Russia Defence and Security Report Q2 2009

BMI 's core scenario for Russia is decidedly bleak with an economic contraction of -4.0% for the fullyear.

It is important to stress that even with this well below-consensus forecast, we continue to highlight downside risks. With Urals oil set to average just under US$43/bbl over the course of the year, the country's external and fiscal dynamics are set to worsen considerably. The current account, which posted large surpluses since 1999 is forecast to fall into deficit by 2010 while the federal budget is expected to flip from a 4.0% of GDP surplus to a 6.8% shortfall. Even more worrying is the lack of stability of the banking system.

While it is already clear that Russia is headed for a recession, these factors suggest to us that the risks of a systemic crisis are concurrently rising. The key question to ask for Russia is, ‘Does the government have enough ammunition to ensure banking system and credit market stability while simultaneously providing the fiscal stimulus necessary to avert a very deep economic contraction?’ While BMI 's core scenario is that the answer is 'yes' at least through 2009, we caution that amid the current global market volatility and unprecedented levels of deleveraging, that there are very real negative risks to this view. We stress that there are multiple inter-related factors which could drive the economy toward a crisis risk scenario at an accelerated pace.

We have lowered Russia's short-term political risk rating (STPR) to 62.9 to take into account the increased likelihood of the deterioration of social stability in 2009 and beyond. With unemployment set to rise back into the double digits, concurrent with a marked erosion of purchasing power resulting from a 27% depreciation of the rouble (versus the dollar-euro basket it is managed against, from its June 2008 peak), there will be significant potential for public dissatisfaction to increase rapidly. Already, at least one major government policy action has directly resulted in large public demonstrations. The decision to increase the tariff on imported automobiles on December 9, 2008, resulted in protests in several major cities, the largest of which occurred in Vladivostok on December 21. More than 100 people were arrested at the demonstration by special Interior Ministry security forces, specially flown in (under direct command) from Moscow.

Especially worrying is the potential impact social instability will have on policy continuity and certainty.

We believe that the most significant foreign policy precedent of the war applies mainly to what Russia refers to as its 'near abroad'. By establishing that it is willing to breach national sovereignty, Moscow has sent a clear message to capitals throughout the CIS, Georgia and Ukraine that its core strategic interests should not be ignored.

As a result of the growing internal conflict in the North Caucasus, Russia has decided to place greater operational emphasis on Special Forces. Developments in Chechnya in 1994 and 1999 showed Russia that regular armed forces were not able to deal with the low-level conflict, and that, more importantly, conscripts were not able to deal with the rigour of an insurgency. What was needed was a professional force dedicated to dealing with insurgencies. Russia’s State Weapons Programme 2015 underwent refinement in 2006. The main aim is to provide Russia with a modernised nuclear deterrent force and to enhance the army’s poor public image. The armed forces were reduced by 200,000 in 2005 in a bid to professionalise the Russian army.

Russia maintains a massive defence industry that, despite pain associated with modernisation, restructuring and excess capacity, supports a thriving export industry. Russia is at least challenging, if not surpassing, the US in terms of total defence industry exports. In 2008, Russia exported US$7bn worth of military items and the government arms-exporting agency Rosoboronexport expects foreign military sales to remain at that level through the next several years.