Russia Defence and Security Report Q4 2008

Quite clearly, the immediate position for Russia is going to be dominated by perceptions in the region of its actions in South Ossetia. If it is seen as strong, decisive and effective then Russia's prestige and influence will be enhanced. On the other hand, if it is seen as belligerent, or even irresponsible, then its standing may be weakened, irrespective of the military situation on the ground. The worst outcome would be an ongoing and indecisive situation such as that in Chechnya.

On a slightly longer term view, the government in Moscow has formulated a plan for re-organisation of its military structures that is ready for implementation. One clear goal of the government-led plan is to have 70% of the armed forces professionalised by 2008, setting targets of professionalising 50% of all sergeants and recruits by 2007, and a quarter of all service people to be employed on a contractual basis by 2008. Resources have also been allocated for rearmament.

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 figure for 2006 was expected to grow by a further 5%. The government arms-exporting agency Rosoboronexport predicted that foreign military sales (FMS) in 2007 would have reached the US$7bn mark.

The boost to the Russian economy provided by surging energy prices in the first half of the year is unlikely to last beyond 2008. We maintain our core view that real GDP growth will decelerate markedly over the medium term, though remain relatively robust. We stress though, that the boost to overall growth provided by the surge in energy prices is unlikely to be sustained beyond this year. The greatest risks to our forecasts lie in the short term. While the Russian economy fundamentally remains a strong strategic growth story, there are worrying signals that the risks to private consumption growth are likely to elevate further through the remainder of 2008. Inflation, in particular, remains a core concern, with headline CPI growth showing little indication of decelerating as yet. The latest consumer price growth figure for July, at 14.7% y-o-y, was down only slightly from the previous five-year high set the month before.

Foreign policy under the new Russian president Dmitry Medvedev is expected to remain largely unchanged from the direction set under his predecessor Vladimir Putin. Indeed, our core view is that Moscow will continue to make efforts to enhance its position within the Commonwealth of Independent States while also taking a more proactive position on global issues. That said, we maintain that on economic matters, Medvedev will take a more conciliatory approach, which bodes well for improved ties with the EU and US.