Ahead of the climax of a high-stakes political cycle, this report provides a fresh assessment of fundamental political risk in Russia. We review the record of the Putin-Medvedev tandem since 2008 in both the policy and political arenas in order to draw conclusions on the implications of one or another decision by Vladimir Putin about what happens next. And we offer our prediction of the outcome.
Russia’s current political cycle tells a fascinating human story since its outcome – which will become clear in the remaining months of this year – hinges on Vladimir Putin’s decision about his own future. But it does not automatically follow that the outcome matters much for investment risks and asset prices. Indeed, it could be viewed as a non-event on the grounds that, regardless of whether Putin chooses to return to the presidency, he will remain the dominant political force and there will be no material changes to the established policy agenda.
We take a different view, as will become clear below. But even if, for the sake of argument, that “no change-no significance” view of the present political cycle were correct, now would in any case be the time for investors to reassess fundamental political risk in Russia. This is because the choices and behaviour of the political leadership, the elite and the voters during the forthcoming election season – the parliamentary and presidential elections are scheduled for 4 December and 4 March, respectively – will produce a rich seam of evidence on the state of the country risk.
We base our political risk assessment on the answers to the following two questions:
In our view, the Putin-Medvedev partnership or “tandem” that has ruled Russia for the last four years may be reckoned a productively stable order. It has anchored the gains of the previous decade – legitimacy, based on a strong central state and improving living standards – while allowing scope for movement and change on several fronts, without which it would be impossible to sustain those gains, let alone build on them. This balance has been facilitated by a natural division of labour between the two leaders: while Putin has provided the anchor, his junior partner, Dmitry Medvedev, has used the formal powers and authority of the presidency to spearhead important fresh policy initiatives. Most such policies require bureaucratic processing, and Putin’s unrivalled authority has been easily channelled for this very purpose from his position as prime minister.
Putin’s “anchor” role has taken the form of paternalism. This was especially visible during the financial crisis and the ensuing deep recession of 2008-09. Putin deployed the financial resources that the state had prudently accumulated during the preceding boom years in such a way as to ensure that everyone felt looked after. The owners of all major industries – whether 1990s-vintage oligarchs or the Putin-era cohort of leadings businessmen and SOE chiefs – kept their property and/or their jobs thanks to a combination of direct bailouts from state coffers and loan refinancings from the recapitalized state banks. Much of this effort was oriented towards employment protection and hence social stability; but a range of transfers through the fiscal accounts also reached the wider public directly – above all, in the form of a roughly 50 per cent increase in basic pension entitlements implemented in late 2009 and early 2010.
Medvedev, meanwhile, seized on the fact that Russia had been so hard hit by the global crisis (no other major oil-producing country experienced anything like the 8 per cent contraction in Russian GDP in 2009) to launch a major new reform drive. His baseline manifesto published in September 2009 – “Forward, Russia!” – denounced complacency about the sustainability of Russia’s development, painted a withering picture of the country’s problems, which would have done any opposition politician proud, and repackaged and refreshed the pre-existing structural reform agenda under the slogan of “modernization”.
In policy terms, Medvedev’s presidency has been vigorous. The main focus has been on improving the business climate, hence raising the investment rate and realizing the productivity gains on which sustainable growth depends: many measures have been designed to counter and deter the predations of corrupt bureaucrats and law enforcement agents on business. In recent months, Medvedev has announced a string of further initiatives on this investment climate agenda. The underlying theme of what is clearly meant to be the core of Medvedev’s second-term programme – even if the proprieties of tandem politics have so far prevented him from presenting it explicitly as such – is reducing the state’s role in the economy. Indeed, the flagship policy is a newly radicalized privatization plan (see below).
The tandem’s policy initiatives have deeper implications than meets the eye
None of this is to say that any of the tandem’s policies have been optimal in principle or adequate in their practical effects. The flaws in both leaders’ records are all too apparent. Many commentators point, in particular, to the lack of evidence that Medvedev’s campaign against corruption has worked and pounce on the many indicators suggesting that the problem of corruption has, in fact, only worsened under his watch. But in our view, this negative evidence only reflects the seriousness of the anti-corruption drive (an argument set out fully in our May 2011 note, Russian corruption revisited). Moreover, any such criticism should be scrutinized from a counter-factual perspective – that is, the possibility that without Medvedev’s initiatives the corruption epidemic might have been even worse.
