WPJ Winter 2003/04 – The Russian Roller Coaster by Ian Bremmer


ARTICLE: Volume XX, No 4, Winter 2003/04

The Russian Roller Coaster
Ian Bremmer*

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As 2003 ended, many Russia watchers shared an uneasy, we’ve-been-here-before feeling. Hard on the heels of the sudden arrest in late October of Mikhail Khodorkovsky— the country’s wealthiest businessman and the chairman of Yukos Oil, until he stepped down—came a flawed parliamentary election and an angry nationalist outcry over real or imagined American meddling in neighboring Georgia’s “velvet revolution.” Hence the credible worry that Russia is no longer safe for international investors and, more broadly, that xenophobic nationalism could poison hopes for an evolving democratic system based on the rule of law.

At the core of these concerns lies the still ambiguous figure of President Vladimir Putin. Is he persevering on the democratic path, as he claims, or, given his service as a KGB officer, is he returning Russia to its familiar autocratic fold? If the latter is the case, what will it mean for Russian relations with the West? Can Russia become a trusted ally and partner, or will it retreat into an ultimately self-defeating nationalism born of misdirected patriotism and the illusion of self-sufficiency bolstered by a wealth of raw materials and an undervalued currency?

My own view, notwithstanding these considerations and looking beyond the headlines generated by the Khodorkovsky affair, is that, for now at least, pessimism is premature. The aim of this essay is to recall the volatility of Western opinion about Russia, to weigh the pros and cons of Moscow’s relations with the oligarchs, and to outline the three key tests for judging Putin’s intentions.

Pessimism vs. Optimism
This is by no means the first time that the United States has had serious concerns about Russia. Indeed, ambivalence goes back to the height of the Cold War, when American public opinion was divided between those who wanted to engage the Soviet Union constructively and pursue détente, and those who believed that the USSR could never be anything but an “evil empire.”

This ambivalence persisted even after 1991, when the Soviet Union ceased to exist and the Russian Federation became an independent state. To some observers, Russia seemed on the verge of becoming one of the world’s largest free market democracies and thus a potential partner and ally. Others saw a Russia still mired in its pre-capitalist Soviet ways, a backward country that nonetheless retained the means to annihilate the world. With the benefit of hindsight, we can now judge that Russia was something of both. But at the time, a plausible case could have been made to justify either the highest hopes or the deepest fears of Western policy-makers. This roller-coaster approach has endured and characterizes the West’s “on again, off again” love affair with Russia.

The pessimists were in the ascendancy during the first years of the newborn Russian Federation, as the country verged on political, economic, and cultural chaos. The privatizations of the early 1990s were in truth a sham. With the tacit approval of President Boris Yeltsin’s government, Russia’s robber barons grabbed the nation’s patrimony, with the result that most Russians decided that if this was free market democracy, they wanted no part of it. In the aftermath of this “reallocation” of wealth to the new private sector, a tiny class of super rich, overwhelmingly corrupt individuals— the so-called oligarchs—stripped the assets of state-owned companies, leaving ordinary Russians considerably worse off than they had been under Soviet rule. The nation fragmented as central authority slackened, provincial leaders filled the power vacuum, and a bloody and inconclusive war in Chechnya drained valuable resources while demoralizing the armed forces. The possibility of a plunge into full-scale anarchy seemed a very real possibility at the time.

But by the latter half of the 1990s, it appeared that the optimists might have been right to keep the faith. By 1998, Russia indeed seemed to be on the road to democracy and free markets. Investor confidence was high. However, that August, with little warning, the inexperienced prime minister, Sergei Kiriyenko, devalued the ruble and announced that Russia would no longer meet its obligations to foreign bond-holders. A fresh Russian crisis materialized, and the ensuing mayhem pushed global financial markets to the brink of collapse.

The roller coaster plunged again toward pessimism. By the end of the Clinton administration, there was an animated foreign policy debate over “who lost Russia.” While the the pundits pointed the finger of blame at everyone from President Boris Yeltsin to Treasury Secretary Robert Rubin, from the bureaucrats at the International Monetary Fund to the Russian robber barons and Harvard University professor Jeffrey Sachs, one thing was clear: virtually everyone agreed with the premise that Russia had indeed been lost.

