest was lost in a single month.
In a single quarter Russia has gone from hubris- riding high in confidence and expectations- to nemesis- a spectacular meltdown across their entire economy.
Yet the political response to this crisis from the Siloviki has been pitifully inadequate. They have continued their aggressive foreign policy: responding to the anti-Iran missile shield by moving short range Iskander missiles into the Kaliningradskaya oblast was a highly unwelcome distraction to President-elect Obama. However since Russia only has six functioning missiles, the threat is ultimately empty. It does, however, underline the fact that Russia would like to be a strategic challenger to Western interests and thus reduces western goodwill to Russia still further.
The determination of Vladimir Putin to return to the Presidency has also been underlined by the increase in the Presidential term proposed by his successor. Yet by doing so he has given reinforcements to those in Russia who speak out against the regime. Until now supporters of Putin have argued that his respect for the constitution was absolute, yet this move makes it clear that it is not, and that threats of dictatorship are not so wide of the mark after all. A Putin return to the Presidency before the expiration of President Medvedev's four year term expires will only add to the perception that Putin is indeed a tyrant. Should he do so, his popularity is likely to be well below the high levels he enjoyed during his first period in office.
In fact the change in the Presidential term only underlines the contempt for Law that has been the hallmark of the Putin regime. It is this contempt that is destroying the economic and social fabric of the Russian State. The root of the popularity of Putin's first term was not so much in any particular policy that he adopted, but in the fact that the overall levels of Russian wealth were being increased by the commodity boom. The end of the boom has thrown the Russian economy sharply into reverse. The regime, whether under Medvedev or under Putin, now faces a return to bad economic times. It will be impossible to eliminate a gathering background noise of criticism, although it is said that there are advanced plans for a further political crackdown should the country hit a period of unrest.
In the end, Putin will discover that Order without Law is highly unstable. Unless the regime faces the demons of corruption and violence and creates a constitutional and legal order it risks a revolutionary explosion. The fact that the regime patronises militant paramilitary "youth" groups such as "Nashi" shows how far away they truly are from understanding the realities of a state of laws. It is not impossible that they could retreat into their authoritarian comfort zone and attempt to create a quasi-fascist government. Yet that might even lead to the break up of the country- a significant and growing proportion of the population of Russia is not ethnically Russian, and the support for the tiny number of Ossetians and Abhaz in Georgia has also woken up the several million Tartars, Bashkirs and of course Chechens.
Hard on the wings of the economic crisis, Russia now faces a constitutional and political crisis.