As for the Putin stability agenda, it could be argued that his actions have been destabilizing. The destabilization in question is fiscal. It results from Putin’s two main policy decisions since 2008, both of which entail large-scale and long-term increases in discretionary spending: the above-mentioned pension hike and the Rb20 trillion (US$680 billion) programme to re-equip the armed forces over the next 10 years (supplemented this year by a new commitment to double military pay, which has led to the projected break-even oil price for the federal budget during the next three-year planning period [2012-14] rising well above US$120/bbl). That said, there can be no doubt about Putin’s conscious and determined pursuit of a strategic national agenda. His basic position is that Russia cannot otherwise be a serious, self-respecting, confident, reliable and stable country and that since such higher spending is feasible (not least because public debt is at present so low), it will be carried out.
The rights and wrongs of these policy issues are not decisive for assessing political risk. Our point here is that a combination of stability and dynamism is essential for reducing overall country risk and that the Putin-Medvedev tandem not only provides this combination but also – thanks to the division of labour inherent in the dual leadership structure – does so in a more sustainable way than arguably could be expected from a sole leader. Any change in the structure and personnel of Russia’s top leadership that emerges in the next few months should be judged on this “dynamic stability” criterion and compared with the 2008-11 tandem. And while a superior version of the “dynamic stability” offered by the current tandem is possible and, of course, desirable, it is not hard to imagine a much less satisfactory political configuration.
Turning from the policy framework to the development of the political system itself in the 2008-11 tandem years, the balance of stabilizing and dynamic elements becomes ever clearer. Power and legitimacy in Russia stem from a “big tent” form of political organization, familiar enough in many countries in recent world history undergoing decades-long reconstruction after some kind of defeat or collapse. In other words, the elite and a solid plurality of the people support a programme of national recovery; and in Russia’s case, that support grew as the country moved from the deep dislocations of the 1990s to a period under Putin’s leadership of much greater stability, rising real incomes and growing self-respect. In the eyes of a still large section of the public, Putin’s power gives confidence that the country will not go off the rails. Indeed, Putin himself occasionally refers to Alexander Solzhenitsyn’s saying that the ruler’s central task is to keep the people safe.
The respective political roles of Putin and Medvedev mirror their division of labour in the policy sphere. Putin – as just described – ensures the bedrock of public support on which legitimacy and stability depend. For his part, Medvedev supplies the more dynamic element by representing the ruling establishment in a more attractive light to the minority of well-educated and mainly younger people who are indispensable for Russia’s successful development. Quite simply, Russia has to compete not only for capital but, above all, for human resources by appearing to its entrepreneurs and innovators as an attractive place to live and work (as opposed to a sink of corruption). The challenge is to stem the emigration of these key wealth creators and to persuade some of the diaspora to return, if only for limited periods (Medvedev made such an attempt during his June 2010 trip to California to promote his flagship project of creating a new Russian IT and technology hub in Skolkovo). To summarize this aspect of the tandem’s dynamic stability formula, Putin shores up the rear while Medvedev is in the vanguard.
As regards the political, bureaucratic and business elite, this same division of labour functions in a still more obvious way. Putin and Medvedev in tandem appeal to broader constituencies within the elite than either could on his own. By making the “big tent” more inclusive, the structure becomes that much more viable. All important policy discussions take place within the “big tent” (while the division of rents and spoils is negotiated in the tent’s dark corners, away from the public gaze).
Case history: The new privatization programme
The mechanism has been on revealing display amid the recent and important revision of the government’s privatization programme. In June 2011 Medvedev proposed that the existing plan to limit privatization of major SOEs to the divestment of minority stakes be revised so that government shareholdings in all companies except those involved in national defence and infrastructure monopolies are sold down to below 50 per cent and, in some cases, to zero. That proposal will not have been to the taste of the managers of state-controlled resource and industrial companies, who operate under the patronage of top government officials from Putin’s closest entourage (Deputy Prime Ministers Igor Sechin and Sergey Ivanov). The outcome that emerged in early August is that Medvedev’s injection of dynamism has had an effect but a balance has been struck in the following two ways:
In political party terms, the “big tent” operates through the United Russia (UR) party, which is led by Putin. Protest sentiment is absorbed and channelled in two “safety-valve” parties, the Communists and Vladimir Zhirinovsky’s “Liberal Democrats”; the former appeals mainly to lower-income groups among the nostalgic older generation and the latter to such groups among the less-educated middle-aged and young. Far from being outlandish, this state of affairs recalls the experience of several stable and rich countries of Western Europe in the post-war decades of reconstruction and recovery. Many of these countries – Germany, France and Italy, for example – were governed for two to four decades from the centre right in the Continental European Christian Democratic “social market” tradition, in which Putin’s own programme, hence the positioning of UR, could plausibly be located once Russia-specific factors are stripped away. But when the moment came for the alternation of power (in Germany in 1969, in France in 1981 and, more messily, in Italy from the mid-1980s to the early 1990s), it was achieved without any systemic destabilization.
