International Security Repercussions of the Global Financial Crisis

In a matter of months the major world economies plunged into the longest recession since the Great Depression. As a result, all countries in the global economic and financial system have been profoundly impacted by the economic crisis, and all by different degrees. This period of economic hardship has also threatened to destabilize the international situation and increase risk of conflicts.

For a number of years the global economy has been driven by cheap credit. Financial distress sown by the bankruptcy of Lehman Brothers made financial institutions more risk averse, severely reducing the availability of credit. Furthermore, soaring risk premiums made the available credit much more expensive. As a result, the corporate sector, as well as private consumers, have cut back on investing and spending, triggering economic downfall.

Thanks to the aggressively expansionary fiscal policy, the global economic freefall was averted within months. On the one hand, developed economies that have responded with unprecedented stimulus packages, still face high unemployment, negative economic growth and soaring public debts. Large emerging economics, on the other hand, accelerated first. China’s output, which never actually fell, was already growing at a rate of 17% in the second quarter. Out of BRIC economies (Brazil, Russia, India and China), only Russia has seen a dramatic economic downfall of a stunning 8 percent this year, despite one of the world’s relatively largest economic stimulus plans. As the world economy seems to have entered a post-crisis revival stage, this stability is an illusion.

There are a number of threats to the current fragile stability. First, the current global economic growth is increasingly dependent on government support. Second, demand in the developed world is to remain weak, especially in the countries with highly leveraged households and dysfunctional banking system. Furthermore, big emerging economies are under serious threat of creating new asset bubbles and other distortions as the governments conduct loose monetary policy. China, for example, keeps its currency artificially weak, which hampers the economy’s transformation toward consumption and makes it increasingly dependent on the rich world. Some expectations for 2010 include sovereign debt defaults, rise in trade protectionism, and even civil unrest and political conflicts.

Current financial distress may provide an opportunity for Russia, China and Organization of the Petroleum Exporting Countries (OPEC) to exert their financial leverage to achieve their political goals. China, for example, is the single largest investor in the U.S. government bonds, which gives the Chinese a great deal of leverage over U.S. interest rate and currency change rate decisions. Furthermore, the BRIC countries’ speculations of a new world currency have a potential to substantially weaken the U.S. dollar. Furthermore, the world’s largest Sovereign Wealth Funds, including major energy exporters, controlled nearly $3 trillion in 2007 and expected to control over $10 trillion by 2012. Driven by high world energy prices, Russia’s wealth and energy markets monopoly has allowed for a increasingly assertive foreign policy toward former Soviet countries as well as the developed world. Such policies eventually led to the war with Georgia in 2008.

Does Russia really need WTO?

Two weeks ago Russia announced the suspension of its bid to join the WTO and now intends to file a collective membership application as a customs union with Kazakhstan and Belarus. There are multiple reasons why Russia should seek to join the WTO as soon as possible, but there are two reasons why it is not a high time to do so. Namely, they are financial crisis and Russia’s sphere of influence.

A quantitative assessment of WTO accession impact on Russia by the World Bank in 2005 indicated that, despite economic benefits are achievable in the medium and long term, many households may lose during a transition period. Employment will decline in the sectors in which Russia has a comparative disadvantage, namely, light industry, food, machinery and equipment and construction materials. Russia’s GDP shrank by 9.8 percent in the first quarter of 2009 and the World Bank predicts a slow and painful recovery with a weak economic growth until 2012. This means that Russia will have to struggle with rising unemployment and possible social unrest for another 2.5 years. Joining the WTO now may exacerbate these negative effects on Russia’s economy.

Furthermore, Russian government will not be able to impose trade restrictions that seem to have a greater calming effect on Russian people than on the economy. World Bank predictions for the economic growth after WTO accession also indicate that liberalization of barriers against foreign direct investment is the most important component of the impact on the Russia’s economy. Thus, in order to achieve huge benefits from the WTO accession, Russia will have to review a number of legal provisions that regulate FDI in the economy, including the famous Strategic Sectors Law. Joining WTO under such circumstances may further hurt the economy and hamper its weak growth.

