USA Quietly Inches Closer to War with Russia

Over the past few years, the Obama administration has intentionally pursued a dramatic expansion of policies that the Russian government and military consider threatening to Russia’s national security. Curiously, the Obama administration launched some of the most concerning elements of this expansion very recently. The policies fall into two overlapping categories: NATO and missile defense.

NATO – Enlargement and Posture

Russia is not a fan of NATO for a few reasons that arose out of the last days and immediate aftermath of the collapse of the Soviet Union. First, Russia was under the impression that – claims it was promised – that NATO would not expand its membership, particularly to countries on Russia’s border. Second, and less important, Russia thought that it would be invited to join NATO at some point, which clearly is not happening anytime soon. Although there are various reasons for Russia’s exclusion from NATO, there is only one logical strategic explanation that has made sense from NATO’s inception to the present: the military alliance is aimed at Russia! Two foreign policy heavyweights admitted as much in a 2014 NPR interview, essentially arguing that Russia would “obstruct NATO’s continuing viability” and undermine NATO’s “cohesion” by introducing a second ‘great power’ to the group. When you consider that we are talking about a collective defense organization, it is difficult not to read these statements other than: “NATO is USA’s platform for deterring and defeating potential great power rivals.”

When you look at recent enlargement efforts, the reason for Russia’s exclusion is pretty obvious. In December 2015, NATO sent Montenegro an invitation to the Russia-bashing party. I am confident most Americans could not point out Montenegro on a map and know literally nothing about it (except perhaps a vague memory of it belonging to Serbia at some point). Montenegro is very small, with a population of 677K people (166/233 countries) and total land area of around 14K square kilometers (156 out of 195 countries). It has just under 2K active duty members in its military. Ask yourself: are Americans ready to go to war for Montenegro?

On a side note, it is interesting that the expansion of NATO has continued with virtually zero public debate or discussion in the United States. Indeed, if you try to search for debates on NATO enlargement, you mostly find references from 1997, in the lead-up to Poland, Hungary, and the Czech Republic joining the alliance. The 2016 presidential election, however, has been a notable exception. Credit for elevating the issue unfortunately goes to Donald Trump, who has advocated reducing (“getting better deals”) our spending on Europe’s defense via NATO. On the Democratic side, Bernie Sanders appeared to agree with Trump on this issue, whereas Hillary Clinton has cited the Russia “being more aggressive” as a reason for continued support of NATO.

Of course, Montenegro is not what really bothers the Russian government – Ukraine and Georgia membership, which we’ll get to – but extending membership to countries like Montenegro in principle makes the case easier for countries like Georgia and Ukraine. Indeed, in April 2008 NATO issued a statement that read, “These countries will become members of NATO.” The Bush administration had supported initiating the membership process immediately, but the Germans and French were opposed. A few months later, Russia invaded Georgia after fighting broke out in South Ossetia. Less than six years later, Russia invaded Ukraine in response to what it called an illegal ‘coup’ against the pro-Russian Yanukovych government; Russia annexed the Crimean Peninsula after the region held a referendum in support of joining Russia. I won’t get into the debate about these two conflicts – who’s to blame, what actually happened, etc. But my interpretation is this: Russia appears committed to ensuring that neither country joins NATO, by diplomatic means or otherwise.

Another area of concern relates to NATO’s posture in Europe, in terms of deployments, military exercises, etc. The changes in posture over the past year have been far more significant than the addition of Montenegro. Indeed, the moves have been so controversial within NATO, that the German Foreign Minister recently warned NATO against “warmongering.” The German FM’s comment was in response to a 10-day exercise simulating a Russian attack on Poland. The exercise follows on a number of other exercises in recent years throughout Russia’s western flank including, yes, Ukraine and Georgia. NATO has also increased troop commitments in Eastern Europe, with an additional 1,000 troops added at the NATO summit this month. Another expansion in NATO’s capabilities – missile defense – brings us to the next topic.