Such analogies are often most revealing at the point where they break down or appear in danger of breaking down. It is precisely the challenge of achieving a stable shift of power to a genuine opposition force that constitutes the main long-term political risk factor inherent in Russian-style “big tent” politics.
The big problem of the ‘big tent’
The level of popular support for UR is declining. In the last national election round, which took place before the global financial crash in late 2007 and early 2008 and which now, with hindsight, seems to have been the high tide of Putinism, UR’s genuine vote share (that is, without any artificial pumping or other abuse) was well above 50 per cent. Since the crisis, the elections to regional legislatures that take place every spring and autumn indicate that this share has declined to not much above 40 per cent. “Indicate” is the right word since in many regions UR’s decline has clearly been masked by official results showing the party doing much better. Probably the single worst case of vote rigging occurred in the election of the Moscow City Duma in October 2009, when UR officially won 66 per cent of the vote, while exit polls suggested that its real vote share was closer to 40 per cent.
While that scandal reflected the death agony of the Luzhkov regime in Moscow, it also highlighted a wider problem. In response to declining popular support and hence legitimacy, the ruling establishment responds by electoral manipulations, which further undermine its legitimacy. Unless a way out of this vicious circle is found, some form of destabilization will be inevitable.
The risk is not a live one in the present political cycle. Public disenchantment – clearly evident from the quite sharp drop in the approval ratings of Putin and Medvedev (see Chart 1 below) – is coming off such a high base that the present leadership (and surrounding “big tent”) could continue in power for at least another cycle without having to resort to repression or the falsification of election results.
Although it may not be immediate, this political risk factor is serious because it is endogenous – that is, it springs from the structure and working of the political system itself. Put another way, the risk would not be eliminated even in an ideal situation where the leadership’s policies succeeded in delivering steady growth untroubled by external shocks. For expectations are always prone to rise even faster than living standards. This can be seen from the public mood as measured in an excellent long-standing survey by the Levada polling organization in which respondents are asked whether the country is heading in the right or wrong direction. In the period 2008-10 the public mood swings predictably down and up through the recession and ensuing recovery. But in 2011 – and this is the revealing point – continued recovery has been accompanied by renewed public disenchantment (see Chart 2 below).
Managing this risk of destabilization as the legitimacy of the ruling establishment is eroded therefore depends on adapting the existing “big tent” model. To return to the starting point of this whole analysis, true stability will always have a dynamic rather than a stagnant bias. The different approaches of Putin and Medvedev to this problem present a very instructive contrast.
Putin’s response – to adapt the ‘big tent’ model – spells chronic political risk
At the regular semi-annual regional elections in March 2011, UR retained control, as usual, of all (11) legislatures that were up for grabs; but its vote share continued the declining trend. Putin commented publicly on the result with his usual incisive frankness. He remarked that although UR (i.e., the ruling establishment) retained broad support, people were getting tired of it: despite the economic recovery, life remained tough and, for many, hope was dwindling. More than once, he indicated that UR itself was part of the problem. The popular anti-corruption blogger Alexey Navalny caused a stir when he described UR as the “party of swindlers and thieves”. Since then Putin has responded with the two big political initiatives of this electoral season.
The first is the creation of a broader movement, the Popular Front, designed to mobilize the much wider support that exists in society for Putin personally relative to the number of people who would be certain to vote for UR. At the time of writing, UR is running a series of regional “primaries” to test the popularity of candidates for inclusion in the real-life UR party list that will appear on ballot papers in the 4 December election of the State Duma. The new Popular Front has had the right to nominate such candidates; and, though strictly controlled, this amounts to a measure of intra-party democracy and competition. Putin’s second initiative is designed to encourage people with drive and talent from all over the country to get on in life. The newly established “Strategic Initiatives Agency” is an implicit acknowledgement of the widespread feeling that upward mobility is blocked by the dead hand of the bureaucracy, which, even as it extorts, monopolizes the best life chances for its kin and cronies.
