Streetwise Professor

March 18, 2009

Priorities

Filed under: Uncategorized — The Professor @ 10:09 am

Diminishing resources, and the prospect that the country’s serious economic straits will linger for far longer than originally thought are forcing Russia into making hard choices over how to spend its reserve funds.  The choices are quite interesting.  

First, what is getting whacked.  At the top of the list:  infrastructure:

[T]he finance ministry released a list of cutbacks for this year’s regional budgets.

The list called for spending on road repairs, building maintenance and other basics to be slashed 50-100 percent in 21 regions, including Moscow and several oil-producing areas such as Tyumen.

. . . .

Badly needed repairs to Russia’s transport systems are meanwhile being shelved indefinitely, transport officials said at an industry conference.

‘The economic situation that has unfolded has forced us to correct many of our development plans,’ Nedosekov said.

Russia’s rail network is more than 50 percent depreciated and most of its fleet of trains and wagons have already passed their theoretical maximum age, according to a recent report by investment bank Renaissance Capital.

Before the crisis, 2.5 trillion roubles ($71.78 billion) per year was slated for transport infrastructure development over the next 20 years, Nedosekov said.

‘Now we are spending 10 times less than that,’ he said.

Rail freight shipments fell 26 percent to 27 percent in the first half of March compared with the same period of 2008 and will fall by a fifth for the year, Nedosekov said.

This trend is cutting deeply into the revenues of transport companies such as state monopoly Russian Railways, which was supposed to fund much of its own development.

The government does not have enough money to compensate for the contraction because its spending on anti-crisis measures is already pushing it toward a budget deficit of around 8 percent.

Private investors, who who were expected to pay for about half of Russia’s infrastructural renewal over the next decade, have fled the sector, leaving only two public-private partnerships in effect out of dozens that had been planned.

This includes the construction of a 43-kilometre stretch of highway between Moscow and  St. Petersburg, the two biggest cities, which have no high-speed road between them.

‘But that doesn’t come to much. There are not 43 kilometres there, but 700. What about the rest of it?’ said Sergei Shishkaryov, head of the transport committee of the lower house of parliament, the State Duma.

Government worker wages are also getting cut:

Workers paid out of the budgets of eight regions face wage cuts of 10 percent to 30 percent, the document posted on the ministry’s website said.

What is getting money?  There is $43 billion going to support social services and “anti-crisis measures.”  That’s a lot of money, and represents on the order of 20 percent of Russia’s rainy day fund.  

But of more interest is the fact that the  military will get a big chunk of money:

Russia said it would re-arm its military and boost its nuclear forces in response to the expansion of Nato to its western frontiers and the increased threat of international terrorism.

Dmitry Medvedev, Russian president, said on Tuesday: “The main task is to qualitatively improve the combat readiness of our forces, above all our strategic nuclear forces.”

Bloomberg has more:

A “large-scale rearming” of the army and navy will begin in 2011, Medvedev said today in  comments  broadcast on state television. “Significant funds are earmarked for the development and purchase” of weapons and spending won’t be curtailed as Russia enters its first recession in a decade, he said.

Defense Minister  Anatoly Serdyukov  said at a meeting of ministry officials that “the likelihood of armed conflicts and their potential danger for our state is growing.” He didn’t elaborate.

Medvedev said last month that the government will maintain spending on armaments procurement and housing for military personnel as it trims spending in the 2009 budget. He has called for a sweeping overhaul of the military since a five-day war with Georgia in August, including an upgrade of the country’s nuclear deterrent and the renewed production of aircraft carriers, as Russia seeks to restore its military power.

Medvedev and Serdyukov also raised the NATO bogeyman to justify the military expenditures in the face of a severe economic contraction.  

These choices are quite interesting, and reveal a great deal.  The focus on military expenditure, justified by risible alarms at security threats to Russia, is of particular interest.  