Missile Defense

Shortly after Obama was elected in 2008, I addressed the missile defense issue and the reactions proponents of the system had to Obama’s election. In the post, I noted that proponents of missile defense were concerned Obama would kill the program. And indeed, Obama did kill the program as designed by the Bush Administration. But rather than scrap the idea of missile defense in Europe entirely, Obama instead proposed an alternative system, which would host missile systems on ships instead of on land in Poland and the Czech Republic.

But Obama’s more conciliatory missile defense program was slowly walked back to the Bush-era approach. By 2010, the Obama Administration was signing an agreement with Poland for hosting missile defense installations on their territory. And the formerly-ship-based program added a radar in Turkey, and an interceptor (missile installation) in Romania. The latter system, which came online this summer, will be under NATO ‘control’, as announced at the most recent summit in Warsaw. In reality, the Poland-based interceptor will be folded into the the currently operational missile defense shield.

Parallel to these efforts – although far less reported in the media – was the creation of a missile defense shield in Asia. This shield is purportedly aimed at deterring North Korea’s nascent and as-yet-ineffective ballistic missile program. Talks between the United States and South Korea began in February 2016, with an agreement-in-principle concluded in June 2016.

China, which has actual ballistic missiles with nuclear warheads that actually work, believes the missile defense shield is in fact aimed at them and not North Korea. Indeed, it is easy to see the hastily-concluded missile defense talks between the U.S. and South Korea as a reaction to increasing tensions over China’s territorial claims in the region, specifically the South China Sea. In October 2015, the Obama Administration released a statement supporting the ‘right of navigation’ around the Spratly archipelago in the South China sea, thereby rejecting China’s territorial claims to the same. Obama backed up his words with action by sending a U.S. Navy warship – the USS Lassen – through the very waters that China claims to itself.

China has claimed – accurately, I think – that these moves have collectively disrupted the ‘strategic balance’ in the region. What China and the Russians mean by this is that, essentially, the U.S. is full of shit and they know that the missile defense systems are aimed at them. Thus, they will need to respond accordingly in terms of military planning, mobilization, and deployment.

Deploying missile defense in Europe and Asia simultaneous has strengthened the Russo-Chinese alliance, still in its infancy. For a number of reasons to lengthy to cover here, Russia and China are not natural allies. Indeed, ‘great’ powers that share borders rarely make for durable partnerships unless motivated by some clear, common enemy. Putin has pursued better relations with China for years now, particularly following the sanctions related to its annexation of Crimea. But China has always seemed more willing to talk than to act. Perhaps China believed that U.S. antipathy towards Russia was of a different species than its feelings towards China. After all, the U.S. has made less political hay out of China’s human rights abuses, lack of democracy/rule of law, etc. Maybe China thought it was special because of its economic relationship with the U.S.

If this is the case, the nearly simultaneous announcement of missile defense shields in Europe and Asia has been a gift to factions in the Russian and Chinese governments pushing for closer relations between the two countries. We may already be seeing evidence of growing ties between China and Russia: two days ago, China’s military announced that it will conduct joint Russian-Chinese military exercises in the South China Sea in the near future.

WWIII, Here We Come?

The developments in Europe and Asia raise the scary question of whether we are slowly inching towards World War III. Certainly our military actions in those regions suggests as much. And for those who say we are merely moving towards a Cold War 2.0, I would reply that a hot war is much more likely, for several reasons:

  • In a bipolar world, each side was far better prepared to anticipate, learn about, and respond appropriately to the adversary’s actions. In a multipolar world, we cannot be sure that the Russia-Chinese alliance is for real, which distorts our threat perception.
  • In the Cold War, we had exceedingly pliant allies in Europe and Asia, all of which still had the memory of WWII fresh in their minds. Now, you cannot say that NATO members are united in treating Russia as a critical threat. Germany and France do not agree with this assessment. And if Brexit is a trend, we can expect more nationalism in Europe and less willingness to carry U.S. water (or those who are, more extreme and willing to engage in off-script antics that ratchet up tensions). In Asia, there is not a broad consensus in South Korea for the missile shield. In Japan, our presence has grown less welcome due to incidents of U.S. soldiers breaking local laws.
  • Conflicts in Europe and Asia are more fluid than at any time in the second half of the Cold War (the era during which all senior decision makers in Russia/U.S./Asia matured).