During a Q&A session with workers at the main factory of the MMK steel group in the Southern Urals in mid-July, Putin replied to a question about the new Popular Front with a revealing account of his political strategy:
"Political stability is essential. No one is going to come and invest in a country that is always shaking like a leaf. Stability is not the same thing as stagnation. While promoting innovation in the economy and democratization in society, we must always ensure a reliable base. Hence the importance of United Russia, for all the frequent and justified criticism of the party. But I am sure that UR colleagues will not take offence when I say that a person who stays in the same position for several years comes to take everything for granted. Quite a few of our [UR] colleagues have begun to grow stale: they need to feel some competitive pressure."
Two important incidental points leap out from this. Putin repeats the very same disparaging language about UR that Medvedev first used in November 2010 in what was reckoned at that time to be an oblique criticism of Putin. And Putin’s criticism of entrenched and complacent party bosses echoes the main argument that Medvedev has been making in his discreet campaign for a second term – namely, that over-dependence on a single individual (i.e., Putin) will make the system less stable. But the main message from Putin here is that the injection of dynamism required to bolster stability can come only by reinvigorating UR itself: legitimacy will be refreshed by shaking out the “big tent”.
This approach cannot ensure stability except in the short term – that is, through the upcoming election cycle. Putin’s belief that coherent and stable government depends on UR continuing to command solid parliamentary majorities implies that the other parties cannot be considered serious and responsible. But Putin himself is largely responsible for the continued lack of a credible alternative political force – one that could ensure legitimate government after voters’ disenchantment with a long incumbent regime became terminal. In his second presidential term (2004-08), new political entrants were, in effect, blocked and open political debate in key media (that is, the national TV networks) was silenced. And while he did support the creation of a loyal opposition social-democratic party (A Just Russia) in 2006, he never willed the means to the end of developing it into a mature competitor to UR.
Another way to promote political competition might have been to force a split within UR itself. But again, the short-term priority has always been to maintain the stable dominance of UR – since this, after the control of the presidency itself, provides the main institutional foundation for the power of the ruling establishment under Putin’s leadership. The latest initiative to refresh UR through the new Popular Front is once again depriving other players of oxygen: for example, Alexander Babakov, one of the original founders of A Just Russia, was reported in July to have joined the Front, along with other (unnamed) comrades.
Medvedev’s response: Pitch smaller coalition tents
In our previous review of fundamental political risk published four years ago (that is, at the same point in the last political cycle), we highlighted this very theme of the empowerment and development of competing political parties as the key to long-term country risk reduction. We stick to that view, while also drawing a lesson from the experience of the past cycle. Rather than pursuing a half-hearted initiative to create a stabilizing opposition from the top down, it might prove more fruitful to adopt a less direct and more patient approach.
This, in any case, has been Medvedev’s approach. It boils down to helping the minor parties compete with UR by making piecemeal – but, in aggregate, substantial – regulatory change and by drawing attention to cases of electoral malpractice. Medvedev has encouraged the revival of the liberal free market party (Right Cause), which, in his publicly stated view, should appeal to those voters (around 10 per cent of the electorate) who are put off by UR and the other established parties. Such voters will include the important human resources for Russia, which, as discussed above, are a particular focus for Medvedev.
It remains to be seen whether the resurrected Right Cause party is capable of tapping that potential support in the 4 December election under its new oligarch leader, Mikhail Prokhorov. In any event, the forthcoming State Duma election campaign promises the most lively and open debate since 1999. Then, as now, the relative openness reflects heightened political uncertainty. The advantage of the gradual relaxation of political controls under Medvedev is that in today’s less impoverished and more stable Russia, open political campaigning will no longer be associated with, and hence discredited by, the sense of threat and breakdown that characterized the 1990s.
If continued, Medvedev’s approach to political liberalization would most likely produce not an outright alternation of power – the hallmark of deep stability in mature representative democracies – but a situation in which UR could no longer control the State Duma without the support of one or more of the minor parties. This is how the dominance of the Italian Christian Democrats was finally broken down in the 1980s, when one of the minor party leaders became prime minister (the fact that the politician in question – the Socialist Bettino Craxi – was later convicted of corruption may make the analogy less attractive but also, given Russian realities, more realistic). This is a more plausible – because more gradual – path to deeper political stabilization in Russia.
A combination of stability and dynamism is always essential for effective policy and reduced country risk, and the Putin-Medvedev tandem has delivered a version of that combination. It may be objected that this attractive-sounding formula has yielded few positive practical achievements. Leaving aside the question of what degree of achievement could reasonably have been expected in the three-and-a-half years since Medvedev was elected president, we strongly believe the tandem’s productivity – in both policy and country risk terms – will improve if it remains in place through the next political cycle. There are two reasons to be confident about this:
The two central policy areas in question are privatization and pension reform – both major top-down drivers for Russia’s capital market. The sensitivities involved in these two areas would be managed and overcome by presenting the resulting policies – which might even extend to some restructuring of Gazprom (or at least the extraction of greater dividends from the gas monopoly) – as part of the implementation of Putin’s national strategy and stability agenda.
