Russian President Vladimir Putin is often described as all tactics and no strategy, but take a step back and it becomes clear he has been preparing for the current showdown for at least 13 years. In that time he has turned Russia into a fiscal fortress, which is now finally ready. It allows him to face down the power of the US more or less with impunity and despite the fact that Russia is weaker than the US on almost every score except nuclear weapons.
But the point of the fiscal fortress is it is a defensive structure, not offensive. Much of the narrative surrounding the “Russia problem” assumes that Putin is actively trying to undermine Western democracies or rebuild the Soviet Union, when if you look at what he has actually done is assume that Russia will be attacked and he has tried, as far as is possible, to isolate Russia from that attack so that the country won’t be forced to do anything it doesn't want to.
Where Putin actually stands between these two poles is a matter of ongoing and never-ending debate. Russia’s efforts to build up massive currency reserves and at the same time reduce its external debt to nothing are clearly defence moves. Its annexation of Crimea, military presence in Donbas and the more recent “exercises” on the Ukrainian border are clearly offensive moves. But as bne IntelliNews and many other commentators were arguing, it was fairly clear that Russia never intended to invade Ukraine, but its plans for the Donbas are less clear.
Understanding what is actually going on has been made more difficult by the “threat inflators” that have a vested interest in exaggerating Russia’s bellicosity, as it brings in money from politically motivated actors in the story like arms manufacturers and local oligarchs as well buying influence in the corridors of power where US politicians, for example, have used the “enemy at the gate” narrative for domestic political ends.
The most recent, and one of the most notorious, examples was well-known Russian hawk, Swedish economist and a Senior Fellow at the Atlantic Council Anders Aslund, who tweeted this week that people in Ukraine were “panicking” due the threat of an imminent invasion. The comment brought down a storm of condemnation and scorn, especially from the locals, who said there was no panic whatsoever. Some concern about Russia’s troop movements, yes, but that was all. The Atlantic Council has been radically pro-Ukraine and, funded by the likes of NATO, the US Defense Department and several of Ukraine’s biggest oligarchs, has lobbied tirelessly for a much harder line against Russia. While few serious analysts expected an invasion, the Atlantic Council continues to beat the drums of war with article after article, and opeds and podcasts.
“The case for Russia as a threat is overhyped by hawks and threat inflators. Outside the nuclear realm, Russia's military might is a shadow of the USSR's. Although capable of generating impressive military power close to its border, Europe has an array of capable regional actors, such as Germany, who are capable of checking Moscow's strength. Russia simply lacks the wherewithal to upset Europe's balance of power, much less conquer the continent,” Joshua Shifrinson, Assistant Professor of International Relations at Boston University, wrote in an article in Newsweek this week.
Shifrinson’s claim to fame is he is the academic that published a paper describing the negotiations with Mikhail Gorbachev at the end of the Cold War that described the promises made by dozens of Western leaders, including German Chancellor Helmut Kohl and US Secretary of State James Baker, promising not to expand NATO eastward by “one inch.” The trouble was that all these were verbal promises; nothing was put on paper, and in retrospect Gorbachev looks naïve to have believed them.
The prickly post-Soviet Russia is a major headache for Europe, which is both dependent on Russia for energy and heavily invested in its enormous retail market. But it’s not an existential threat.
Strategist vs tactician
Putin is usually painted as a thug who has no interest in Russia’s future and is only in the game to enrich himself and his entourage. He follows current affairs and acts when he sees a weakness to very effectively undermine Western unity and play up the many divisions between the Allies, for want of a better word.
But this doesn't give Putin credit for the long-term planning that spans decades that clearly has gone into getting Russia ready for exactly the current showdown. That’s the advantage of holding office in an authoritarian regime: you assume you will be in office for decades so you plan decades in advance, whereas the longest time horizon for most Western politicians is 4-8 years. Putin has already been in office for over two decades and may remain there for another decade and a half.
As bne IntelliNews has argued elsewhere, the confrontation has its roots in the US decision to unilaterally withdraw from the ABM missile treaty in 2002. This was a major pillar of the Cold War security deals to keep a lid on a possible nuclear conflict with the Soviet Union. That was followed by a string of withdrawals from similar Cold War-era treaties, and the ongoing eastern expansion of NATO. More recently, the Western allies have deployed missiles in Romania and Poland as part of the missile shield against “rogue states” nominally North Korea and Iran, but in practice as the missiles were deployed along Russia’s western border, it was quiet clear who the West really considered rogue.
Putin responded to these trends with his now famous Munich Security Conference speech warning that Russia would respond in kind unless the West took account of Russia’s concerns and interests. Putin specifically brought up those broken promises described in Shifrinson’s paper during his speech in Germany.
The same year Putin began to actively prepare. The plan was twofold: modernise Russia’s army to the point where it could face down the NATO forces in Europe and, if not defeat the US, promise to do so much destruction in a fight that military solutions would be off the table; and secondly, construct a fiscal fortress to make Russia impervious to sanctions.
In the same year as the Munich speech the Central Bank of Russia (CBR) began a policy of actively buying gold and build up the share of gold in its reserves which it continued for over a decade and only stopped actively buying last year. A third of Russia’s $580bn cash pile is now gold.
The military modernisation really took off in 2012 and drained the budget of all its spare resources. When then Finance Minister Alexei Kudrin objected and tried to push through a budget that would continue the prosperity of the preceding decade he was sacked.
The modernisation programme has continued for eight years and was seen as more or less achieving its goal in 2018 when the Kremlin turned its attention back to boosting prosperity and dealing with the stagnant incomes that were starting to become a political problem. The man put in charge of drawing up those plans was Kudrin.