In an upcoming series of posts, I will expand on U.S.-Russian relations in the context of the current U.S. presidential elections.

 

Posted in russia

Russia’s New Old Anticorruption Campaign – “We’re serious this time!”

There’s an article on Bloomberg that caught my eye (h/t @agoodtreaty). The article claims that Pres. Putin approved the launch of a ‘new’ anticorruption campaign following a meeting at the Presidential residence in October. According to the article, this was ‘shocking’ news and represents a ‘win’ for the civiliki in their battle vs. the siloviki. Putin will apparently announce the anticorruption campaign during his Address to the Federal Assembly in December.

First, I am wondering whether the whole liberals vs. security types is a useful framework for understanding post-Medvedev Russia. My guess is not. And especially not after Ukraine and the sanctions. Indeed, even the most ‘liberal’ members of the Russian government and society have dug in and are ready for anything – 50 years of hard times, Cold War, even WWIII.

Second, since when is an anticorruption campaign in Russia a ‘new’ idea? The stated purpose of the campaign is to raise economic growth. The article quotes a number of breathless Russian elites who point out that reducing bribes will have an immediate effect and is like cutting taxes without straining the budget (but not if the ruble is worthless!). OK, accepting those arguments are valid in a vacuum, why didn’t they just do this earlier? Oh yeah, they did:

  • 2012 Address to Federal Assembly“We will certainly continue to combat corruption, which is a threat to national development prospects. I would like to stress that businesses must never enjoy any privileges based on their proximity to the executive, legislative or judicial government bodies at any level.”
  • 2013 Address to Federal Assembly“[P]ublic councils should … be active participants in anti-corruption efforts.” ; “there is a lot of corruption in … [the permitting procedures]. This is where the root of the problem lies.”

But as the Russians always say, “Где посадки?” (where are the convictions?). 2012 is an interesting year to check, because Putin’s speech followed a number of high-profile corruption scandals. I summarized these scandals here. It almost seemed like some high-level officials would go to jail, which would be a major development for Russia. So let’s check in with how the implicated officials from each scandal are doing:

  • Anatoly Serdyukov (former Minister of Defense) – pardoned in March of this year
  • Alexander Provotorov (former CEO of Rostelecom) – no charges, and a commercial court even approved his ‘golden parachute’ recently
  • Elena Skrynnik (former Minister of Agriculture) – no charges, and her deputy has still not faced a court
  • Yury Urlichich (former head of GLONASS) – no charges, and subsequently got a job as CEO of Sitronics, a subsidiary of the Sistema Group.
  • Roman Panov (former Deputy Head of Ministry of Regional Development) – a ray of sunshine: his trial is finally looking like it maaayyybeee will start. When the prosecutor read the charges last month, Panov replied, “I cannot really understand what I’m being accused of.” So he plead not guilty.

So two years and no convictions. And we all know, if Russia really wanted convictions, they would get them. Keep in mind the officials listed above stole around USD 1.75 billion.

Most likely, the upcoming anticorruption ‘push’ will result in firings and jail time for a bunch of low-level officials demanding small payments for routine stuff like a permit. Don’t get me wrong, these guys terrorize ordinary people every day and it is not a bad thing that they are punished.

But, treating corruption the same as air in a bike tire reveals the truly rotten character of the Russian state. They accept that corruption exists at all levels and even should exist. Putin has reportedly endorsed this view. It is just another tool to pursue certain ends, like eliminate adversaries or, in this case, promote ‘economic growth’. Really, the goal is to ease the pain of the sanctions, prop up Putin’s popularity, and thereby maintain Putin’s system. But Putin’s system relies on two pillars: popular support and bureaucratic support. Popular support comes from unflagging economic growth. Bureaucratic support comes from permitting officials to use their positions for ‘entrepreneurship’. Faced with low oil prices and the sanctions, how long before one of these pillars collapses?

