Putin can't keep his promise to Russian people

Forbes: 17. December 2014
Op-ed by Paul Roderick Gregory

Russia's Prime Minister Dmitry Medvedev (R) speaks during a meeting on the financial and economic situation with Central Bank Chairman Elvira Nabiullina (L), Finance Minister Anton Siluanov (2nd L) and Deputy Prime Minister Igor Shuvalov (3rd L) in the suburban residence "Gorki" outside Moscow on December 16, 2014. The Russian ruble crashed to new record lows on December 16,

Russia’s central bank waited until the early morning hours to raise its interest rate from 10.5% to a whopping 17.5% to encourage citizens to hold rubles and foreigners to buy rubles. Rather than building confidence, markets interpreted the move as panic. By late afternoon, it took an unprecedented 80 rubles to buy one dollar. Despite its vaunted reserves, the mighty Russia gives the appearance of a Latin American banana republic, dependent on one product, with a collapsing economy and declining living standards that can no longer support Vladimir Putin’s expensive foreign adventures or keep alive his social compact with the Russian people.

Vladimir Putin’s social compact with the Russian people is clearly defined: Putin agrees to give the Russian people rising living standards, jobs, regular pensions and economic stability. In return, the Russian people look the other way as Putin and his inner circle steal the country blind, destroy alternate media, and suppress all internal dissent. Those who witnessed (as I did) the economic chaos, unpaid pensions and salaries, runaway inflation, and harassment by mafia and petty officials of the Yeltsin years understand the appeal of Putin’s social compact. But Putin is no longer keeping up his end of the bargain. Will the Russian people continue to look the other way? That is the question.

Putin’s Russia officially became a banana republic as Russian citizens and foreign INVESTORS drove the ruble to new lows despite the central bank’s surprise astronomical increase in the interest rate from 10.5% to 17.5%. (Just imagine the temptation for INVESTORS “stretching for yield” in a world of zero interest rates.) The absent ruble recovery suggests that investors, both inside and outside Russia, expect further currency losses to offset the interest-rate differential and have lost confidence in the Russian state. They may even begin to worry about default.

The government of Russia has been called into emergency session. The results are predictable. President Vladimir Putin, following his custom, will call the responsible ministers on the carpet, blame them for the currency collapse, instruct them to correct the mess they made, and perhaps fire them. Russian media will show Putin as a resolute figure, fighting for the Russian people against incompetent bureaucrats, who have allowed such problems to arise. Of course, Putin himself will have no share of the blame.

My prediction is that, with the likely failure of the sky-high interest rate gambit, Russia will introduce currency controls, reminiscent of the Yeltsin years. Russian citizens, but not Putin’s inner circle, will be restricted in their ability to convert rubles into dollars. Passengers arriving and departing from Sheremetova Airport will again have to fill out currency forms to demonstrate they are not taking out more dollars than they brought in. Russian companies will be forced to repatriate all dollars earned abroad. Russians can kiss their foreign vacations good-bye, even if they could afford them, and they’ll have to forego the foreign cars and French perfumes to which they have grown accustomed. Those who can leave Russia will do so, and they will go with their money. Without a rule of law to protect them, successful Russians cannot risk keeping their assets in Russia.

The Putin administration’s optimistic boast that a falling ruble brings in more rubles for the budget (because oil is traded in dollars) offers no solace to pensioners and government workers – the core of Putin’s constituency. Yes, the Russian government may be able to pay pensioners and state workers the same rubles as before, but they lose a considerable amount of their purchasing power to rising inflation. Putin’s Ukrainian adventures do not help. Pensioners already know that funds have been diverted from the pension account to accommodate Crimean newcomers. And only 5-6% of Russians are willing to sacrifice pensions and social expenditures for the sake of Crimea or their brethren in the Donbass.

The collapsing ruble also complicates the huge refinancing overhang facing Putin’s “national champion” companies like Gazprom and Rosneft, which have been excluded from Western credit markets by sanctions. Much of Russia’s vaunted rainy-day funds must be exhausted just to refinance their current debt, much less acquire new debt for INVESTMENT.

Russia’s beginning recession will not be a mild half percent or so but more in the neighborhood of 4 to 8%. Mr. Putin’s pocketbook can no longer afford grandiose new pipelines into Europe or keeping the People’s republics of Donetsk and Luhansk afloat, especially now that Ukraine has said, “You broke them. You pay for them.” Putin must pay the thousands of mercenaries in Ukraine, and he must keep expanding his well-paid army of propaganda trolls. And he must keep his inner circle happy. With so many demands on a limited budget, Putin must be fuming.

Putin has not held up his end of the bargain he made with the Russian people. Let’s see what their reaction will be. We must assume they can put two and two together.