• STRATFOR ANALYSIS

    Russia can no longer afford to buy allies

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    AS it curbs spending, the Kremlin plans to limit loans to foreign countries, hindering its ability to influence countries to support its agendas.

    Russia will continue granting small loans, or large loans in small tranches over a period of time, to its critical allies.

    Moscow will be more selective in choosing recipients of large, lump-sum loans, targeting recipients based on strategic need.

    Analysis
    Russia’s limited financial resources continue to hurt the Kremlin’s ability to operate as it has over the past decade. High oil prices, and resulting energy revenues, were largely responsible for skyrocketing economic growth since Russian President Vladimir Putin’s government took over in 2000 — with the exception of the 2008-2009 global financial crisis. Prosperity enabled Moscow to spend liberally on its military, its economic development and, more subtly, its loans to countries in exchange for influence. But oil prices have fallen, domestic industry has slowed and the West has placed sanctions on the country that have soured investor sentiment, together creating an economic crisis for Russia. The Kremlin must now make painful decisions to keep its economy afloat, and everything is open to cuts, including foreign loans.

    Last year, Russia slipped into its second recession in six years, and there is little optimism that it will end anytime soon. The Russian federal budget will certainly remain strapped this year, as the government uses its National Reserve Fund to cover any deficit more than 3.5 percent. To avoid bailing out large Russian firms and banks, the Kremlin is considering a privatization scheme, but it will likely have little success under the current investor sentiment toward Russia because of its position on Ukraine. Meanwhile, the government has slashed spending in 2016 for every ministry and portfolio except pensions, forcing all sectors to be selective in how to spend their resources. For example, defense spending cuts have left enough funds for Russia’s operations in Ukraine and Syria but not for the large-scale military rearmament program Russia needs to maintain a robust and modern military. The Kremlin hinted that it might cut the budget further in the weeks ahead.

    Of course, Russia still has reserve funds. Currently, the central bank holds $371.5 billion in currency reserves. The rainy day funds, which overlay with the currency reserves, stand at $49.72 billion in the Reserve Fund and $71.15 billion in the Wealth Fund. But the Kremlin has already blown through half the Reserve Fund in the past year, and in the last recession it saw how quickly currency reserves were spent.

    Now the Kremlin is looking at another opportunity for belt-tightening: foreign loans. Over the past decade, it has used foreign loans from government coffers to press its agenda with and in other countries. These are loans directly from the government’s VTB bank, though there are many loans from Russian companies (such as Rosoboronexport, Gazprom and Rosneft) along the same lines. In recent years, these loans were many times not investments at all but incentives to induce the countries to make foreign policy decisions in line with Russia’s needs. In addition, the Kremlin often either wrote off the loans, or the terms of the agreement were skewed to become more like a bailout than a loan.

    Past financing
    A primary example of this exchange of finances for influence was in Ukraine. In December 2013, Russia offered to purchase $15 billion of Ukraine’s debt and give the country a 33 percent discount in natural gas prices. Kiev simultaneously froze negotiations with the European Union over its association agreement. Russia went through with a $3 billion purchase of that debt, though protests soon broke out in Ukraine, leading to the Euromaidan uprising and the collapse of the pro-Russia government. Now, Moscow and a pro-West Kiev are locked in a bitter legal battle over repayment of the $3 billion debt purchase, which Moscow would have likely ignored with the previous government. Kiev argues that the debt purchase was an outright bribe to the previous government to remain in Moscow’s camp.

    Russia regularly assists its closest allies in the former Soviet region with loans and postponements of repayments. In 2014, Russia granted Belarus a $2 billion loan to keep Minsk close as NATO increased its operations in the region. And in 2015, Russia aided Belarus with its debt repayments ($860 million) as the country weathered its own economic slump. Armenia, Kyrgyzstan and Kazakhstan continually receive smaller financial aid packages (in the hundreds of millions of dollars) to stimulate their economies, modernize their militaries and overhaul industry. Kyrgyzstan received a loan of $1 billion in May 2014 in return for joining Russia’s then-Customs Union.