Posted in bribes, bureaucracy, clans, corruption, criminal law

Russia Declares Open Season on American Brands

For Russians hoping to enjoy a Big Mac, America’s Favorite Fries, and wash down their meal with a Jack Daniels, the news is not good. In a thinly-veiled effort to retaliate against the United States for its Ukraine-related sanctions, Russian regulators are now targeting iconic American brands. This goes beyond the transparent, retaliatory sanctions Russia already adopted against imports of certain agricultural products. Instead, the most recent measures fall into the ‘asymmetrical’ variety, of which Russia is so fond.

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Here’s what has been done so far:

  • McDonald’s – Rospotrebnadzor closed 4 Moscow restaurants of McDonald’s, including its legendary Pushkin Square location (the first McDonald’s ever in Russia). Today, the Russian authorities announced that they were widening the probe into McDonald’s, with new inspections scheduled in the Sverdlovsk region. This follows an earlier investigation by Rosselkhoznadzor into the level of antibiotics found in meat used by McDonald’s. It all started in April when, after McDonald’s closed its locations in Crimea, professional clown and Russian Duma Deputy Vladimir Zhirinovsky (LDPR) demanded retaliatory actions against the fast food chain (although apparently Crimeans were about to dump McDonald’s first anyway).
  • Bourbon – Russian authorities have also targeted U.S. manufacturers of bourbon, including Kentucky Gentleman, Jack Daniels, and Jim Beam (never mind that the Jim Beam brand is owned by Japan-based Suntory Holdings).  Kentucky Gentleman imports were banned earlier this month due to alleged pthalate contents in its bourbon; Jim Beam was ordered removed from shelves after Rospotrebnadzor found that its bottles supposedly did not meet the required labeling standards; and Jack Daniels was targeted by Rospotrebnadzor after the regulator found “chemical substances not common to whiskey” in its Tennessee Honey Liqueur (honey, perhaps?).

Western companies should expect such ‘asymmetric’ efforts by the Russian authorities to increase. Indeed, you can expect a number of ‘copycat’ inspections after the Moscow branches of regulators like Rospotrebnadzor take action, such as in the McDonald’s case. Obviously, the targeting strategy is aimed at iconic American brands for which Russia represents an important market. Russia has long been a growing source of revenue for McDonald’s, and it has escalated its expansion into that country, most recently with the first master franchise agreement with Rosinter. Similarly, Beam has been making inroads into Russia, where whiskey consumption has been growing exponentially among traditional vodka drinkers.

The whole idea behind this approach to hurting U.S. companies is not only to retaliate for the sanctions, but also to promote ideas that U.S. products are tainted or defective in the public mind.

So who will be next on Russia’s list? Here are some guesses:

  • Coca-Cola – Coke – perhaps the most iconic American consumer brand – has been pushing deeper into the Russian market in recent years, adapting to Russian preferences for juice and kvass over soda (Pepsico has a greater share of the juice market). In 2010, Coca-Cola acquired Nidan, a Russian juice-maker. But this year, they shuttered two Russian factories due to declining demand. Thus, targeting Coca-Cola is appealing from a symbolic and economic nationalism point of view (i.e., ‘bring our jobs back’).
  • Automakers – nothing is more American than cars, and both GM and Ford have established manufacturing presences in Russia over the past decade. Specifically, the plants in Russia conduct final assembly tasks of parts shipped from all over the world. Unlike consumer products that are sold within Russia, however, the authorities cannot ban sales of cars meant for export to Europe. Thus, the measures taken against automakers would probably involve slowing down customs clearance times of parts coming into the factory, which could devastate their ability to fill orders from dealers in the EU. My only hesitation here is whether Russia would be willing to target its own non-oil exports just to hurt U.S. companies – thus, it will be a test of how committed they are to this path.
  • Tech Companies – Putin already announced that Russia was going to eliminate its use of IBM and Microsoft in government offices. And they could take the same ‘slowdown’ approach to imports as they do with car makers. But I’m thinking more about Google (YouTube), Facebook, and Twitter. Not only are these companies the face of modern American business, they’ve also been used as platforms for anti-regime messages. Personally, I think Russia would rather siphon off all the data these companies generate within its borders than ban them completely. But that doesn’t mean they won’t harass them generally with dawn raids and the like. More likely, I could see the Russian authorities using the vague terms of its new extremism law to selectively target U.S. tech companies for content hosted on their sites.
  • Airlines – Russia has threatened to withdraw overflight rights to airlines based in countries that have adopted sanctions, but this seems a bit extreme for Russia. Again, Russia will most likely pursue a more passive-aggressive strategy that will be unofficial and thus unattributable to any one decision maker. One example I recall: United Airlines used to have a direct flight from DC to Domodedovo, but eliminated the route once Domodedovo started price gauging United on the cost of fuel. I could see Russian airports initiating the same tactic, and also causing delays through ‘safety’ inspections and withholding takeoff clearance.
  • American Films – non-Russophiles may not know it, but Russia actually has its own little film industry, carved from the remnants of the epic era of Soviet cinema. Caps on foreign films have been floated in the past.  But again I could see the extremism law being used to target American movies on a case-by-case basis, particularly in the case of blockbusters competing with local work.
Posted in coca-cola, Cold War, duma, economics, extremism, film, Foreign direct investment, foreign investment, Government of Russia, internet, ldpr, nidan, Putin, sanctions, u.s.-russia relations

