by Charles Grant

Like the US, China and India, Russia has never been a big enthusiast for multilateral global governance. When the Russians believe that working through multilateral institutions will suit their interests, they will do so. But Russia’s history, size and traditions make it sceptical of multilateralism. Only with great reluctance did then President Vladimir Putin sign the Kyoto protocol on climate change – when he realised that Russia would benefit financially through the sale of unused carbon allowances.

Russia has never shown a lot of interest in multilateral institutions, other than the privileged clubs it is a member of, such as the G8 and the UN Security Council (UNSC). Presidents Yeltsin and Putin have had similar views on global governance, both preferring to talk of multipolarity rather than multilateralism.

As a G8 member, Russia has not been in favour of broadening the membership to include countries like China. But now that the G20 has become an important group, in some ways replacing the G8, Russia willingly takes part. Russia evidently likes the UNSC, being one of five veto-wielding members. But it has shown less interest in the UN as a whole and stayed on the sidelines during the discussion of UN reform at the end of Kofi Annan’s tenure as UN secretary-general. When Russia does take part in global bodies, it often seems more interested in the status of membership than in active participation.

Russia is ambiguous on whether it wants to join the World Trade Organisation – its membership talks with the WTO have dragged on since 1993. Earlier this month Russian trade officials told EU negotiators that they hoped to join the WTO this year – but then Prime Minister Putin said that Russia would want to join only as part of a grouping with Belarus and Kazakhstan. That is likely to delay membership.

Russia is more comfortable with regional organisations than global bodies, perhaps because it can play a leading role in them. It likes the Collective Security Treaty Organisation, which links a number of former Soviet countries, and the Shanghai Co-operation Organisation, which brings together most of the Central Asian countries and is dominated by Russia and China. There has been talk in the Kremlin of a ‘gas OPEC’, hooking together Russia, Iran and other producers such as Turkmenistan.

Russia strongly dislikes NATO for several reasons: the US leads the alliance, Russia believes the West would not allow it to join, and NATO’s expansion symbolises Russia’s strategic retreat since the Cold War. In recent years Moscow has taken against the Organisation for Security and Co-operation in Europe, whose observers have criticised the conduct of elections in former Soviet states. That is one reason why President Dmitri Medvedev came up with the idea of ‘a new European security architecture’ last year. Medvedev has said this should bring together Russia, the US, European countries and European security organisations. But his government has not yet produced any specific proposals.

The economic crisis is spurring governments around the world to think seriously about reform of global governance. For example the membership of the Financial Stability Forum is being broadened to include the leading developing economies. The IMF and World Bank are preparing for another round of reform. The effort to combat climate change is likely to lead to new global institutions. Yet Russia has been reluctant to put forward its own proposals on global governance. Why?

Russian foreign policy is hyper-realist. Russian diplomats tend to believe that countries are most likely to achieve their objectives through being tough and unyielding rather than by compromising or working things out in international organisations. Their worldview focuses on power rather than rules. It is natural for large and strong countries to be realist; it tends to be smaller and weaker states that see multilateral institutions as a bulwark against bullying by the powerful. And perhaps Russia’s difficult history – it has never had defined frontiers and has usually got on badly with its neighbours – has encouraged the realism.

The fact that Russia is big makes it reluctant to cede much authority to multilateral bodies. For in international organisations small countries can wield disproportionate influence. One thing that Russian diplomats find infuriating about the EU is that small countries can veto its decisions – for a while Lithuania blocked the negotiation of an EU-Russia trade agreement. Tiny Georgia could, if it really insisted, stop Russia joining the WTO. Seeing itself as a great power, Russia has – ever since the Congress of Vienna, almost two hundred years ago – liked the idea of a concert of powers. Thus it enjoys its role in the ‘quartet’ that is supposed to handle the Middle East peace process: Russia sits alongside the US, the UN and the EU.

Russians should rethink their scepticism towards multilateral institutions. The Russian economy is globalising. Sberbank’s recent purchase of a major stake in General Motors Europe is just one indication of this trend. Gazprom is buying energy infrastructure in many EU member-states. Russia’s leading metals companies are building global networks. The long-term prosperity of the top Russian firms depends on their buying companies and raising money in the world’s major financial centres.

Russia is developing global economic interests and will need to defend them. This is best done through strong multilateral institutions. If Russia joined the WTO it would be harder for other countries to impose anti-dumping duties on Russian exports. As a leading exporter of energy, Russia has an interest in joining the International Energy Agency, and helping it to develop into a body that can smooth out volatility in oil and gas prices. Russia should also take more interest in the future of the IMF and the World Bank, and in the emerging institutional framework for regulating global financial markets.

The Europeans – who, unlike the Russians, Indians, Chinese and Americans are instinctively multilateralist – should encourage the Russians to view multilateral institutions as a tool for promoting their national interests. The WTO is the prime example of an organisation that would deliver tangible benefits to Russia, and the EU – as Russia’s biggest trading partner – should urge the Russians to made up their minds to join it.