The decision to cut infrastructure spending, and to splurge on the military brings to mind Gogol’s observation “In  Russia  there are two big problems:  bad roads  and a lot of fools,” or Custine’s excoriation of the country’s byways.  Russia’s long term prospects depend, in part, on improving its wretched, largely Soviet-era infrastructure, both road and rail.  It was inevitable that the crisis would force the country to curtail its ambitious (not to say unrealistic) plans in this area, but the decision to essentially zero out this expenditure points out the increasing recognition that the crisis is likely to be long and deep.  When you face starvation, eating the seed corn is a hard, but necessary choice.  But this points out that the economic crisis will have very long-lasting effects on Russia, and postpone indefinitely its ambitions to develop a modern economy.  The already ramshackle will only degrade further.

But why choose a ramshackle military over ramshackle roads?  Ah, that is the interesting question.  Part of this is the intense desire to restore great power status.  But that’s not all of it.  The concentration on social expenditures betrays a concern about popular unrest; the preservation of military spending betrays an even deeper concern about military unrest.  And it is the latter that truly troubles Putin and his minions.  

An important harbinger of the problem occurred recently:

After last week’s demonstration by members of the much-decorated 67th Spetsnaz Brigade in Berdsk against the Russian defense ministry’s plans to disband that unit, the chief of the Russian general staff said over the weekend that Moscow in fact had no such intention and that the 67th’s officers would be given posts in the Siberian Military District.

Army General Nikolay Makarov’s declaration was clearly intended to mollify the officers of the unit. He said that they represent “the elite of our forces, the gold fund as it were, and that no one has any plans to do away with their priceless military experience, which was acquired in the most extreme circumstances” (www.newsru.com/russia/14mar2009/genstab.html).

But because it appears that his words apply only to the officers and not to the professional soldiers in these units and because Makarov said that the officers will serve in a single new unit consisting of officers and men from the second spetsnaz brigade which now exists there, it is possible that this announcement may not have the effect the general was hoping for.

On the one hand, his comment may not reassure at least some officers and many of the men in the 67th – as well as their families and those living in Berdsk who rely on both – that they have a collective future and can rely on this latest version of what Moscow and its officials say they intend.  
And on the other, Makarov’s decision to make this statement is certain to encourage some within the 67th and quite possibly other officers and men affected by military downsizing plans to protest as well. After all, by going into the streets, the 67th and its supporters have won what may be a reprieve if not a victory.

The possibility that there will be more such protests within the military is further increased by the rising number of protests in the civilian population. Over the course of the last week, there were marches in Moscow and a number of other cities. And yesterday, there were especially large protest meetings in Vladivostok and St. Petersburg.

 
This is a big deal. Spetsnaz are the Russian special forces. (They are not exactly equivalent to the Green Berets, or the Seals. They are more like the Army Rangers.) They are controlled by Military Intelligence (GRU). Spetsnaz are the kind of troops the government would rely on to deal with very messy situations. If they are unreliable, or are dissatisfied with the government, they would pose a very serious threat. Very serious. This is not a group of grumbling conscripts with nondescript leadership, bad morale, bad training, and bad transport. These are the elite. The government cannot afford to have outfits like these disgruntled.

It is particularly interesting that the government has limited its concessions to the officers.  These are the most educated and politically aware.  They also share many interconnections throughout the country, and are a self-identified elite.  Therefore, they incur lower costs to coordinate action among themselves.  The officers present the greatest danger, and by focusing concessions on them alone the government economizes on the cost of buying off the malcontents.

Interestingly,  the demonstration cost the head of the GRU his job:

The head of the GRU, Russia’s military intelligence service, was reported to have resigned yesterday after special forces soldiers under his command took part in an anti-government demonstration earlier this month.

General Valentin Korabelnikov was absent from a meeting of top defence officials yesterday when Dmitry Medvedev, president, spoke about military reforms.

The unrest in the military runs deep.  The proposed reforms are extremely unpopular with the uniformed military–many of whom will be on the streets if the reforms are actually implemented.  The FT has more:

The head of Russia’s military intelligence service, the GRU, was reported in the Russian press to have resigned on Tuesday after special forces soldiers under his command took part in an anti-government demonstration earlier this month.

