Russia's Big Chill

If you want to take the pulse of Russia, as its oil and gas boom of the past few years comes to a sudden and wrenching stop, leave behind the garish consumerism of Moscow and drive 220 miles (354 km) southwest to the small Russian town of Lyudinovo. For the first part of the five-hour trip the road is a smooth four-lane highway that whisks you past gleaming gas stations and a brand new Samsung TV factory. Then everything slows down. The highway turns single-track and becomes progressively rougher. For the last 20 miles, you bump along the ruts, distracted only by the swaying rows of silver-birch trees that flank the road.

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There's nothing flashy about Lyudinovo (pop. 47,000), whose name translates roughly as People's Town. The central square is a traffic island with a Soviet T34 tank on a pedestal, a World War II memorial. Next to it is a farmers' market, where babushkas from nearby villages with woolly hats and dodgy teeth sell homegrown carrots and potatoes for 25¢ per pound. But look closer, and it's clear that even Lyudinovo isn't frozen in time. A shopping emporium that opened a year ago sells South Korean refrigerators, French yogurt and fake Italian pumps. Several houses are being built on the outskirts — the first new residential construction in more than a decade. And until recently there was plenty of work for everyone at the five factories that employ the bulk of the townsfolk. (See pictures of Russian aristocracy.)

No longer. Starting in early November, four of the five factories abruptly informed their workers that they were switching to a three-day week. Then the layoffs started. The cast-iron foundry, which pays the best wages, cut 80 of its 1,200 workers, and managers announced that they might have to fire up to 600 more. The cable factory — which just this year started up a new production line — laid off 40 people, and cut pay for those who remained by 15%. At least they're being paid: the machinery factory nearby is two months in arrears. "People woke up one day and everything had changed," says Ivan Pronin, the editor of the local paper, the Lyudinovo Worker. "It's like a hurricane blew through here all of a sudden."

As the world financial crisis buffets country after country, Russia was never going to be spared. It's in much better shape than it was during the last financial crisis, in 1998, when the ruble collapsed and the country defaulted. This time, Russia has $450 billion in foreign reserves left from the $600 billion it had amassed thanks to the soaring energy prices of the past few years. Its biggest banks, all of them state-controlled, appear to have largely avoided the toxic assets that have been the downfall of so many of their counterparts in the U.S. and Western Europe. Yet Russia has been caught unawares by the domino effect of the financial crisis because of its unhealthy overdependence on oil, gas and metals, which account for more than three-quarters of export earnings. The collapse in energy and commodity prices since this summer is exposing Russia's fragility: the boom, it turns out, was built on expensive oil, and precious little else. Economic growth, which averaged more than 7% for the past five years, has tumbled and may drop below 2% next year. And for the first time since the collapse of the Soviet Union in 1991, the threat of large-scale unemployment looms. "Money was falling from the sky in the past two to three years," says Maxim Oreshkin, the head of research at private-sector Rosbank in Moscow. "Now it's stopped falling."

This all amounts to the first serious test of "Putinomics" — the domestic policies put in place by Prime Minister Vladimir Putin during the two terms of his presidency from 2000 to 2008, and continued by his successor, President Dmitri Medvedev. While oil money was pouring into the state's coffers, the Kremlin was able to dispense largesse to ordinary Russians through generous social spending programs and hefty pay raises awarded by the monolithic state companies that dominate the economy. Jobs were plentiful, and over the past five years, average wages have risen by 25% annually. Even then there was money left over, which the government put into a rainy-day fund — never imagining that it would need to draw on it so soon.

Today, Russia's finances look a lot less robust. The government budget was based on oil at $70 per barrel, way above the current 
 level, and it will consequently swing into deficit next year for the first time since 2001. The stock market has dropped more than 70% in the past year, as the nation's business élite dumped stocks to repay the huge loans they took out to finance acquisitions in Russia and abroad. Capital is fleeing — investors have pulled about $190 billion out of Russia since August — and the ruble is under pressure.

At first, the Kremlin tried to prop up the currency, but after blowing through tens of billions of dollars in September and October, it changed course in mid-November, and has since begun a policy of phased devaluation. That's calling up bad memories of the ruble's collapse in 1998, and prompting nervous talk around kitchen tables about what to do this time around. On Dec. 4, Putin fielded vetted questions from around the nation on a televised call-in show. One of the most poignant was a text message from an unnamed viewer: "What will happen to the ruble, and what is the best currency to keep deposited in the bank?" Putin's hopeful reply: "There will be no sharp fluctuations in the ruble's exchange rate."

Lyudinovo's woes are not exceptional. The markets for the huge exporting firms that are the foundation of Russia's recent prosperity have suddenly dried up, and that's having an immediate effect on machinery makers and other manufacturers. Construction has also seized up in many places. Last month in Moscow, lack of funding stopped work on a Norman Foster — designed skyscraper called the Russia Tower that was going to be the tallest naturally ventilated building in the world. (See pictures of Moscow.)

The biggest fallout to date has happened in cities that are wholly dependent on one big industry, especially steel or autos. In the Urals town of Magnitogorsk, a gigantic steelworks has placed 3,000 workers on forced leave. In Novolipetsk, to the east of Lyudinovo, thousands more have been furloughed since Nov. 14, when the steel factory idled two of its blast furnaces. Alexei Mordashov, one of Russia's best known oligarchs, has shelved an $8 billion investment program at his Severstal metals company that was scheduled for 2009-2011. The government now estimates that companies will lay off about 200,000 workers over December and January, but that's probably an understatement. Yevgeny Gontmakher, an economist who heads the Russian Academy of Sciences' Social Studies Center, expects that Russia's official unemployment rate, long below 6%, will be twice that level in 2009.

Lyudinovo is no stranger to unemployment: it suffered a bad bout in the early 1990s, when several of the town's factories closed and 4,000 workers lost their jobs. But by this October, after a run of good years, the number of unemployed people had fallen to just 320. That number doubled in November, and for next year all bets are off. "This is just the beginning," worries editor Pronin.

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