Self-Interest and British-Russian Relations

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In early 2000, the British Embassy in Moscow took a bit of a gamble. They persuaded then-Prime Minister Tony Blair to meet with the new face in the Kremlin and heir apparent -- then-acting President Vladimir Putin. This was one of Blair's first major foreign policy initiatives. At the time, it was a bit of a shocker -- a popular, powerful, top-level, democratically-elected leader meeting with an unelected, unknown, KGB spy who was failing to manage a bankrupt country overrun by shady oligarchs.

The irony of the current situation is that it illustrates what a far-sighted step the British Embassy took at the time. In early 2000, Putin was weak and Russia was dangerously unstable. Britain's influence in Russia was somewhat limited during the '90s by the much firmer relationship between Boris Yeltsin and former German Chancellor Helmut Kohl. As Russia gradually emerged from the hangover of the '90s, and a shockingly competent Putin began to find a place for Russia on the global stage, the British-Russian relationship helped both sides. For a brief period from 1999 to mid-2002, Britain was perhaps Russia's closest Western ally. Putin benefited from Britain's political recognition and Britain remains Russia's most important partner in finance and business. The recent expulsions of diplomats is important partly because the British-Russian relationship matters so much to both sides.

Blair's successor seems equally keen to use Russia to demonstrate independence in its foreign policy. While Blair was the first world leader to publicly accept a post-crisis Kremlin, British Prime Minister Gordon Brown appears to be the first to draw a definitive line in the sand. It has been a long time coming, but the expulsion of the four diplomats sent a clear message to the Kremlin: The long era of making allowances for the post-Soviet mess is ending. Strangely enough, this may be partially beneficial for the Kremlin. As long as investment continues to flow in both directions, tit-for-tat diplomat expulsions play well politically to the domestic audience and demonstrate an international equality of sorts.

The immediate cause of the squaring-off between Russia and Britain is something of a red herring. There was no way that Russia was ever going to hand over Andrei Lugovoi for trial in Britain. The decision in the end was political, not legal. It reflects the far from incomprehensible stance that if London will not countenance the extradition of Boris Berezovsky and Chechen rebel envoy Akhmed Zakayev, then there is no good reason to cooperate with Lugovoi. London's argument that Britain's refusal to extradite is legal, not political, seems only as relevant to Moscow as the Kremlin's argument that Lugovoi cannot be extradited because it is against the Constitution.

The Britain-Russia standoff is the latest symptom of a larger conflict -- a jockeying for position as Russia reasserts its interests globally. Defining the confrontation as a new Cold War is misleading. Relative to the grotesque East-West confrontation during the Soviet era, the current tension in British-Russian relations is a fairly petty affair. It is a conflict of realpolitik that is messy, irritating and ugly, but not globally destabilizing -- more of a global cold sore than a global Cold War.

Russia has in recent years proven rather inventive at getting what it wants. For example, it appropriated Yukos, renegotiated the Kovykta and Sakhalin oil and gas deals, while inviting Total into the huge Shtokman project in the Barents Sea and inviting Germany to join the Baltic Sea gas pipeline. Moreover, it criticized the United States and Britain in the Middle East, while keeping options open with Iran. It is also building stronger ties with China while demonstrating a willingness and ability to cut energy supplies to Europe.

In addition to these inventive initiatives, there have been the downright irascible: hounding the British ambassador in Moscow, Tony Brenton; allegedly attacking government and tourist web sites in Estonia; banning wine and water imports from Georgia; and taking the visa registration process to a new level of bureaucratic absurdity.

Of course, both sides will argue that the other is at fault. Certainly, Russia's lack of institutional flexibility and the resulting difficulty in efficient implementation of policy leaves Russia looking less polished. Similarly, the limited checks and balances in the political system and the consequent lack of input into the decision-making process explains some of Russia's mistrust and occasional myopia.

But Russia would probably argue that the final justification for its current tactics is that they work. Unlike the Baltic states, Georgia and Ukraine have so far been prevented from moving closer to NATO. The bellicose threats to retarget Russia's nuclear arsenal has slowed plans to install a missile defense system in Eastern Europe.

While relations with Britain are tailspinning, those with France are improving, following Total's exclusive invitation to join Shtokman. Last year was the Year of Russia in China, and 2007 is the Year of China in Russia. BP is looking for new partnership opportunities with Gazprom. Rosneft has been the best-performing large Russian hydrocarbon stock since its initial public offering. Foreign policy under Putin seems to reflect popular opinion closely.

The tougher stance of Brown's new government is therefore interesting. Britain's recent willingness to see its political relationship with Russia deteriorate to new post-Soviet lows is the most extreme example of a what seems to be a new determination on the part of at least the United States and Britain to act more firmly toward Russia. While Italy and France still seem keen on erring toward engagement, German Chancellor Angela Merkel also seems more willing to push back than her predecessor.

The Western political community seems ready and willing to be more aggressive toward Russia. The hope that the Kremlin's prickliness was a passing phase on the transition to a Western model seems to have faded. This will likely have consequences. Russia will continue to kick back hard on Georgia and Ukraine. Any support over Iran will be linked to Kosovo. The missile defense plan is a terrific provocation given what Moscow views as broken assurances from NATO regarding expansion into Eastern Europe. The retargeting of missiles and the tearing up of arms agreements are designed to upset the West to the same degree. I don't believe that the trial balloon of threatening the Bank of New York over alleged money laundering was a casual undertaking.

But the deteriorating politics do not need to have an impact on business or finance. On the same day Britain announced that it was expelling the diplomats, the Russian equity market posted its highest close ever. With $12 billion of investment, Britain was the second biggest foreign investor in Russia in 2006, and most of the investment was in retail, communication, trade and construction. BP announced recently that it wanted to increase cooperation with Gazprom to invest more into Russia. Purportedly, 50 percent of all apartments sold in London for more than ?1.5 million ($3.1 million) are bought by Russians. There is no sign of any decline in the desire of Russian firms to list in London and vice versa.

Outside of oil and gas, Russia needs massive foreign financing for the investment needed to retool after 20 years of underinvestment. Russia will be the largest car market in Europe by 2010, by which time it could be a bigger car producer than Britain. China expects to quadruple trade with Russia to $80 billion by 2010.

Britain was right and far-sighted to engage with a weak and uncertain President Putin in 2000. Engagement then helped create the strong and self-confident Russia that it is today. As a result, Russia is able to push for its own interests internationally and to become an increasingly important and integral part of the global financial and business community.

Britain is probably taking the correct position when it shows its willingness to face up to a stronger Russia. Politics based on self-interest are evolving and are likely to continue to look rather ugly, particularly given Russia's institutional weaknesses and peculiarities. But by the same token, the business and financial relationship is likely to continue to deepen because that is also where the mutual self-interest lies.

Roland Nash is managing director and head of research for Renaissance Capital.