On reflection, that pessimism was premature. Russia’s by then chronically absentee President Yeltsin orchestrated a surprisingly smooth transition in 2000 to a relative unknown, Vladimir Putin, with as little bloodshed as the final Soviet handover of power to Yeltsin by Mikhail Gorbachev. Equally important, the economy rebounded impressively, due partly to the devaluation of the ruble and partly to high oil and other commodity prices. The war in Chechnya remained a major thorn in Putin’s side, but the president’s popularity soared on the strength of his hard line toward the Chechen rebels. Russia didn’t seem to be in such bad shape after all.

Putin vs. The Oligarchs
Investors gradually recovered their confidence and have returned to the markets. Putin, viewed as a steady hand on the tiller, was an important factor in persuading investors that Russia might again be worthy of their trust. Indeed, Russian bond and equity markets have proved to be among the world’s best performers over the past few years. Last October, the Moody’s rating agency acknowledged the turnaround by giving Russia an investment-grade rating— allowing it to attract a new class of portfolio investors. There was renewed talk of foreign direct investment in the country, as bankers once more filled business-class seats on flights to Moscow and financial institutions began hunting for office space. With his strong domestic hand, and a percolating economy bolstering his standing, Putin became one of the most popular elected leaders in the world, with approval ratings consistently over 70 percent.

What the investment bankers and investors who were lauding Putin’s strength as a leader failed to grasp, however, was that in consolidating power in a country with little history of anything other than autocracy, Putin would drag his feet when it came to political reform. For better or worse, democracy is on hold in Russia. In contrast to Mikhail Gorbachev, who embarked simultaneously on political and economic reforms and, by so doing, fatally weakened his capacity to punish and reward recalcitrants,.Putin appears determined to pursue economic growth through a host of landmark legislative acts—tax, judicial, and land reform among them—while holding tightly to the reins of government.

Many financial analysts and investors mistakenly believed that the absence of political reform was at the root of the crisis of 1998. But it was a lack of central authority— not the lack of democracy—that was the problem. When Putin was elected to the presidency, economic policy was effectively created and implemented by various provincial governors and businessmen— all a law unto themselves. Putin correctly understood that rebuilding central authority and consolidating the Russian state had to be his priorities. And that meant, above all, finding some workable accommodation with the oligarchs.

When Putin took office, he struck a Faustian bargain with the oligarchs who had deeply embedded themselves in the policy-making process in the final years of Yeltsin’s rule. According to an unwritten but clearly understood deal, the oligarchs would be permitted to keep their ill-gotten gains so long as they paid their taxes and forswore grand political ambitions. The latter was harder to police, but the more obvious strictures were that the oligarchs refrain from using their influence in the Duma, the lower house of the Russian parliament, or in the executive branch to make policy and from using the media they controlled to criticize the government.

Drawing by Curtiss Calleo

While the requirement that the oligarchs stay out of politics was clear enough, it was not rigorously policed. However, when two of the original oligarchs, Boris Berezovsky and Vladimir Gusinsky, used their television stations to broadcast criticism of the Kremlin, they found themselves under criminal prosecution in 2001 for money laundering and other charges. Both eventually fled the country, and their media holdings were stripped of their oppositionist character, effectively becoming cheerleaders for the Kremlin.

However, other channels of political influence remained open to the remaining oligarchs—a group of some dozen men who, among them, control roughly 70 percent of the Russian economy. Putin had retained Aleksandr Voloshin, Yeltsin’s capable and savvy chief of staff. It was Voloshin who pushed through Putin’s economic reforms and was the point man for dealing with the Bush administration. At the same time, he served as the intermediary within the Kremlin between Putin and “the Family,” holdovers from the Yeltsin era with close ties to the business elite. With Voloshin as Putin’s right-hand man, the oligarchs continued to have a voice in the corridors of power.

Moreover, the Duma had evolved from a rubber stamp for the Kremlin into a more independent legislative body. The oligarchs quickly adapted to the new situation, becoming sophisticated lobbyists and using their financial resources liberally and to marked effect. They exercised considerable influence, notably over tax legislation. Draft laws sent to the Duma by the Kremlin emerged at the end of the legislative process substantially amended, generally to the benefit of the oligarchs.