Putin’s Bad Month – How the Sanctions Are[n’t] Working

Will the history books view the shooting down of MH17 as a similarly crystallizing event like the assassination of Franz Ferdinand nearly 100 years before? Maybe (probably depends on whose books you will read). In any case, it is difficult to overestimate the significance of that apparently accidental event, which arguably convinced the EU (read: Germany) to adopt stricter sanctions against Russia.   [Sidebar: many have compared the downing of MH17 to that of Iran Air Flight 655 in 1988. I agree, it seems similar. The difference is that where Putin has tried to pin the blame on the Ukrainians for ‘creating the conditions’ that led to the tragedy, Pres. Reagan immediately repudiated Pentagon claims that the US Navy did not shoot the Iranian airliner down].

The key to the new sanctions: freezing major Russian companies out of the global, dollar-based financial system (the ‘matrix‘ I wrote about earlier). Strangely, statements from Russian officials have vacillated from claiming that the sanctions have no impact to admitting their devastating consequences. The news yesterday, however, seemed to corroborate the latter group: Rosneft is requesting $42 billion in emergency funding from the Russian government to offset the effects of the sanctions. To put this figure in perspective, here are some fun statistics about what $42 billion represents:

  •  2% of Russia’s GDP
  • 24% of the Reserve Fund+National Wealth Fund
  • 41% of Rosneft’s revenues
  • 472% of Rosneft’s net income

At the same time, oil prices have remained low despite the conflicts in Ukraine, Gaza, and Iraq, thereby limiting the financial levers available to Moscow.

oil price

 

And this is only a few weeks after the new sanctions went into effect – it will get worse (perhaps far worse) before it gets better. Indeed, it will arguably get worse for both Russia and the West.

But the sanctions are working, right? Not really, if the aim is to influence Russian policy. Indeed, an internal Sberbank note on the sanctions comes to the following conclusions:

1.       We can be fairly certain that sanctions will not succeed in compelling Russia to reverse course as Russia is a textbook case of a country that will not respond to sanctions. It has a strong leadership with popular support, already poor relations with the West, an alternative supporter in China, and a high perceived cost to amend its policies.  

2.       We should expect sanctions to go on until the situation in Ukraine is resolved through victory or negotiation.

3.       It may be that sanctions are just for domestic consumption in the West, and this is clearly what the market hoped at the start.  However, there is a danger that sanctions are ratcheted up until they really do cause economic damage in a (probably futile) attempt to make the costs outweigh the benefits. 

4.       The West can’t afford to stop importing Russian energy, and Russia can import most goods from Asia, so the key sanctions levers that the West has are high tech exports and financial markets.  As we have noted many times, Russia is highly unusual to have such large and integrated financial markets and yet to defy its providers of capital.

5.       We reiterate our longstanding view that the option value of Russian shares lies at around 1,000 on the RTS, that the oil sector is the safest place to be within the market, and that the banks are the area most exposed to sanctions. 

