Published On: Thu, Jul 14th, 2016

Third-Quarter Forecast 2016: Former Soviet Union

Third-Quarter Forecast 2016: Former Soviet Union

Russia’s Standoff Continues

This quarter, Russia and the West will remain locked in an intractable standoff. Now that the European Union is set to extend sanctions, Moscow does not see a reason to compromise for now. As Europe begins discussions to ease sanctions later in the year, however, Russia’s view could change. The European Union’s internal focus on managing Brexit, though likely an enduring trend, will probably make issues such as the Ukraine crisis, Nagorno-Karabakh and perhaps even Russia sanctions lower priorities for the European Union in the short term. Russia could take advantage of the divisions between EU members, but Moscow will be careful not to act too aggressively. Instead, it will focus on winning the support of Russia-friendly member states.

Russia will continue its active military involvement in the Syrian conflict this quarter, prioritizing air support to loyalist forces, particularly in Aleppo. As fighting heats up near the Syrian capital, refugee flows could increase, exacerbating Europe’s migrant problem. Moscow will keep pushing for increased coordination with the United States, but the harder it tries to engage the United States in a more substantive dialogue, the more acrimonious the relationship between Washington and Moscow will become.

In Syria and elsewhere, cooperation between Moscow and Ankara depends on Washington’s involvement. Although Turkey has laid the groundwork to resume negotiations with Russia on the Syrian crisis, Moscow will be cautious in allowing Ankara into the country and reluctant to give up its relationship with the Kurdish People’s Protection Units. This quarter, Russia and Turkey will also rekindle talks in other areas, including trade and tourism. As Moscow looks to revive plans for energy infrastructure in the Black Sea, Russia will renew negotiations with Turkey over natural gas.

Tensions between Russia and the West will continue beyond the NATO summit, which took place in Warsaw, July 8-9. During the summit, NATO confirmed its plans to station four battalion task groups on a rotational basis in the Baltic states and Poland. These countries will also ramp up their own efforts at military modernization, focusing on air defense. NATO also continued discussions on Black Sea deployments. Considering the issue concerns many member states, they eased tonnage restrictions on the Black Sea that the Montreux Convention imposed. In addition, NATO announced measures to strengthen cooperation — albeit far short of a membership action plan — with Georgia and Ukraine.

Russia, in turn, will focus on its military position in the Western Military District and in border areas such as Kaliningrad, Belarus and Crimea. Over the long term, Moscow will stick with its current strategy, prioritizing its strategic nuclear forces in response to U.S. ballistic missile defense initiatives, transitioning its forces in the Western Military District to prepare for large-scale conventional war and strengthening its Black Sea Fleet. As Russia and NATO scale up their military operations, nuclear arms treaties such as the Intermediate-Range Nuclear Forces Treaty and New START will come under mounting pressure.

Investing in the East

In the third quarter, Russia will maintain its emphasis on East Asia. Russia will hold its Eastern Economic Forum in September, intended to attract investment, partnerships and technology from the East, particularly China, South Korea and Japan. During the recent St. Petersburg International Economic Forum, Russia initiated several deals with these countries, and the Eastern Economic Forum will offer an opportunity to finalize many of them. In September, moreover, Russian President Vladimir Putin plans to visit Japan. Both countries are interested in increasing investment agreements, and they are also once again negotiating a formal peace treaty that includes the exchange of an island. But in light of the upcoming elections, Russia will be careful in presenting the talks to the public to avoid nationalist backlash over the loss of territory.

Fostering Growth and Quashing Unrest

Though Russia’s recession is no longer deepening, its economic crisis wears on. To combat stagnation and encourage growth, the Central Bank of Russia will implement a string of measures, increasing budgetary spending and cutting interest rates and salaries. The ruble’s value is stabilizing, which means that one of the main drivers of inflation is letting up. Before the end of the year, the government hopes to reduce inflation, which climbed to 15 percent at the start of 2016, to under 6 percent, a goal that may prove unattainable. Nevertheless, falling inflation will be enough to pacify the public, especially as the Kremlin eases its monetary policy and the economy begins its slow recovery.

