Responding to a Pandemic, Putin Trades Russia’s Future for His Own

Vladimir Putin had a very different economic plan for Russia in 2020 when he announced sweeping changes to the Russian constitution in January and endorsed legislation to reset his term limit in March, allowing himself the option to remain in power until 2036. With a National Welfare Fund (NWF) worth more than $156 billion in hand, it was anticipated that the Kremlin would increase social spending to soothe any public discontent with Putin’s announced continuation in power. But Covid-19 and a poorly timed energy price war with Saudi Arabia upended those plans, confronting the Kremlin with a grim new economic reality as it approaches a national referendum on proposed constitutional changes and 2021 parliamentary elections. In April, a simultaneous collapse in oil prices and a 33 percent drop in economic activity resulted in a staggering GDP contraction of 28 percent. The Russian Central Bank forecasts a 4-6 percent reduction in GDP in 2020. Several macroeconomists expect the economy to shrink by more than 10 percent this year.

While Russia is not alone in grappling with a sudden and extraordinary global economic downturn, Moscow’s response to the crisis is constrained by a set of circumstances particular to Russia. If oil prices remain unexpectedly low (below the current $40/barrel level the government currently budgets) for several years, the government may be forced to consider two politically unattractive and risky options: either increase taxes on its citizens to sustain planned investment or consolidate the budget by cutting spending on the politically important National Projects.  Even if global energy prices rebound, however, the policies that Moscow has already implemented to date are reconfiguring Russia’s economy in the long term, making it more susceptible and vulnerable to future external shocks and less policy responsive. In fact, Russia’s current timid economic response to the pandemic suggests this is already the case. To date, Russia’s direct anti-crisis measures add up to under 3 percent of GDP, compared to roughly 10 percent in Germany and the United States. The long-term political repercussions from the economic fall-out may not be fully understood for several years.

Russia enters a global recession at once better prepared and more vulnerable—a paradox of the government’s dependency on oil and gas revenue, its failure to implement serious economic reforms, and six years of Western-imposed sanctions. Its large current reserves and NWF are both products of prudent monetary and fiscal policies that balanced the budget at an artificially low price of $40-42/barrel. This conservative approach, guided by the Kremlin’s desire to reduce impact from future Western sanctions on its economy and financial markets, will mean that Moscow will likely not have to borrow in international markets. Despite some internal division, Russia’s able economic technocrats have safely maneuvered through the rocky shoals of past crises. Yet the depth and timing of the current crisis suggest that the toughest decisions lie ahead.

Wanted—more oil and gas revenue. Russia’s Ministry of Economic Development expects an average price of Urals crude in 2020 of $31/barrel, down from pre-crisis estimates of $57/barrel. Because Russia only taxes windfall revenues at above $15/barrel, at a price of $20/barrel, taxes on oil and gas contribute would just 5-7 percent of consolidated budget revenues, Bank of America estimates. For comparison, at an average Brent oil price of over $60/barrel in 2019, oil and gas revenues satisfied 40 percent of the Russian budget and roughly 30 percent of GDP. Current official projections put average Ural prices at $35/barrel in 2021 and $42/barrel in 2022, but as consecutive waves of outbreaks stall efforts to reopen around the global world and experts fear an autumn rebound in infections, a pessimistic scenario would see oil prices drop to below $30/bbl for a period of two years or more. This will force the Russian government to spend its $156 billion NWF quickly to fill in deficits.

How long will $156 billion last? At the current deficit level of 4-5 percent of GDP in 2020, the NWF won’t last long. Deutsche Bank estimates two years under a pessimistic scenario of $15/barrel while other economists estimate three years. Pandemic-related closures to the economy will significantly lower non-oil and gas revenues, including from value-added tax (VAT), income tax, and customs duties. Combined with low oil prices, the Russian government may be forced to burn through its National Welfare Fund (and potentially go into debt) or face a set of politically risky alternatives.

When in revenue need, tax the people. In order to maintain spending plans, the Kremlin could attempt to cover some of the budget gap by shifting a greater share of the tax burden onto its citizens—just as Russians are becoming poorer as a result of Covid-19. Real incomes, already down by 7 percent since 2014, are expected to drop an additional 5 percent this year, according to Alfa Bank estimates. In an April poll, 54 percent of respondents in Russia reported a loss of income due to Covid-19. Former finance minister Aleksei Kudrin anticipates a spike in unemployment to 10 percent. Meanwhile, two-thirds of Russians have no savings. The Kremlin will be cautious: its attempts to reform the antiquated Russian pension system by raising retirement ages fueled major protests in 2018; a general feeling of malaise and socioeconomic anxiety connected localized protests across Russia in 2019.