Charles Grant is director of the Centre for European Reform.

by Katinka Barysch

Russia’s economy has been hit hard by a triple whammy of capital outflows, collapsing oil prices and falling global demand. In the first three months of the year, output was down by 10 per cent compared with a year earlier. The retail boom that had fuelled growth in recent years has turned into a slump. The output of the manufacturing sector is contracting at a rate of over 20 per cent year on year. Construction is in deep recession. The current-account surplus has melted away.

However, the latest economic indicators suggest that the economic contraction is at least slowing. The oil price has recovered to over $70 a barrel. Surveys show that credit conditions are easing and managers are a bit less gloomy. Capital outflows have slowed. So has inflation, which has allowed the central bank to finally cut rates. International reserves, although down from 2008 peaks, still stand at $410 billion. The government is making plans for recapitalising some of the country’s banks.

Investors still remember the rapid, V-shaped recovery that followed Russia’s last financial crash in 1998. In the following nine years, the Russian economy grew by an average of 7 per cent a year. Will Russia be able to pull out of trouble this quickly again?

On the plus side, Russia’s government finances are in incomparably better shape than they were ten years ago. Back then, it was short-term public borrowing that triggered the crisis, ultimately forcing the government into default. Since then, the budget has shown a healthy surplus, allowing the government to stash away $140 billion in a reserve fund. So although revenue has collapsed (half of it comes from the oil and gas sector), the authorities have room for fiscal manoeuvre. Public spending will also have a bigger impact on the economy, simply because the Russian state is much bigger than it used to be (federal budget revenue was 13 per cent of GDP back in 1998, today it is over 20 per cent, according to Erik Berglőf from the European Bank of Reconstruction and Development).

Also, in 1998 the Russian economy had only just returned to growth, following years of severe post-transition recession. Now, after ten years of uninterrupted expansion, fewer Russians are living hand to mouth and many should be able to draw on savings to tide them over the most difficult period.

However, there are also reasons to expect the current crisis to be more severe and drawn-out. The 1998 crisis mainly affected emerging markets. This time, the recession is global, which means that no country will be able to export its way out of trouble. (Russia exports mainly raw materials, as well as some metals, timber and heavy industrial goods. But it is the collapse in demand for non-oil exports, such as steel products, that is causing the most trouble since these are often produced in isolated one-industry towns.)

Depressed global demand also means that the rally in oil prices is likely to be short-lived. After 1998, the oil price climbed steadily from around $10 a barrel to a peak of $140 last summer. Many forecasters expect oil prices to linger around $50-60 this year and next – not disastrously low but not enough to fuel a strong Russian recovery either. Moreover, Russia’s economy today is much more dependent on oil and gas sales than it was in 1998. Back then, oil and gas sales accounted for 44 per cent of export revenue, now the share is over two-thirds. Many manufacturing and services industries are directly or indirectly linked to the resource sector.

Perhaps the biggest difference lies in the role of banking and borrowing. Although both crises originated in the financial sector, in 1998 this sector was still so small that its collapse barely affected the wider economy. Then, credit to firms and households stood at 9 per cent of GDP; today it is over 40 per cent.

In recent years, much more of that borrowing came from abroad so the drying up of global liquidity in 2008 hit Russia hard. The World Bank estimates that in 1998-99, the reversal in foreign capital flows amounted to less than 2 per cent of Russian GDP. In 2008-09, it was close to 12 per cent of GDP.

Domestic banks cannot take up the slack because a rising share of bad loans will constrain their ability to start lending again. The health of the banking sector is difficult to assess. Official numbers show that the share of non-performing loans has climbed from 1 per cent at the start of the year to 4 per cent today. Given the sorry state of Russian industries, this is still an implausibly low number. Independent assessments put the share of bad loans at anywhere between 10 and 20 per cent.

As a result of these factors, the Russian economy is likely to take longer to come out if its slump than it did ten years ago. The World Bank predicts a contraction of almost 8 per cent this year, but some forecasters thinks even this is too optimistic and they question whether Russia will be able to make even timid recovery in 2010. Most economists agree that Russia stands little or no chance of returning to the 7-8 per cent growth rate that it enjoyed before the crisis struck

The big question is what the changed growth outlook will mean for Russia’s internal stability and the government’s willingness to implement economic reforms. In 1998 Russians expected very little from their leaders in Moscow. They were positively surprised when the Putin administration after 2000 started to implement some useful reforms, such as simplifying the tax system and cleaning up regulations.