6.       The main hope for the next market bounce centres on a new attempt to negotiate a comprehensive solution.

Thus, the sanctions are unlikely to influence the behavior of either side. But missing from this analysis is the broader, long-term consequences of Russia’s decoupling from the international system. At some point, it will not be so easy to just ‘flip the switch’ and go back to how things were circa February 2014. If the sanctions have the effect of freezing Russia out from access to international finance and investment – or at least dramatically increases the costs of accessing such finance/investment – then this will turn out to have been a bad month for Putin indeed. The only way for Putin to avoid such a scenario is to blink first or, given his perfected media manipulation machine, declare victory and leave Ukraine alone (a more likely scenario in the event oil prices suffer further declines). In other words, Russia could go back to Feb. 2014 or on the road to N. Korea, and it’s all up to one highly unpredictable man. Sounds like a paradise for foreign investment.

Posted in Economic development, economics, Foreign direct investment, foreign investment, foreign policy, moscow, Novatek, oil, Putin, Rosneft, Russian economy

Strategic Sectors Law Update – First Commission Meeting of 2014

On June 26, 2014, PM Medvedev chaired the first 2014 meeting of the Commission on Foreign Investment. At the meeting, several deals were discussed/approved and amendments to the Strategic Sectors Law were discussed.41d4eb09b1f883a168e5

According to public sources, the following deals were addressed:

  • Fresenius Kabi (Germany) -> Binnopharm/Alium – the German-based Fresenius Kabi purchased stakes in Binnopharm and Alium from Sistema JSFC and other shareholders. The acquired companies manufacture pharmaceuticals in Russia such as Combivir (HIV treatment), Salbutamol (asthma), and Erythopoietin (anemia).  Fresenius Kabi will own 51 percent of a joint venture that will hold 100 percent of the companies’ shares (Sistema will retain 37 percent and Zenitko 12 percent).
  • Palfinger (Austria) -> Velmash – Palfinger of Austria together with Steindl Forsttechnik GmbH purchased respectively 60 percent and 20 percent interests in Velmash, a Russian manufacturer of hydraulic loading and unloading equipment. The remaining 20 percent will be held by PMHJ Holding Global Ltd., about which there is literally no information on the internet. I suspect it is either
  • EuroChem (Russia*) -> Astrakhan Oil & Gas Company – EuroChem (ЕвроХим) is purchasing the Astrakhan O&G Company (ANGK). The deal was subject to the Strategic Sectors Law despite the beneficial owner of EuroChem (Andrey Melnichenko) being Russian because, as usual, the transaction was done through various offshore trusts/companies. FAS had previously delayed the deal over competition law concerns. In February of this year, EuroChem acquired 20.1 percent of ANGK for RUR 1.34 billion (USD 38.09 million). The previous owners of ANGK were Gazprombank and the Federal Agency for State Property Management.
  • Abbott Laboratories (U.S.) -> Veropharm – the meeting touched on an application by Abbott to purchase an ownership stake in Veropharm (Верофарм) for USD 495 million from OOO “GardenHills” (ООО ГарденХиллс”), a holding company owned by Roman Andreev with 80 percent of the shares Veropharm. GardenHills recently purchased most of the outstanding shares, which previously traded freely on the RTS. FAS head Igor Artemev stated that Abbott submitted an ‘incomplete application’ and had inquired about the missing documents, which prevented the commission from approving the deal that day. Artemev alluded to a deal from 2013 that the commission denied – Abbott’s proposed acquisition of Petrovaks – but added that he thinks the Veropharm transaction will be a success.

Proposed Amendments to Strategic Sectors Law

Artemev also summarized developments with proposed amendments to the Strategic Sectors Law, which have been dragging out for quite some time. The draft law has already been approved in the first reading, and the second/third readings – which will contain a number of amendments – are scheduled to be done later this year. Here is a copy of the latest version of the amendments, which you can track here.

 

Posted in Business, Business and Economy, Dmitry Medvedev, economics, FAS, Foreign direct investment, foreign investment, Gazprombank, legal update, legislation, oil, pharma, russia, strategic industries