Putin may not have been happy with the oligarchs’ continuing influence over economic policy, but he was more concerned with political challenges to his rule. After Berezovsky and Gusinsky fled into exile, there was just one billionaire who, in the Kremlin’s view, continued to cross the line, refusing to observe the rules of the deal Putin believed he had made. This was Mikhail Khodorkovsky, the CEO of the oil giant, Yukos, and Russia’s wealthiest man, with an estimated net worth of $8 billion.

The Khodorkovsky Affair
Khodorkovsky was enthusiastically feted in the West for his eloquence and sophistication, and his willingness to play by Western rules. The then 30-something Yukos chief, with his trademark Spartan wardrobe, emerged as a notable leader among Russian executives in aspiring to and often achieving Western-style standards of management, accounting, and corporate governance. Khodorkovsky also spent considerable sums on public relations, charitable endeavors, and lobbying, both at home and in the United States. Even so, he remained unpopular in Russia, as the memory of how he had acquired his wealth—using his political connections to purchase some of Russia’s choicest oil assets at fire-sale prices— lingered in the public consciousness.

Early in Putin’s presidency, Khodorkovsky managed to cultivate cordial relations with Russia’s new president and was a frequent visitor to the Kremlin. Khodorkovsky even began to be mentioned as a potential future prime minister (although this story may have been confected by Khodorkovsky’s media machine). But over time, and particularly as the Russian political class began to focus on the December 2003 Duma elections, while other oligarchs worked quietly backstage to ensure that their interests would continue to be represented in the new Duma, Khodorkovsky changed tack. He began to provide generous funding—directly and indirectly—for most or all of the parties likely to feature in the next Duma, particularly the two more liberal reformist, pro-market parties, Yabloko and the Union of Right Forces.

Khodorkovsky’s political activities now exceeded normal business lobbying and, to many observers, it seemed obvious that he was trying to build a foundation of support in the Duma with an eye toward a future in politics. Meanwhile, rumors began to circulate that Khodorkovsky was positioning himself to run for president in 2008, when, under the term limits established by Russia’s constitution, Putin would have to leave office.

To Putin, this amounted to a clear challenge to his authority. Moreover, Khodorkovsky began to antagonize the president on a personal level, directly challenging his authority on a broad range of issues and even showing up at the Kremlin in casual attire for a meeting with the very formal Putin. Last July, the Kremlin loosed a clear warning shot by arresting his business partner, Platon Lebedev, on charges of fraud and tax evasion. Khodorkovsky himself was brought in for questioning. Perhaps persuaded that his position as CEO of Yukos and the strong international support he enjoyed offered him special protection, Khodorkovsky, instead of heeding that not-so-subtle hint, stepped up his political activities. Putin appears to have spent little time agonizing over an appropriate response. He evidently felt he needed to make an example of Khodorkovsky to reassert his authority, and on October 25, armed agents intercepted the Yukos chief at a Siberian airport and brought him back to Moscow in handcuffs.

Putin knew that Khodorkovsky’s arrest on fraud, tax-evasion, and other charges, and its aftermath—the freezing of Khodorkovsky’s equity stake in Yukos and the subsequent resignation of Chief of Staff Voloshin— would shake international confidence and threaten Russia’s two-year-long stock market boom. The Kremlin therefore immediately sought to limit the damage. Publicly and privately in his meetings with foreign and Russian bankers, Putin emphasized that the arrest was about the actions of one individual and not the start of a crusade against Russia’s business interests.

In the wake of Voloshin’s departure, many expected that the shadowy siloviki faction within the Kremlin—officials with backgrounds in law enforcement or in the KGB—would have the upper hand. Instead, Putin promoted two liberal-minded technocrats from St. Petersburg, Dmitri Med-vedev and Dmitri Kozak, to the top two positions on his staff, a clear signal to Russia’s oligarchs, and to the West, that they could expect business to go on as usual. Medvedev wasted no time in acting on his mandate to calm the tense political situation, immediately issuing a statement criticizing the general prosecutor’s office for being overzealous in its campaign against Khodorkovsky.

Thus far, Putin’s efforts to restore investor confidence in the markets have met with only limited success. His assertion that the action against Khodorkovsky will not spill over into a broader campaign against private business has been largely accepted. But the incident has increased worries that the Russian reform process will turn sour. Not surprisingly, the Russian equity market, where Yukos Oil plays a major role, drifted into the doldrums in December, trading in a range of 15–20 percent below its peak prior to Khodorkovsky’s arrest.