    Outside of the former Soviet states, Russia offered loans in 2013-2014 to Bulgarian, Greek and Serbian energy and construction firms in exchange for their governments agreeing to Russia’s then-proposed South Stream and TurkStream pipeline projects meant to bypass Ukraine to transit natural gas. When both Cyprus and Greece were in search of financial bailouts in recent years, Moscow offered to provide funds. Russia wanted to protect Russian money being held in Cypriot banks and to persuade Greece to break rank with the Europeans and Americans on sanctions over Ukraine. But Germany and other EU countries convinced them otherwise, preventing Russia from doing more than restructuring Cyprus’ past loans and giving Greece minor financial assurances through the BRICS bank.

    Current problems
    But Russia’s increasingly restricted cash supply will curb its previous strategy of throwing money at countries to compel their cooperation. Since mid-2015, Russia slowed doling out smaller loans to foreign countries and has pledged only a few large loans.

    Kyrgyz President Almazbek Atambayev announced that Russia would likely not provide the remaining $1.7 billion loan for its Kambarata hydroelectric plant. Atambayev nullified the 2012 agreement with Russia on Jan. 22 on the grounds that Russia had disbursed only a $300 million tranche of the loan. Nearby Uzbekistan also opposed the project because it would reduce the country’s water supply. Since Kyrgyzstan already depends on Russia financially, Moscow will accept the collapse of this agreement. What Moscow will have to watch for is another country — such as China, which is steadily building clout in the region — trying to fill the financial vacuum it leaves.

    The Kremlin is also reconsidering its loan to Iran. In November, Moscow and Tehran agreed to a $5 billion loan and a $2.2 billion line of credit. Though the Iranian government confirmed the agreement, Russian Deputy Finance Minister Sergei Storchak indicated in January that the $5 billion loan was not yet finalized. The deal was seen as Russia’s attempt to maintain influence with Iran as Tehran begins to open to the West. Previously, Iran had few options for alternative funding, but as Iran and Europe (and eventually the United States) begin to interact once again, Moscow’s waning financial influence will diminish even more.

    Furthermore, in November 2015, Russia agreed to loan Egypt $25 billion to construct the country’s Dabaa nuclear power plant, covering 85 percent of the building costs. Russia set the terms for Egypt to begin repaying the loan in 2029 and spread the payments over the subsequent 22 years — a favor to financially strapped Cairo. It was taken as a signal Egypt was trying to diversify its relationships with the United States, all while Russia increased its footprint in the Middle East after entering the Syria conflict. The large price tag and upfront costs will burden the Russian government if it fulfills the agreement, though Cairo may become a crucial partner as Moscow tries to play various regional actors and Washington for its own gain.

    Finally, Russia looks intent to fulfill a large loan with Hungary. Hungarian Prime Minister Viktor Orban visited Moscow on Feb. 17, where Putin confirmed that his country would fulfill their previous agreement for a $10.8 billion loan for the expansion of Hungary’s Soviet-era Paks nuclear plant. The agreement had stalled for two years, but Russia’s continued commitment looks to be used to persuade Hungary to help Russia build a coalition to end crippling sanctions. Orban said at the news conference with Putin that he did not believe EU sanctions against Russia would automatically renew after they expire in July and that EU countries were beginning to see the need for cooperation. Russia would likely trade the large sum of money for Paks if Hungary would vote against extending sanctions. A statement from General Electric proposing its involvement in the Paks project should Russia step out is probably motivating Moscow to act quickly as well as block further U.S. influence in the region.

    One way to help mitigate the financial costs of these large loans could be to give them out in smaller and longer-term tranches instead of lump sums. Russia implied as much with Iran, offering the $2.2 billion credit over two years, while reconsidering the lump $5 billion loan. Russia will continue its policy of smaller loans to its key allies, such as the $200 million loan agreed to with Armenia on Feb. 19. It is unclear if the Kremlin’s tradition of writing off many of these loans in gestures of goodwill can continue, but the Kremlin can always restructure the debts of the loans already issued instead of writing off the debts completely.

    If Russia neglects these allied states it risks a detrimental breakdown in relations or another country replacing its influence. However, its years of wild spending have forced the Kremlin to pick and choose the countries it assists and how much the Kremlin can spend without breaking its finances.

    © 2016 STRATFOR GLOBAL INTELLIGENCE

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