Siim Kallas: Why The West will never understand Russia

Moscow will look for every way to circumvent the sanctions and encourage divisions within the European Union before the question of economic sanctions returns, writes Siim Kallas.

In pursuit of her “near abroad” policy, Russia has occupied parts of Georgia, Moldova and Ukraine, annexed Crimea, and supported Armenia in its partial occupation of Azerbaijan.

So it is hardly surprising that Russia’s neighbors, the Baltic countries and Kazakhstan, are fearful of further aggression. Sweden deployed a significant naval force to look for a supposed Russian submarine in its territorial waters. The West, including the European Union, has responded with economic sanctions.

But how relevant are these sanctions and what is their impact on the Russian economy and Russian politics? To Western thinking, their impact is substantial. Russia’s allies portray them as simply irrelevant. Which is closer to the truth?

One factor which suggests sanctions do present serious problems for Russia is the credit crunch which is looming for many Russian companies. It will be at its most severe by 2016. In December of this year, the Russian corporate sector will have to repay 32 billion dollars, and any refinancing is likely to attract very high interest rates. Overall, between now and the end of 2015, Russian banks and companies will have to repay no less than 134 billion.

One of the flagships of Russia’s energy sector – the oil company Rosneft – is also in serious financial trouble. Heavily indebted and cut off from the EU and US capital markets, it is relying on state support from Moscow and pre-payment contracts with China to meet its debt obligations.

The Russian budget is under pressure on both the revenue and cost sides. Moscow has tried to borrow via debt auctions, but nine successive auctions have failed. On the October 24 it was able to borrow a modest 208 million euros. But the rate of interest – 9.37 percent - looks more like usury. As is well documented, there have been unprecedented capital outflows, while at the same time the forecast for military spending in 2015 has increased by 21 percent.

The Russian authorities, including its central bank, have firmly declared that there will never be any restrictions on capital movements, or on the free float of the rouble. But given the usual level of reliability of Russian public policy statements, such promises should not be taken at face value. The vast majority of Russians have always lived under a rigid currency control regime.

At the very least, we should prepare for limited debt defaults by Rosneft and the troubled Russian banks. There is also the real possibility of complete bank failures.

All this points to a Russian economy in deep trouble. But Russian society is very resilient to economic sanctions. This is a society which has for centuries accepted the loss of prosperity as part of the cost of imperial and military objectives.

And here lies the fundamental difference between affluent Western consumers and the people of Russia. Over the last twelve months, the rouble has depreciated by 16 percent against the dollar. Rouble holders have become significantly poorer compared with dollar owners. But who cares? For 130 million Russians, the exchange rate plays no part in their lives.

The food embargo? There has been hunger and a shortage of food in Russia for decades; a little less sausage today makes no difference.

Thousands of Russians may have bought property in London, Scandinavia, the Baltics, Dubai and elsewhere as escape-purchases against the day when things become unbearable. But only 8 percent of Russians spent their holidays abroad in 2013; 92 percent stayed at home.

The number of Russian dollar millionaires may have doubled in the last year, but the overall prosperity of Russia’s citizens fell by 6 percent in the same period.

The fact is that most Russian citizens live still in Soviet conditions – the same miserable apartments, the same relative poverty, the same almost total isolation from outside world. They inhabit a society which is highly resistant to Western economic sanctions and is always ready to suffer in support of higher political objectives – mostly involving aggression outside Mother Russia herself.

It all adds up to a stable and deep-rooted power base for Russian assertiveness and confrontation with the West.

So what are the implications? Russia’s problems with refinancing will come to a head at the end of 2015. The most probable date for the expiration of Western sanctions is August 2015. Does anybody seriously believe that Russia will end its occupation of territory in Ukraine, Moldova or Georgia?

Of course, Moscow will look for ways to circumvent the sanctions. Switzerland is always ready to lend, even though the price paid by Russian companies to Swiss intermediaries is enormous.

And what about the short term? For Russia, it remains vitally important to encourage divisions within the European Union before the question of economic sanctions returns. Moscow will use every trick in the book – propaganda, blackmail, even bribery. They will work through lobby groups; they will use fake diplomacy; they will make false peace proposals.

And if, by the end of 2015, things look even worse, what are the odds against another military adventure to boost morale?

Siim Kallas is a former Vice-president of the European Commission. He is currently a professor of international economics at the University of Tartu. The article was first published on