Within a week of his arrest, Khodorkovsky resigned as the CEO of Yukos, although he remains its main shareholder. He had already been planning for the succession at Yukos by appointing Simon Kukes chairman of the board. Kukes, Russian-born and a chemist by training, had become an American citizen after emigrating from Russia in the late 1970s. His résumé includes stints at Phillips Petroleum and Amoco as well as the Russian Tyumen Oil Company, or TNK, where he served as president from 1998 to 2003. At TNK, Kukes transformed an initially antagonistic relationship with British Petroleum into a landmark joint venture agreement announced in February 2003 that created Russia’s first Western-Russian partnership, TNK-BP. Stepping aside from TNK after the merger, Kukes was approached by Khodorkovsky to join the Yukos board as his heir apparent. The leadership handoff came earlier than either expected.

With Kukes now at the helm of Yukos, the company may resume business as usual in early 2004. But in the short run, with Khodorkovsky’s 39.5 percent of Yukos shares frozen by the government and the case against him still unresolved, any major equity deals with foreign companies (including ongoing discussions with Chevron-Texaco and ExxonMobil) are out of the question; even the merger with Sibneft, a nearly completed deal that would have created the world’s fourth largest oil company, looks all but dead at the time of this writing.

With the uncertainty surrounding Khodorkovsky and Yukos front-page news, it is important to weigh fundamentals. And, in fact, not that much has changed. Russia remains the world’s largest energy producer. Its economy is sound and its currency reserves are still growing. The all-important U.S.-Russia relationship—based on common interests with respect to security and counterterrorism—is strong. Russia’s relations with the European Union and most of its neighbors are also good. Even in the neighboring Caucasus and Central Asia, where recent and pending leadership transitions raise fears that Moscow will stir up discontent to maintain a firm grip, the Kremlin’s response has been one of restraint. All things considered, Russia still looks considerably more stable than worried international investors and volatile stock market prices would have us believe.

Putin and the Challenges Russia Faces
For the time being, President Putin is well positioned to contain the damaging fallout from the Khodorkovsky affair. Yet, as one hears in Moscow, there are other, more problematic, issues that could undermine Russian stability.

The first is the war in Chechnya. Beginning in 1994, Russia’s military efforts to prevent the breakaway province from establishing its sovereignty have been a brutal and bloody affair. Tens of thousands of civilian casualties have resulted, and the war has generated significant terrorist activity in the North Caucasus, and throughout Russia. There are no prospects of meaningful negotiations between Moscow and Chechen representatives.

Chechen alienation from the Russian government is near complete, and the rebels’ capacity to disrupt the Russian state is increasing. Chechen militants are responsible for the only known incident of radiological terror against a civilian population, having buried high-isotope cesium in Moscow’s Ismailovsky Park in November 1995, with the intention of displaying to the Russian government the type of attack it should prepare for if their demands were not met. Russia has the world’s largest concentration of unaccounted for radiological materials in its stockpiles, which could be put to use in explosive devices, and the Chechen resistance is becoming more and more technologically sophisticated. A successful “dirty bomb” attack in a major Russian city is an increasingly credible threat, and while this might not lead to significant casualties, the psychological and economic consequences would be immediate and devastating.

Moscow needs to address the Chechen issue, and a meaningful start could be made by instigating a widespread purge of Russian security forces in Chechnya to mitigate the worst human rights offenses being perpetrated there. While it is impossible to imagine any near-term negotiation that would satisfy both sides, efforts to build trust through improving the security and livelihood of Chechens would be a stabilizing first step. Beyond that, Moscow could benefit from coordinating its efforts more closely with the international community. Russia’s willingness to cooperate with the United States in tracking down terrorists in Georgia’s Pankisi Gorge is a welcome move, but it reflects only cooperation on the ground and falls far short of a meaningful solution to the problem.