Another aspect of Putin’s decision on WTO is Russia’s assertive policies toward its neighbors. Russia believes into a multipolar world and would like to become a center of integration in Eurasia. This requires for establishing a close relationship with its partners and which Russia deems its circle of influence. Kazakhstan is assuming chairmanship of the OSCE in the next year, and is a growing energy power in the Central Asia. Staying outside the WTO allows Russia to use trade barriers in its foreign policy, mainly in regard to its neighbors that act against Russia, for example, Ukraine.

The most important question is whether the customs union with Belarus and Kazakhstan is possible. Just days before the announcement of the customs union formation, Russia has been engaged in a “milk” war with Belarus that clearly showed the scope of the relationship between the two countries. Kazakhstan may also be increasingly reluctant toward Russia’s demands as it is trying to lead its own economic policy and highly values its sovereignty. These tensions may hurt the effectiveness of the Customs Union.

This period of the economic crisis can be a period of opportunities for Russia. It can establish long-needed economic institutions that will enable Russia to mitigate the pain imposed on the industries and population in the period of a downturn, and increase labor productivity and industrial efficiency. Russia has a huge potential to come out of this crisis with stronger economic institutions and checks-and-balances system, that will be enable Russia to reap huge gains from its future WTO accession even in the short-run.

Russia’s policy in the North Caucasus. What Russians should learn from Obama’s speech?

Situation in Russia’s North Caucasus is becoming alarmingly unstable. While the Kremlin was able to stabilize Chechnya, mainly by flooding the republic with federal money and giving Chechen authorities all the freedom they want, Dagestan is becoming the next hotbed for insurgence and failure of the Kremlin’s policy in the region.

High unemployment, reaching 80% in Dagestan, corruption, arbitration of authorities, high crime rate and absence of rule of law largely contribute to formation of insurgence as a form of protest against the current regime. These factors have reached such a magnitude that local authorities and criminal clans within these republics have started to collide to gain control. The opposition is suppressed with a significant help of a 1999 Law ‘On Wahhabism and Religious Extremism’, that equips local authorities with an effective way to get rid of the opposing forces by trying them as religious extremists and wahhabi. Chechen authorities have become bold enough to reach to their opponents in Moscow and abroad. “Power in exchange for stability” pact between North Caucasus and Moscow has failed.

The U.S. deals with a similar problem in regard to Muslims and has been fighting insurgence in Afghanistan and Iraq. In the aftermath of nine eleven and Bush policies toward the Muslim world, the relationship between Muslims and the West has been undermined, as it has let a great deal of people in the West to view Islam as inevitably hostile. In order to fix this, Obama administration adopted a new, peaceful policy toward Muslims. In his Cairo speech, Obama called for partnership with Islam and a search for new grounds of interaction.

Russians also view Islam as hostile and dangerous. Muslims face extraordinary difficulties with employment when escaping from North Caucasus to other Russian regions. Hate crimes are on the rise among Muslims and these attitudes have long been supported by Russian authorities. Ineffective Kremlin policy in North Caucasus only adds fuel to the fire, leaving large populations of North Caucasus without basic living norms and creating grounds for opposition and insurgence.

Russian government, at its top, needs to adopt a new policy toward its Muslim population, similar to those of Obama administration. North Caucasus republics should receive funding for social infrastructure, and small business development programs should be launched. Tolerance toward Islam should be promoted among Russians. This will help prevent escalation of violence in North Caucasus. About 20% of Russian population is Muslim, and it is increasing quickly. There is even an idea spread by official muftis that Russia is a Christian country temporarily. Putin’s tactic of force and reliance on administrative resource is not going to work anymore.

Medevedev has announced his plans to meet at a big meeting with Muslim leaders. It is fascinating that the meeting of this scope will be held for the first time in the history of modern Russia. This shows that Medvedev once again asserts himself as someone who wants to depart from Putin’s authoritarian methods and start a diplomatic dialogue with Muslims. It seems that Medvedev understands that only well-defined policy of Russian leaders toward Islam may lead to a stable situation in North Caucasus. The only factor that may affect this equation is how much political power Medvedev will gain in the near future.

What CIS really needs from Russia?

Russia's influence in the CIS has been deteriorating over the past months, and some observers are already seeing a possibility of an orange or velvet revolution in Moldova and Georgia. Opposition in Georgia failed to topple the Saakashvili government and still rejects the offer to negotiate. But what does it mean for Russia?