General Valentin Korabelnikov was absent from a meeting of top defence officials on Tuesday when Dmitry Medvedev, Russian president, spoke about military reforms. The reforms, announced last year, would slash the officer corps by half in a bid to create a more agile force.

“The main task is to qualitatively improve the combat readiness of our forces, above all our strategic nuclear forces,” Mr Medvedev said, adding that Nato was continuing to expand closer to Russia’s borders.

A ministry representative told Interfax news agency that Gen Korabelnikov was “on vacation” and declined to comment on reports that he had resigned.

On March 9, covert operation specialists from one of the GRU brigades due to be demobilised as part of the reforms took part in a demonstration in Novosibirsk demanding the resignation of Anatoly Serdiukov, defence minister.

“They didn’t participate as soldiers, but some of them were there as individuals” said Alexei Rusakov, a deputy in the Berdsk city council, who helped organise the demonstration.

The GRU protest and Gen Korabelnikov’s absence on Tuesday underline the depth of resentment over the reforms. Opposition to the cuts is adding to a climate of instability in Russia, which is reeling from the economic crisis.

Russia’s military has been historically cautious about getting involved in politics.

Public anti-government protests, while still small, are becoming more common as unemployment and wage arrears rise.

On Monday a message posted on the defence ministry website assured members of the 67th GRU brigade that they would be given different jobs in the armed forces. “The officers of the 67th brigade are the elite of our military, our ‘golden foundation’ and no one has the intention of rejecting their priceless military service,” it said.

The reforms were first broached in October, following Russia’s victorious war against Georgia, which nonetheless exposed the lack of modern equipment and a top-heavy military bureaucracy.

The war also caused tension between the army and the Kremlin, according to retired officers, who said the generals were unhappy with the political decision to end the conflict before Georgia was completely defeated.

Lev Ponomarev, a human rights organiser in Moscow and opposition figure, said the government was committing a grave error by proceeding with the military reforms in a climate of unrest. “The reform of the army was planned before the crisis, and maybe it was a rational thing to do then. But now, in this environment, to dissolve two brigades of GRU, who are specialists in secret warfare, I can’t think of anything stupider.”

I can’t think of anything stupider, either, Lev.  That’s the kind of thing that will get your insurer to yank your whole life policy.  

So, how to tamp down the unrest?  Well, first, stop doing stoopid stuff.  Second, shower shiny new toys (or the promises thereof) and some apartments on the military.

Moreover, even though the government is reducing support to oligarchs, it is continuing its support forailing defense manufacturing firms  (H/T Penny):

The fortunes of the Russian defense industrial sector at present make AIG and Bank of America look like the financial picture of health. The Russian industrial conglomerate umbrella company, Rostekhnologia (ROT) that has monopoly control over the entirety of the nation’s defense industry is headed by Sergei Chemezov. He is also a life-long–and perhaps the number one–FOV (Friend of Vladimir Putin) in the Russian government, the two having first befriended one another when they served together in the former East German Democratic Republic (GDR) as KGB officers during the waning days of the Cold War.

Chemzov recently announced that 30 percent of Russia’s defense industry is on the verge of bankruptcy and that of the 70 per cent remaining only half of those may be categorised as “stable.” Those that are in danger of becoming insolvent include more than half of the enterprises in Russia that produce ammunition and explosives.

When ROT was officially formed last year–taking control of a total of 426 firms in one fell swoop–Chemezov looked like the all-time world champion of corporate raiders. Moreover, 118 of these firms had no connection to the defense sector, but were merely large, moneymaking enterprises that were ripe for the picking. “T. Boone Pickens, eat your heart out,” seemed to be the theme of the day for Russia’s number one FOV.