During the third quarter, one of the most pressing economic challenges that the government will face is drafting the final versions of the 2016 budget, due in October. Finance Ministry and central bank officials will struggle over a string of budgetary items, namely how much to devote to the 2016-17 anti-crisis plan and how to fund it — through Reserve Fund withdrawals or international borrowing. The future of wide-ranging regional, public and corporate subsidies will also be up for debate. Finally, the Finance Ministry will proceed with privatizing Alrosa and Bashneft. Meanwhile, unless he gets an advantageous offer from China, India or another global power, Rosneft chief Igor Sechin will continue to resist plans to privatize a large portion of his company by year’s end.

In the Kremlin and beyond, the Russian people will become more divided over how to address the country’s economic and foreign policies. The Russian public will continue to bear the brunt of the economic slump, giving rise to more protests across the country.

With the approach of parliamentary elections in September, the government worries that economic protests could grow and turn political, as they did in response to allegations of election fraud in 2011 and 2012. This time, the ruling United Russia party will not blatantly manipulate the elections. Instead, it will hold elections earlier than originally scheduled and work with other mainstream parties to flood the electoral system with options. Organizers of previous protests will be detained or sidelined as the vote approaches, and Putin will test out his new National Guard and increase the Federal Security Service presence across the country to crack down on demonstrations. As much as the Kremlin needs United Russia though to keep its majority in parliament, it must also keep protests to a minimum to validate Putin’s fourth run for the presidency in 2018.

Some Progress for Ukraine

After a major government shake-up brought Prime Minister Volodymyr Groysman to power last quarter, Ukraine’s political situation will likely steady in the third quarter. Political stability will facilitate further reforms, enabling Ukraine to access the International Monetary Fund assistance package that has been stalled since the beginning of the year. This will give Kiev much-needed financial reprieve.

Even so, Kiev will face challenges in other areas, most notably in eastern Ukraine. Since the European Union has decided to extend its sanctions on Russia for another six months, Moscow has less incentive to make any immediate security concessions in the Ukraine conflict. Consequently, clashes between Moscow-backed separatists and Ukrainian security forces will stay at a simmer and could escalate, though major offensives or land grabs are unlikely. In September and October, the breakaway republics of Donetsk and Luhansk are scheduled to hold primaries for local elections. Kiev, however, will not recognize the votes, which will showcase the failure to implement the Minsk protocols. Nevertheless, Russia and the West will continue their negotiations over Ukraine’s future, but they are unlikely to reach any breakthroughs this quarter.

Elsewhere in the Former Soviet Union

Eastern Europe

Estonia, Latvia, Lithuania and Poland will each receive a deployment of additional NATO troops on a rotational basis in September. Though Belarus will further pursue its campaign for economic integration with the West, NATO buildups in the Baltic states and Poland will push Minsk toward deeper military cooperation with Moscow. In Moldova, pro-Russian and pro-EU groups will hold competing rallies ahead of the country’s October presidential election — the first direct vote since 1996.

Caucasus

Political activity and strife within the ruling Georgian Dream party will intensify in Georgia as parliamentary elections, slated for early October, draw near. Pro-Russian forces will become more active in the country, but they will not be enough to undermine Georgia’s focus on the West. The dispute between Armenia and Azerbaijan over Nagorno-Karabakh will remain contentious this quarter, though major military escalations like that of the previous quarter are unlikely. The two countries will maintain their regular diplomatic meetings, as Russia — as the most influential external power and mediator in the standoff — tries to keep the conflict manageable. Turkey and the United States will also be involved in the negotiations, though Moscow’s fraught relationships with Washington and Ankara will impede any meaningful political progress over the dispute.

Central Asia

In Central Asia, low oil prices, falling remittances and growing unemployment will prolong economic problems, fomenting unrest and political instability. Kazakhstan will be particularly vulnerable as its economy languishes and the government tries to contain growing dissent in the country, especially in its energy-producing western regions. The threat of militant spillover along the Afghan border with Central Asia will be a persistent concern for Tajikistan, Uzbekistan and Turkmenistan, prompting Russia, the United States and China to boost their respective security partnerships in the region.

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