It is clear that the opposition to Saakashvili that will come to power will be much more pro-western than Saakashvili itself, and this does not align with the Russia's interests. Georgia will make every effort to join NATO in any case either under the current rule or its successor. This makes Russia lose its stand in the CIS region.

Another country that promised to be friends with Russia forever, has been consistently looking to the West. It is clear that Russia-Belorussian 'friendship' was based solely on the economic subsidies and help from Russia. Belorussia was receiving $1.5 bln. worth of gas subsidies a year, and was promised a economic bailout if it were to declare sovereignty of Abkhasia and South Ossetia. But it didn't, and it didn't get the money from Russia. The West can provide more than just financing the Belorussian elite and authoritarian rule of Lukashenko. In fact, by providing more benefits to his people Lukashenko will be able to regain his rule and power.

"In general, Lukashenko will gradually move to pursue a policy that will be more independent from Russia, and this is natural. He is a strong leader and does not want to be dependent on anyone" - said foreign policy analysis Oreshkin on Ekho Moskvy Radio. Furthermore, the IMF delegation just arrived in Minsk, and Belorussia will likely to get a line of credit. This forces Lukashenko to turn to the West.

In Moldova, Voronin has shown that he is not in favor of tough control and tries to improve his image in the West. As as he succeeds there will be little control left for Russia. Furthermore, Russia is more and more likely to lose its control in Chechnya as economic conditions deteriorate and the battle for power now came to Moscow. This is the first sign that the situation in Chechnya is out of Russia's control.

To sum up, Russia's influence in the CIS has become overly dependent on money that Russia was able to provide at no or little cost. As situation in Russia continues to deteriorate, and Russia has lost its gas price leverage in CIS it will keep losing its influence.

Gazprom secures a new pipe extension

Russia today reported that Italy's economic Minister wished to bring Russia's gas through an extension of the Blue Stream pipeline that is going to end in Turkey, to Italy. In the light of the latest crisis with Ukraine and the gas cut-offs that were felt almost everywhere in Europe, this idea provides a solution. Transporting energy through more politically stable countries bypassing Ukraine will low gas delivery risks.

With this statement Italy become the number one advocate for a higher dependency on Russia's energy supplies. This comes about when the European economies are anticipated to start growing by the desired pipe construction deadline and will be able to rely on higher volumes of Russia's gas by 2015-2016. Extension to the Blue Stream pipeline also makes alternative projects Nabucco and TGI more and more unlikely to be pursued.

Time to save

In 2008 Americans reduced their debt outstanding for the first time since the World War II, according to the Federal Reserve, says the Wall Street Journal. What could this mean for the future of the global economy?

Well, first of all, it is a positive trend that will potentially be able to eliminate current disproportions in the global economy, but might also be bad news. If the idea to save lingers in the American’s minds the process of the global economic recovery may take more time as the major component of GDP, consumer demand, will not grow as fast. Countries like China will be severely affected by this as they are heavily dependent on the demand for consumer goods in the U.S.

Situation in the emerging economies would be different as U.S. investors have additional funds to invest into the high return BRIC markets. Ultimately, we might see Americans returning to their old spending habit, but it will likely to take a few years.

Russian oil - strategic asset or good business to China

After several weeks of negotiation, China and Russia’s RosNeft and TransNeft reached a strategic agreement for China. Under its terms, China will receive and expanded supply of Russian oil in exchange for $25 billion of low-interest loans. We all know what it means for China, but what does this agreement mean for Russia and its strategic oil industry?

Russia was able to strike the biggest oil deal with China, providing it with 10% of China’s demand for oil. I believe the decision is very timely and shows a very important trend of Russia’s foreign policy – economy first, foreign policy ambitions second.

Rapidly depleting Russian foreign currency reserves hinders the government’s ability to provide strategic companies with bailout and credit money. At the same time, this industry is proclaimed to be strategic, therefore, needs to be protected from the external influence. It seems like the Russian government finally realized the dangers that the world economic crisis has brought for the country, and let its largest corporation to enter profitable and natural-for-business deals. Let’s just hope that other Russian corporations stop waiting for the government money and start seeking money abroad.

For China, the contract reduces the risks associated with oil deliveries through Mongolia, and by sea from Australia and Africa, and from Saudi Arabia. A new oil-pipe to China that Transneft will start constructing in the mid-2009 will further decreases these risks. The contract is also a positive step in Russia-China relations and a good point of leverage for future deals.