However, some seven months later, accumulating all of these industries into one basket does not seem like the smartest move any more. The 340 out of the 426 ROT-controlled firms that are defense suppliers currently owe 25 billion roubles (US $17.5 billion) of debt. In the aftermath of the global economic downturn, not only have Russian banks closed their doors to lending to these defense enterprises, but those banks that have remained open to lending have raised interest rates to 12 to 13 percent. These interest levels have caused ROT to open negotiations with western banks, although no one from the Russian arms export monopoly has been willing to reveal which banks they are actually in contact with.

“Credit is the most painful topic,” said Chemezov. “With such high [Russian banking] interest rates, we are simply unable to develop industry.” The current policies of western banks, however, are not encouraging due to their recently declared unwillingness to make additional loans to the east–even to those former Warsaw Pact nations that are now members of the EU.

. . . .

Back home in Moscow and one day after Chemezov’s announcement of the impending financial meltdown in the defense sector, the Russian government announced loans of $56 billion to provide some relief to these defense firms. Additionally, and following the example of the U.S. government’s bailout scheme, it was announced that the Kremlin would increase its control in RSK-MiG and other major arms producers by buying more shares in these enterprises. Whether these bridge loans will be enough to sustain these firms during the current economic crisis remains a large question, given that there are no solid prospects for major export or domestic orders in the near future.

Despite these handouts from the Russian state, there are still plenty of reasons to believe the Cypriot deputy defense minister was spot on in his assessment. First of all, explained a Moscow colleague, “the record to date of money being loaned by the state central budget to defense industry is not a happy one. Examples of some of all of this money being diverted into peoples’ pockets are well-known, so it is questionable if even half of this $56 billion will end up where it is supposed to.”

“Additionally, it is impossible to deny that some parts of Russian industry are no longer capable of producing a full-up weapon system and never will be able to again. Sooner or later Russia will end up importing weapons–instead of making them as they have done for decades. It is already easier all the time to import foreign components that are incorporated into Russian weapon platforms for the simple reason that there are no longer any Russian analogues to these components in production. Moving from this situation to importing whole, final-production weapon systems to Russia is not such a small step anymore.

When Chemezov created ROT and acquired control of almost every Russian industrial enterprise worth owning he looked as though his corporate behemoth had also acquired that “too big to fail” label that we are hearing so much about in the United States during the current world financial meltdown. But, just wishing does not make it so. No one can undo the almost 20 years of neglect and zero investment that Russian industry has suffered. No matter how much is done now failure in the defense sector seems about the only option and drinking the night away in Abu Dhabi instead of tending to business is only going to accelerate that decline.

The comment about the potential ulterior motive for this support–to keep the goodies flowing to the connected–is particularly apposite in this instance.

So, the bottom line: damn the future, save the regime today.  The primary threats to the regime are popular unrest and the military, and especially, as Goble notes, a synergistic combination of the two.  So, axe capital expenditures on everything but the military, pay off the  babushkas, keep the military happy, and keep disgruntled oligarchs in line by proceeding full speed ahead with the Khodorkovsky/Lebedev prosecution despite its lack of merits.  (Indeed, the lack of merits may be a very deliberate feature intended to emphasize the awesome and arbitrary powers of the state to destroy anyone it chooses.)  

In brief, the government is going into survival mode, and using a combination of sticks and a diminishing supply of carrots to pacify the most direct threats.  Thus, Priority One is self-preservation.  

Will it be enough?  Maybe.  Maybe not.  Shrinking financial resources sharply constrain Putin’s options.  A coalition of peeved oligarchs and military types could pose a serious threat.  Throw in regional governors sensing distraction and weakness at the center and problems could become acute.

As I’ve noted before, the main advantage of a central government is the difficulty potential opponents face in trying to coordinate their actions.  Playing divide and conquer through threats and bribes impedes coordination as well.  But, the fuel for a conflagration is there.  A spark–which could come from anywhere–is all that is needed to set it off.  A major confrontation or failure somewhere could be sufficient to overcome the coordination problems for a critical mass of individuals and lead to a serious challenge to the regime.  And if that happens, there can be a rapid shift of equilibria from uncoordinated passivity to unified opposition.  

That’s what Putin fears most.  His spending priorities demonstrate that quite clearly.  

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