World - Financial crisis shakes the Kremlin

Judy Dempsey

BERLIN: President Dmitri Medvedev of Russia was supposed to have given his first State of the Union address a week ago.

It was long overdue and eagerly awaited, especially since Medvedev had been making the rounds of several European cities since taking office last May to tout Russia's new foreign policy.

In Berlin and in the French city of Évian, Medvedev had set out his proposals for a new European security system. Part of the context was NATO's plans to expand further eastward, eventually admitting Georgia and Ukraine, and the Pentagon's decision to deploy part of its anti-missile shield in Eastern Europe. Medvedev made it clear that the Kremlin opposed both developments.

The more interesting aspect of his proposals was the need to modernize the security structures established during the Cold War. These include NATO and the Organization for Security and Cooperation in Europe with the United States playing a big role in both.

At Évian, Medvedev explained how his new security system for Europe would work. It would be legally binding and based on three "no's": No ensuring one's security at the expense of others. No actions by military alliances or coalitions that undermine the unity of the common security space. No development of military alliances that would threaten the security of other parties to the treaty.

Most East European governments concluded such a treaty would give Russia a veto on NATO expansion and missile defense.

While the proposals had a polemical ring to them, Medvedev's way of presenting them showed Russia's new confidence based on petrodollars and reserves of over $500 billion. As the short Georgia-Russia war of August showed, Moscow was not going to let NATO or the United States dominate security policy in its own backyard.

Even as the text of Medvedev's State of the Union address was being finalized, the event was postponed. Russia watchers say the global meltdown - which Prime Minister Vladimir Putin so confidently insisted last month would not affect Russia - shook the Kremlin. It has wiped out vast riches of the oligarchs and reduced the reserves to $300 billion. Medvedev called off the address.

"Many of the intentions and declarations of the security strategy will have to be revised," said Nikolay Petrov, a political analyst at the Carnegie Endowment for International Peace in Moscow. "The financial crisis and the Georgia war have changed a great deal here in Russia."

Take Gazprom. Its chairman, Alexei Miller, recently predicted that Gazprom would become the world's biggest company in terms of market capitalization. But now, the giant energy company, which borrowed heavily to finance prestige projects at the expense of modernizing the energy infrastructure and putting new fields into production, is seeking fresh money.

"Gazprom's acquisitions were based on the premise of high oil prices," said Anders Aslund, a Russian expert at the Peterson Institute for International Economics. "Russia's exports last year amounted to over $500 billion, of which $400 billion were from commodities. The fall in commodity prices and the drying up of new credit is a real shock to the Kremlin and the oligarchs," said Aslund.

Of course, the Kremlin will not allow Gazprom, one of its most important strategic assets, to default. But analysts say Gazprom will be forced to abandon some of its big projects, including the Russian-Italian South Stream pipeline that is supposed to link Russia with the Balkans by a pipeline under the Black Sea. "Who is going to finance this $20 billion project?" said Aslund.

Other big investments, particularly social ones - pensions and education, housing and hospitals - could lose out, too. "When Medvedev was deputy prime minister he was in charge of this big national program," said Hans Janus, a board member of Euler Hermes, the state-backed German export guarantee insurance company that is heavily engaged in Russia. "Then, Medvedev had lot of money to play around with." Now, there is less to go around, and Putin, as prime minister, has taken charge of these programs.

What is also coming to haunt the Kremlin is how it treated the oligarchs. Putin had made an example of the energy tycoon Mikhail Khodorkovsky, destroying his political ambitions and business empire after he was imprisoned on charges of tax fraud. The Kremlin played the remaining oligarchs against one another in order to bring them under control. As a consequence, they refrained from dabbling in politics, debating economic modernization, investing in philanthropic programs or promoting civil society.

Yet it would have been in the interests of the Kremlin to encourage and speed up the modernization and diversification of the economy so as to reduce Russia's reliance on commodities. "That might have cushioned the impact of the price fall in commodities," said Janus, who has long urged the Russian business community to branch out.

The financial fallout is far from over for Russia. The most serious crisis is looming in the provinces. There, hundreds of smaller banks, some adequately capitalized, others not, are facing difficulties. The European Bank for Reconstruction and Development says these banks have been crucial for lending to small and medium-size businesses, especially manufacturing, and creating a propertied class by extending mortgages.

But in Moscow, the big state banks, already rescued by the Kremlin, are not lending to smaller banks. Russian analysts fear the emerging entrepreneurial class and regional banks could go under. "We are talking about hundreds and thousands of small businesses," said Petrov.

Some analysts see a silver lining in the Russian crisis.

Aslund says a massive political vacuum could open up now that the oligarchs are in financial straits and the Kremlin has misjudged the long-term effects of the global meltdown. "It is too early to say who will fill this vacuum, but we must not ignore a growing middle class," said Aslund.

Others say Russia is at a juncture. "This crisis will show whether the system, which has become so inflexible, will be able to modernize," said Petrov. "If not, it will become more and more inefficient and be replaced by another system - evolutionary or revolutionary. So far, the Kremlin does not want to talk about it."

Medvedev's State of the Union speech has, for now, been rescheduled for next week.