Russia Defence and Security Report Q1 2009

As the financial crisis in Russia deepened in October 2008, the government was particularly proactive in developing policy mechanisms to shore up the economy and domestic capital markets. Thus far, Moscow has announced approximately US$200bn in varying forms of financial aid for struggling banks and corporates. Cheap capital has also been put on offer from the Central Bank of Russia (CBR) which had lent RUB182bn in unsecured funds to Russian banks.

We expect the government to continue aggressively providing support for the economy, especially as conditions are expected to worsen in 2009. There is also recognition from government officials that revenue growth was likely to stall in line with falling oil prices.

We have slashed our growth forecasts for Russia to take into account a rapidly decelerating global economy, falling oil prices and tightening credit conditions in the domestic banking sector. While a robust H108 performance ensured that full-year growth in 2008 remained relatively strong at 5.9%, economic expansion is expected to fall markedly further to an 11-year low of 3.6% in 2009. We expect a general recovery to begin in 2010, with headline real GDP growth forecast to come in at 4.8% that year and average 6.4% between 2011 and 2013. Russian economic growth is expected to remain highly correlated to global commodities prices through the long term and by 2010, oil prices are forecast to rise back above the US$80.00/bbl level.

Approval ratings for Russian President Dmitry Medvedev and Prime Minister Vladimir Putin sagged in October as concern over the direction of the economy overtook the widespread support for the war with Georgia as the most prominent public issue. However, both Medvedev and Putin remain by far the most popular politicians in the country, and there is no credible opposition that is in a position to take advantage of falling government support.

Russia's August 7 2008 invasion of Georgia will continue to cause tensions in its bilateral relationships with the EU, US and several of its neighbour states through the medium term. This has prompted a reappraisal of the country's political risk profile especially as it will likely delay the achievement of core foreign policy objectives including membership in the WTO and OECD, as well as a partnership pact with the EU. We stress, however, that elevated tensions do not mean a return to Cold War-era policies or tactics. Ultimately, the deep economic integration between the EU and Russia will ensure that the longterm impetus remains toward improving relations. While the EU remains overwhelmingly dependent on Russia as an energy transit corridor, as well as primary source of natural gas and oil, this is also reflective of Russia's dependence on the EU market which accounted for 50.8% of total Russian exports in 2007.

We believe that the most significant foreign policy precedent of the war applies mainly to what Russia refers to as its 'near abroad'. By establishing that it is willing to breach national sovereignty, Moscow has sent a clear message to capitals throughout the CIS, Georgia and Ukraine that its core strategic interests should not be ignored.

As a result of the growing internal conflict in the North Caucasus, Russia has decided to place greater operational emphasis on Special Forces. Developments in Chechnya in 1994 and 1999 showed Russia that regular armed forces were not able to deal with the low-level conflict, and that, more importantly, conscripts were not able to deal with the rigour of an insurgency. What was needed was a professional force dedicated to dealing with insurgencies. Russia's State Weapons Programme 2015 underwent refinement in 2006. The main aim is to provide Russia with a modernised nuclear deterrent force and to enhance the army's poor public image. The armed forces were reduced by 200,000 in 2005 in a bid to professionalise the Russian army.

Russia maintains a massive defence industry that, despite pain associated with modernisation, restructuring and excess capacity, supports a thriving export industry. Russia is at least challenging, if not surpassing, the US in terms of total defence industry exports. In 2005, Russia exported US$6.1226bn worth of military items and the government arms-exporting agency Rosoboronexport predicted that foreign military sales would reach the US$7bn mark in 2007.