Meanwhile, work on building fortress Russia was well underway. One of the sanctions threats made in the last weeks is to expel Russia from the SWIFT money payment system in the hopes of crippling the country’s international financial operations. However, in anticipation of exactly this move the Kremlin built its alternative MIR payment system that mirrors SWIFT and has been actively signing up its BRIC allies to join the system. Work on creating MIR began about a decade ago.
At the same time, Putin as part of his “de-offshorisation” campaign banned government officials from having offshore accounts or owning assets, such as property, overseas. Russian companies have been “encouraged” to re-domicile their legal entities from favoured offshore havens like the Caymans, BVI, Cyprus and the Netherlands to “onshore havens” in Russia. International technology firms were told they have to store all their data on individuals in servers on Russian territory. And so on. Everywhere Russia has tried to bring all significant business back inside its territorial boundaries.
In parallel with the new financial infrastructure being created, the government started pouring money into industry to make Russia as autonomous as possible. What started as tit-for-tat sanctions on EU agricultural produce quickly turned into a state investment programme to produce as much food at home as possible. The Kremlin has poured money into agriculture to the point where it has now become self-sufficient in poultry, pork and will soon be so in beef. Grain production has soared and in 2018 Russia produced 135mn tonnes of grain – the biggest crop in the country’s entire history. Putin has turned the country from a net importer into the biggest exporter in the world, adding grain to gas as a tool of international diplomacy and further deepening Russia’s integration into the global economy.
Elsewhere, Russia’s leading corporates have also embedded themselves into the global economy as the US attempted in 2018 to impose sanctions on oligarch Oleg Deripaska’s Rusal showed: aluminium prices spiked by 40% on the London Metals Exchange (LME) when the US Treasury Department (USTD) tried to ban investors from working with Rusal but was forced into a humiliating climbdown within a few months. Those sanctions were quickly cancelled, the only sanctions on Russia to be removed so far.
The most obvious aspect of the build-up of Putin’s fiscal fortress has been the accumulation of hard currency reserves and the reduction of Russia’s exposure to dollar-denominated debt. Last year the Central Bank of Russia (CBR) began selling off its US T-bill holdings and the central bank passed its $500bn “comfort level” the same year.
At the same time, the funds in the National Welfare Fund (NWF) have been accumulating and now stand at some 11% of GDP. During the 2020 coronacrisis Russia’s budget went into deficit for the first time in years, but rather than tap the NWF, which is what it is there for, MinFin chose to issue more local debt instead to preserve its war chest, which is now seen more as a strategic, but defensive, weapon than as an economic resource.
As part of this de-dollarisation process Russia and China have switched from setting their mutual trade in dollars – the usual currency of international commerce – to local currencies. The share of rubles and yuan in Sino-Russian trade as risen from nothing in 2018 to a quarter now. Likewise, trade with Turkey, a major supplier of agricultural products to Russia, is also increasingly done in local currencies.
In addition to the gross international reserves (GIR) build up, the Ministry of Finance has built up its own reserves. The latest round of US sanctions imposed on April 15 target Russia’s domestic OFZ bonds for the first time, which are used by MinFin to fund the budget and it has been issuing some RUB3 trillion ($40bn) worth of these bonds a year. While the US has threatened to ban its investors from holding these bonds altogether, MinFin holds a reserves of RUB9.5 trillion of cash in various forms that it can tap in an emergency. MinFin could simply stop issuing OFZs tomorrow if it wants and issue no local bonds for three years before it started to run out of money.
These and other similar measures mean Putin’s fiscal fortress is formidable. It is so well stocked with cash supplies and MIR payments system weapons that it can in effect fend off almost all economic attacks on Russia. There is little left that the West can do to seriously hurt it.
Fiscal fortress is ready
After at least 13 years of work the Kremlin seems to think that its fiscal fortress is complete.
MinFin has basically been operating an austerity budget for at least a decade to be able to build up these financial resources, which is why, despite its towering mounting of cash, Russia’s economic growth and real incomes continue to under-perform.
Like the Eurasia of Georgia Orwell’s 1984, Russia has been on a perpetual war footing and the population has been asked to suffer the inconveniences for the sake of the country, which they have begrudgingly done so far in the battle with Oceania and East Asia.
The plan seems to have been to build up Russia’s resources to the point where it is impervious to international sanctions – and as bne IntelliNews reported, the lack of sanctions on secondary market trading and ownership of OFZs – suggest it has reached that point.
The plan going forward seems to be to preserve those resources at all costs, but to take the surplus and start spending it on restoring the prosperity the people enjoyed in the happier times of the boom in the noughties.
For example, the rules governing the NWF say that the first 7.5% of GDP in the fund cannot be touched, but the government can spend everything above that level, and it intends to do just that, directing most of that money into economic growth multiplying infrastructure investment.
With the fiscal fortress complete the game has changed. The break-even price of oil for the Russian budget is estimated to be about $42 but the market price of oil has been averaging over $60 all year. While the so-called budget rule means that excess oil revenues are still siphoned off into the NWF, instead of simply accumulating this extra money to build its fiscal fortress, the government is clearly now planning to start spending this surplus on fixing Russia Inc and start behaving like a normal country.
You could draw a parallel between Orwell’s famous novel and Putin’s State of the Nation speech this week: as the government of Eurasia would do periodically when announcing good news: “Victory on the Western front. The tobacco allowance has been increased by 10 grams a week!”