Russia is about to plunge into financial crisis. How will citizens react?
But these are not normal times in Russia. After launching an invasion of Ukraine just days ago, Russia is facing some of the toughest financial sanctions any country has faced in modern history.
Russia is about to plunge into financial turmoil
Many Russian central bank assets are currently unusable due to EU and US actions. In addition, many large Russian banks will soon no longer be able to use SWIFT to settle payments. Meanwhile, the value of the ruble is collapsing in local markets. Although the markets are not open at this time, reports indicate that its value went from around 70 to the dollar to 150 to the dollar in after-hours trading.
All this gives the impression that the financial system is fragile for Russian citizens. They responded today by withdrawing hard currency from ATMs across the country. Because it’s Sunday, the banks aren’t even open for regular service, so we won’t know until Monday how badly Russians will react to the financial turmoil.
Indonesia offers some lessons on what could happen
What happens when a regime like Vladimir Putin’s in Russia faces bank runs and a currency crash?
Political scientists have studied the political consequences of financial crises. In my 2009 book on the Asian financial crisis, I wrote about what happened to Indonesian dictator Suharto when it became clear that Indonesian banks were insolvent and the currency was in free fall. Suharto’s struggles in 1998 suggest that Putin could face real economic difficulties in the coming days.
Like Putin, Suharto bolstered his dictatorial rule through close ties to an elite group of wealthy elites (known in Indonesian as the “konglomerat”). Like Putin’s oligarchs, these super-rich elites oversaw wildly diverse business empires that blurred the lines between public and private authority. And they too owed their wealth to the patronage and patronage of Suharto.
Much like Putin in 2022, Suharto in 1998 was seen by many Indonesians and foreign observers as erratic. He was prone to quick decisions and quick reversals, and seemingly blind to the consequences of his actions, such as forgoing an IMF bailout to protect his youngest son’s monopoly on cloves.
Of course, Indonesia had not invaded any neighboring country in recent years, so the specific drivers of the Indonesian crisis of 1998 were different from Russia’s emerging crisis of 2022. But the financial fallout could be quite similar.
Putin’s big financial challenge is to convince people that there is nothing to worry about with their money – they will be able to access it when they need it. This confidence will prevent the risk of panic on Russian banks. But just talking about financial stability can make people nervous. If everyone wants to access their savings by withdrawing cash from ATMs, banks may not be able to cope. People’s individual strategies to protect themselves can cause a banking crisis in which everyone suffers.
Putin doesn’t have many options
Putin’s options to solve this problem are limited, as are Suharto’s. His choices boil down to this: print lots of money on demand to cover all withdrawals; increase very high interest rates; or implement any monetary controls.
The first option generates inflation. It also doesn’t really help solve the main problem: high inflation will cause people with rubles to convert those rubles into dollars, gold or something else with a more stable value. This would push the value of the ruble even lower.
The second option aims to keep money in the banks (and rubles in Russia) by offering much more attractive returns to holders of ruble savings. But this is unattractive for many other reasons. With luck, this may eliminate inflation, but it may also bring spending and investment to a screeching halt in Russia. It can avoid the financial crisis, at the cost of a generalized recession.
The third option seems to be the most interesting. Indeed, it is an option that Prime Minister Mahathir Mohamad monitoring during Malaysia’s economic crisis in 1998. But it was highly unpopular among Malaysia’s wealthier elites, who were no longer able to move their savings and investments across borders. Moreover, in Russia today, such controls should be combined with controls on bank withdrawals to strengthen the national financial system itself. Russia’s central bank proclaims its financial system to be liquid precisely to avoid having to.
I argue in my 2009 book that the Indonesian oligarchs thwarted Suharto when he tried to implement the same solution in early 1998. They only supported Suharto as long as they could transfer their money overseas if necessary – a powerful check on Suharto’s power to behave in ways they didn’t like. When the political situation turned sour in Indonesia, the oligarchs left with their money almost overnight.
Foreign sanctions may mean Putin doesn’t have to worry so much about oligarchs fleeing abroad with their money. Tough sanctions against his closest oligarch supporters mean they can’t spend their money overseas anyway. Even so, currency controls and withdrawal bans would likely cause a full-scale financial crisis overnight.
It is difficult to see how Russia’s domestic financial turmoil will end. The next 24 hours will be one of the most eerily interesting financial policies Russia has seen since its two most recent financial crises, one of which (in 1998) ultimately paved the way for Putin’s rise to power.
In the meantime, however, Ukraine’s supporters in the international community may be considering how to leverage Russia’s threat of financial collapse to their advantage. Giving the oligarchs an exit option could provide the leverage they want to restrain Putin’s aggressive and destructive international behavior, showing him its domestic consequences.
Thomas Pepinski is Walter F. LaFeber Professor of Government and Public Policy and Director of the Southeast Asia Program at Cornell University, and Nonresident Senior Fellow at the Brookings Institution.