Since then, Putin’s muscular rhetoric, combined with Alexei Kudrin’s sound macro-economic management, have raised expectations. The people that took to the streets in Russian cities in recent weeks and months did not so much protest against government policies as demand government help. The government could react either by getting serious about modernising and diversifying the economy. Or it could resort to economic nationalism and populist spending increases. So far, there is more evidence of the latter than the former. Prime Minister Putin has personally instructed companies to clear wage arrears and criticised shops for overcharging struggling families. On June 29th, he told the managers of Russia’s biggest banks that they should not go on summer holiday before they have significantly increased lending to the corporate sector (he even gave them a numerical target of $16 billion). With this kind of crises response, Russia’s growth prospects could end up being lower not only in the short term, but for many years to come.

Katinka Barysch is deputy director of the Centre for European Reform.

by Katinka Barysch

Many people in the EU tend to see Gazprom as a mighty giant that uses energy as a political tool on behalf of the Kremlin. They say that Russia has leverage because it controls 40 per cent of the EU’s gas imports. They fear that Gazprom may again cut gas flows to Ukraine this winter. They should think again. Realities on the international gas market have changed. Gazprom faces almost unprecedented uncertainty. It should therefore be keener on stable energy relations and co-operative customers. There may be an opening for a revived EU-Russia energy dialogue.

Gazprom’s energy strategy, and its political swagger, were predicated on the assumption that gas demand in the EU – by far the company’s most lucrative market – would continue growing. But in 2009, European gas demand fell for the first time ever. In the short term, this may even have suited Gazprom. Many analysts had warned that Russia may be unable to fulfil its export obligations from 2011 onwards because it does not invest enough in developing new gas fields in Yamal and Shtokman. Russia’s ability to supply is now more in line with gas demand.

In the medium term, however, the outlook for the gas market is foggy. For a company that must ponder multi-billion dollar investments to prevent an impending output decline, sits on a $40 billion debt pile and faces tougher competition, this is an uncomfortable position to be in.

The sluggish global economy will cap energy demand at a time when technology has opened up entirely new possibilities for producers. In 2009, output of so-called unconventional gas (gas coming from rock formations) in the US has risen so fast that the US has mothballed its LNG terminals. LNG tankers from Qatar started sailing to Europe instead. The additional supplies have depressed prices in the ‘spot’ market for short-term gas contracts. Spot gas became very cheap compared with piped gas from Russia or Algeria, which is tied to the oil price with a lag. European companies bought more supplies on the spot market and Gazprom lost out.

If the price gap persists, the big European companies, such as E.On, Gaz de France or ENI, will want to renegotiate their long-term ‘take or pay’ contracts with Gazprom. Russia, so far, wants none of it. If the Europeans buy less than the minimum amount fixed in these agreements, Gazprom can charge them a fine. But if spot prices are sufficiently low, that may still make business sense.

It is not only slow global growth and new technology that are causing uncertainty for Gazprom. So are the EU’s climate change targets and its emerging diversification strategy.

The gas industry argues, somewhat optimistically, that tougher CO2 targets will play in its favour as EU countries are forced to shut down polluting coal plants. Energy experts are not so sure. If the EU is to achieve both its target to increase energy efficiency (by 20 per cent by 2020) and boost the share of renewables to 20 per cent, the role of gas in the energy mix will have to shrink. At the same time, the Europeans are debating how to diversify their gas supplies away from Russia, to minimise the risk of further gas crises like the ones in 2006 and 2009. Many in Europe ridicule the EU-backed Nabucco pipeline as a pipe dream. But Gazprom has taken it sufficiently seriously to move ahead with its €20 billion South Stream pipeline that would compete with Nabucco for both Caspian gas reserves and South East Europe’s fast-growing energy markets. Austria is the latest country that appears to have switched sides from Nabucco to South Stream.

Pipeline competition, disputes over long-term contracts and uncertainty over both supply and demand make for an antagonistic energy relationship. Neither the EU nor Russia can want this.

The EU’s energy majors will want to wiggle out of their inflexible 30-year agreements but without endangering their working relationship with Gazprom. Some of them have upstream interests in the exploitation of Russian oil and gas fields. Some are involved in multi-billion euro joint pipeline projects with Russia. Long-term contracts will remain important for EU-Russia energy ties, but perhaps without the outdated practice of linking gas prices to those of oil.

Pipeline competition is souring the political climate in Europe. The EU and Russia should discuss whether Nabucco and South Stream might be merged. Russia will need western capital and know-how to develop difficult new gas fields. The EU wants Russia to sign up to joint principles on energy sector investment and transit, especially after Moscow recently withdrew its signature from the Energy Charter Treaty. Russia seeks European help to make its hugely wasteful industrial and power sectors more energy efficient. The EU wants Moscow to adopt greener policies.

These issues, and plenty more, could fill a reinvigorated EU-Russia energy dialogue with substance. Gazprom’s weakened position may bring Moscow to the negotiating table in a more compromising and constructive mood. Progress on energy co-operation could help dissolve the gridlock in EU-Russia relations.

Katinka Barysch is deputy director of the Centre for European Reform.