The second issue is the brewing antagonism between China and Russia over influence in Siberia. Russia maintains complete political control over the resource-rich, India-sized expanse of its Far East and Siberia, but the economic balance is increasingly, and rapidly, tilting toward China. Indeed, local Russian leaders estimate that ethnic Chinese control nearly half of the Siberian economy. The demographic trends are striking: there are roughly 18 million Russians in Siberia, compared to over a quarter billion Chinese just across the border in China’s northern provinces. And the internal balance is shifting, with Russians leaving the already sparsely populated region and (the largely illegal) Chinese migrants arriving in droves. The potential for interethnic violence is thus sure to grow. Local Russo-Chinese relations are increasingly dominating Siberia’s elections and are likely to evolve into an issue that must be addressed directly by the Kremlin.

Not only is China exerting increasing economic influence over Siberia, the strongest demand for Russian energy comes from China. The potential exists for a synergistic and mutually beneficial relationship between Russia and China, based on the energy resources of eastern Siberia. From Russia’s point of view, this is a region with massive hydrocarbon potential, but one that is remote from potential markets. For China, importing hydrocarbons from eastern Siberia would have a clear strategic benefit, as they would be delivered via overland pipelines. This would reduce China’s dependence on seaborne imports, which the Chinese military considers insecure. But there is a conflict brewing over Siberia—this being demonstrated by the way the Kremlin has danced around approval for a pipeline deal that would transport oil from Angarsk in eastern Siberia to refineries in the Chinese city of Daqing. Moscow is concerned about placing the future of Siberian energy exports in the hands of a single country. Instead, the government is considering a much longer pipeline, technically more difficult and more than twice as expensive to build, to the eastern port of Nakhodka, which would allow Russia to export to the global markets.

Putin must be willing to tackle the simmering conflict over Siberia head on with the Chinese government. He must also be ready to address these issues constructively, and at the highest levels, with local Russian leaders, rather than allowing them to take matters into their own hands, which will inexorably lead to deep political conflict.

Finally, the third, and potentially most destabilizing, issue facing Putin is democratic reform. What happens when Putin has consolidated power and carried out the many components of his economic reform package—when the controversial dislocations from energy reform are at an end and WTO accession is fully at hand? Will he then be willing to start spending some of his political capital in order to create a truly representative political system with legitimacy invested in durable democratic institutions rather than in the person of the president?

This is undoubtedly the key question. The important Russian presidential elections will not be those held this coming March, the results of which are a foregone conclusion, but those scheduled for 2008. According to the Russian constitution, Putin is not permitted to run for a third term. He has repeatedly and publicly said that he has no intention of standing for election a third time. But in 2008, the Russian president will be only 56 years old, a virtual sapling compared to his predecessor, Boris Yeltsin. Members of Putin’s cabinet will no doubt be clamoring for him to stay on for reasons of self-interest. Large segments of the public may also wish him to do so.

Were Putin to subvert the constitution in an attempt to stay in power past 2008, it would be a disaster for Russia’s democratic hopes. If Russia can maintain its economic growth for the next five years, and if President Putin has ended the threats to central state control from Russia’s oligarchs and local leaders, there will be no reason for him to deny Russians the ability to make their own political and economic choices. At some point in a country’s development, democracy and prosperity become mutually reinforcing and the absence of democracy becomes an obstacle to economic growth and popular well-being. Whether Putin will be able to act the democrat after close to a decade as a near autocrat remains an open question.

The Khodorkovsky affair has once again led many Western analysts and policymakers to adopt a pessimistic view of Russia. But if we have learned anything in the last decade, it is that this pessimism could dissipate surprisingly quickly. When it comes to Russia, the roller coaster of opinion has everything to do with perceptions of the moment and very little to do with underlying reality.

Much depends on Vladimir Putin. So far, he has handled his job well, or at least well enough. His commitment to economic reform has by and large been exemplary, and his commitment to political consolidation and reasserting central authority has not— yet—assumed a dictatorial form. The Khodorkovsky affair is worrisome, but on balance, it still looks to be the exception to the rule.

Putin has four more years to show Russia and the world who he really is. He will face serious challenges—in Chechnya and in China—and the Russian economy will be hard-pressed to sustain the dramatic growth of recent years. But ultimately, the greatest threat to Putin’s legacy remains Putin himself. If, in 2008, he does indeed step down, Russia and the world will breathe a sigh of relief and thank him for his leadership. If he does not, all his positive achievements may amount to little more than a prelude to authoritarian rule and decline.

—December 26, 2003

*Ian Bremmer is president of Eurasia Group, a senior fellow at the World Policy Institute, and a columnist for the Financial Times.

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