The continuation of the Putin-Medvedev tandem would therefore be a positive and productive result – one with the potential both to trigger a short-term rally in Russian asset prices and to drive a longer-term re-rating. In our view, this is also the likely result. Predicting a positive outcome as the probable outcome might seem like wishful thinking. But our main assumption here is a realistic view of the force of inertia.
The Medvedev presidency has been Putin’s own project – his most important political initiative in recent years. The cornerstone of that strategy is stability, which means, in practice and above all, the stability of the ruling establishment. Keeping things as they are is therefore the path of least resistance. If Putin decided to push his protégé aside and take full power back into his own hands by returning to the presidency – and this is the solid consensus forecast – there would be some sort of power struggle. We do not mean to suggest that Medvedev would directly oppose Putin (let alone run against him as a candidate). But we do believe that in the remaining months of his term of office, he could be expected to use his presidential powers to fire some parting shots – in both policymaking and politics.
The consensus view that Putin will return to the Kremlin goes on to forecast that he would then appoint a leading reformist official as prime minister. The two most frequently mentioned names are Igor Shuvalov (now First Deputy Prime Minister) and Alexey Kudrin, the long-serving Finance Minister. The idea is that this would preserve the key feature of the Putin-Medvedev tandem – namely, the coalition within the elite and combined appeal to varied public constituencies (the very ingredients of dynamic stability discussed in the “Context” section of this report). But this idea is based on a false premise. In Russia’s constitutional system and political culture, the prime minister will always be a cipher. The only exception to this rule is when – as has been the case since 2008 – the post happens to be filled by the undisputed national leader. Ordinarily, the president calls all the shots, especially if he can command a solid majority in the State Duma. So Putin as president with, say, Shuvalov as premier would not be a remake of the Putin-Medvedev tandem, but a wholly different political construction. Moreover, it would be less effective than the tandem.
The reasons for this do not include fundamentally different policy preferences: although Putin does have his blind spots, the differences between his and Medvedev’s agendas are widely exaggerated. Nor are the respective strengths and weaknesses of the two leaders as personalities and politicians particularly relevant. Rather, the problem is that a new Putin presidency would be constrained by the baggage of long incumbency. A string of legacy factors, regardless of their rights and wrongs (the Yukos-Khodorkovsky affair, past foreign policy conflicts, the “state oligarchs”), would hamper innovative policymaking. Put another way, Putin’s comparative advantage at this stage in his career is that he can provide the stabilizing ballast to a younger leader with the fresh political capital required to forge ahead on key fronts.
The consensus view among Moscow commentators has proved wrong at all previous political turning points in post-Soviet Russia. For example, until Putin came to power in 1999, the cast-iron orthodoxy was that Yeltsin would be succeeded by a new ruling group led by Yury Luzhkov and Yevgeny Primakov. Four years ago, a widespread view was that Putin would change the constitution in order to remain president – a view based, like today’s consensus, on the assumption that such a powerful and successful leader would not give up power voluntarily.
So we are not troubled by being out of consensus. But if for once the consensus proves correct and, consequently, our prediction turns out to be wrong, then – for the reasons just set out – Putin’s return to the presidency should be regarded as a negative development relative to the present tandem arrangement.
Whatever Putin decides to do, the short-term market impact will be positive – owing to the simple fact that political uncertainty will have been removed. While Russian equity and debt prices could be expected to bounce unhesitatingly on the news that Putin supported a second term for Medvedev, the market’s reaction to the prospect of another Putin presidency would also be favourable – not only because of the long-awaited visibility on the political front but also because Putin would take care to pre-empt forebodings of Brezhnev-style stagnation by reaffirming his commitment to the latest market-friendly initiatives associated with Medvedev, such as more radical privatization, financial market development and measures to improve the business climate.
The short-term decision for investors is therefore one of tactical positioning. If, as we predict, Medvedev gets the green light for a second term, it would make sense to enter this decisive political season in Russia with an overweight position. Those investors who go along with the contrary (consensus) forecast – that Putin will take full power back into his own hands – should keep some powder dry. This is because an announcement by Putin that he is heading back to the Kremlin might initially disappoint the market, creating a buying opportunity ahead of a relief rally on improved political visibility.
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