by Luke Rodeheffer, an analyst at Global Risk Insights
Russian leaders may celebrate annexing Crimea, but it will cost the Russian economy. Already weak, this latest move threatens to send the country into recession.
Following the successful referendum on Crimean independence and the Russian Duma allowing Crimea and Sevastopol to become part of the Russian Federation, the Kremlin celebrated on Friday evening with a fireworks display. Yet, the events are hardly a source of celebration for Russia’s economic outlook, but threaten instead to send the already beleaguered economy into recession.
Capital flight has plagued Russia since the onset of the global economic crisis, and the unfolding events in Crimea have given these outflows a new boost. The Gaidar Institute for Economic Policy has predicted that a record $75 billion in capital could flow out of Russia in the first quarter of 2014, much more than the total capital flight for 2013. Russia’s current account surplus is rapidly shrinking, and may soon no longer be adequate to offset capital flight.
One collateral effect of accelerating capital outflows is a further weakening of the Russian ruble, which has already lost 10 percent of its value against the dollar since the beginning of the Crimea crisis. The ruble’s value had already decreased by six percent in 2013. Russians have begun converting rubles to dollars on a mass scale, with $6 billion converted since the beginning of the year. Yields on Russian bonds have also increased, reaching 9.66 percent.
American and European sanctions targeting Russian businessmen have led the credit agency Fitch to cut their investment grade for the Russian Federation to BBB, the second lowest. Standard & Poor’s made a similar move last week. Estimates of just 1 percent GDP growth are optimistic at best. The subsidiary companies of Russian banks operating in Ukraine, particularly Sberbank and VTB Bank, also face potentially catastrophic losses if the Ukrainian banking sector collapses.
The reunification of Crimea with the Russian Federation comes at a time when Russia’s regions face a growing budgetary crisis. Only six of Russia’s 83 regions managed to cover expenses last year, and regional debt more than doubled to nearly $18.5 billion. Russian opposition leader Boris Nemtsov calculated the costs of subsidizing Crimea to be around $3 billion, much higher than the costs of supporting Chechnya – a region that has drawn the ire of Russians for the effect of its dependence on the rest of the country.
Crimea’s 2-million strong population includes 560,000 pensioners and 200,000 government employees, placing a significant financial burden on Moscow as over half of the region’s budget was already supplied by Kiev. Furthermore, the region was dependent on Kiev for 80 percent of its electricity and nearly two thirds of gas supplies, requiring significant infrastructural investments from Moscow. The cost of Russia’s military actions thus far, between moving forces into Crimea and massing soldiers and combat equipment on the Ukrainian border, are estimated to be between $50 billion and $70 billion.
The annexation of Crimea could also have unintended consequences for Russia’s political stability. The Kremlin’s decision is a win for Russian nationalists, who have become increasingly emboldened in recent years, as the decision to add Crimea to the Russian Federation indicates that Moscow regards ethnicity as more important than territorial integrity. The decision to allow a referendum sets a bad precedent for regions of Russia with separatist tendencies, despite recent Russian legislation criminalizing separatist sentiments.