Reduce national investment plans. To avoid shifting the tax burden, the Kremlin could consolidate spending by cutting back on long-awaited investment in infrastructure, Putin’s signature “National Projects” and the centerpiece of his fourth term. This carries its own set of risks. For one, any delay or reduction in infrastructure spending would only elongate the length of the recession and further dampen future growth prospects. Moreover, Russia’s revamped government has staked its political legitimacy on the technocratic execution of a long-awaited economic growth package. A retreat from this mandate to a return to an era of low growth and austerity would undo Putin’s January efforts to refresh his leadership as a more modern and responsive version of itself.

Scant support for small businesses. For many businesses, the Covid-19 economic damage is already done. Although small and medium-sized enterprises (SMEs) employ roughly a quarter of Russia’s workforce and have been touted by Putin as an engine of entrepreneurship and diversification for the Russian economy, the crisis response package assembled by the Kremlin has done little to help these enterprises. Modest support has come in the form of minimum wage payments of about $160/month (not much to live on by Russian standards and well short of average wages of over $620/month). But only a portion of small businesses have qualified for the help, and the delayed availability of payments means many businesses have gone or are likely to go bankrupt in the meantime. The Russian Chamber of Commerce estimates that one in three small businesses will not last more than a quarter, while Natalia Orlova, the chief economist of Alfa Bank, estimates just 0.3 percent of GDP has gone to business in direct payments. This has become a political sticking point, with Russian opposition leader Alexei Navalny advocating for substantially increasing funds to SMEs. 

The oligarchs will grow stronger. The anticipated loss of the SME sector will further concentrate wealth in the hands of large, Kremlin-connected businesses that have long dominated the Russian economy, undoing whatever modest progress has been made since 2008 in creating a more dynamic and diverse economy just as the dangers of Russia’s vulnerability to oil price fluctuations are most apparent. This concentration heightens opportunities for graft despite President Putin’s admonishment to the government to spend resources more efficiently and to fight corruption. Diminished state funds may initiate high-profile elite conflicts or magnify those that began prior to the pandemic.

The politics of a weakening economy. Few doubt that Putin will get his way in a nationwide referendum now rumored to take place this summer (most likely by mail, in accordance with a new national law permitting remote and digital voting). But he will enter a new political era with a poor track record of delivering economic growth—Russian GDP growth hasn’t topped 3 percent since 2012—and, as reserves rapidly diminish, on more tremulous fiscal footing.

An even weaker economy will create a new set of political pressures for Putin. As the dust settles from the government’s uneven response to Covid-19, an already restive population will begin to ask hard questions. The economic devastation wrought upon SMEs alone—without an increase in taxes—could encourage a critical mass of a typically apolitical middle class into politics for the first time. The tenuous provision of social services, in particular a health care system that is under enormous strain beyond large urban centers, may also fuel protests. Already, signs abound of disapproval over Russia’s handling of the coronavirus epidemic. Underequipped doctors and nurses have been dying at alarming rates, and in some cases, have faced intimidation and even detention for challenging official figures on the virus’s spread within Russia. Frontline health workers are asking why cash bonuses promised to them by the state have yet to materialize. Many are quitting. On April 20, hundreds broke quarantine in Vladikavkaz to protest the fact that business restrictions seemingly did not apply to the beer factory owned by relatives of the regional governor. Corruption has botched the response in other ways, as reports emerge of regional officials trying to defer blame by revising down infection data. In other cities, Russians have taken to virtual protests to express their ire.

As protest sentiment mounts, the Russian government will have to navigate the competing mandates of refilling Russia’s wealth fund to prepare for the next crisis while it confronts greater demands for social spending from economically vulnerable populations. All the years of economic policy aimed at insulating Russia from external shocks have been unable to overcome the basic characteristics of Russia’s economy—heavily reliant on state investment for growth, and dependent on oil for revenue—which directly tie Russia’s economic fate to global economic recovery and growth beyond Russia’s borders. Ironically, Putin’s “Fortress Russia” is highly economically dependent on the rest of the world. His best chance to strengthen Russia lies in a more resilient and diversified economy. But what strengthens Russia weakens Putin’s hold on power, and as he rewrites the constitution to allow himself another term as president, we know his power will be what is preserved. 

Cyrus Newlin is an associate fellow with the Russia and Eurasia Program at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Heather A. Conley is senior vice president for Europe, Eurasia, and the Arctic and director of the Europe Program at CSIS.

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Heather A. Conley

Cyrus Newlin

Cyrus Newlin

Former Adjunct Fellow (Non-resident), Europe, Russia, and Eurasia Program