Under Pressure: How are the sanctions impacting the Russian Economy?

One year has passed since the beginning of the conflict in Ukraine. The situation on the battlefield seems uncertain, mainly due to the military and financial aid from the West to Ukraine. Also, despite several efforts from this block to discourage Putin from pursuing the war, the financial and economic sanctions imposed on Russia seem not to have had a clear impact on Russia's Economy. According to the International Monetary Fund (IMF), in 2022, the Russian economy only shrank by 2.2%, contrasting with the 15% fall in Gross Domestic Product (GPD) analysts expected in March 2022. Energy-related products allowed a current account surplus of approximately 300 billion dollars. The financial system stabilised, as well as inflation levels (12%). Unemployment rates have hit the lowest values since the collapse of the Soviet Union (4%). So, why haven't the punishments on Russia caused a heavy short-term shock on the country's economy?

In response to the invasion, the West prepared a new sophisticated package of sanctions on Putin's autocracy, aiming at triggering a liquidity and current account crisis in Russia that would significantly reduce the resources available to pursue the conflict. In the long run, these measures targeted to diminish Russian productive capacity and technological superiority, attempting to reduce Kremlin's ability to engage in a future war. Hence, the international community implemented several measures against Russia, such as cutting off Russian banks from the SWIFT international payments system, interdicting Russia's access to the EU's capital and financial markets, restricting oil imports or prohibiting Russian firms from buying certain goods, with potential use for military purposes. But it seems the Kremlin had started to strengthen the economy long before the beginning of the war.

In fact, after Russia annexed Crimea in 2014, not only it started to accumulate a large stock of international reserve assets, which was revealed to be important in controlling the ruble collapse immediately after the war broke out, but also diverted its financing partners from the West into China. Analysing data on cross-border syndicated loans to Russia, one can conclude that, from 2012 until 2022, China has become the principal lending source of Russia.

Relative to trade between Russia and the West, the first sanctions packages focused more on Russian imports than on exports, meaning that exports from EU countries have decreased more than the trade flows in the opposite direction. Moreover, although those countries have started reducing energy purchases from Russia, the recent spike in energy prices provoked an increase in Russian exports from the beginning of the conflict until November 2022. Since the share of crude and oil products in total exports and in the federal budget revenues are 40% and 30%, respectively, the associated current account surplus allowed Russia to protect its financial system and finance the war. The recorded balance of payments has also prevented the Russian GDP from falling abruptly.

Although Russia's main indicators of economic activity do not portray the real impact of the sanctions, it is relevant that the retail sector, where the majority of the country's workforce is employed (18.75%), fell 10% in 2022. Also, more than 500 thousand people left Russia since the beginning of the war, revealing discontentment and concern amongst the Russian people.

In an attempt to further suffocate Russia, the oil price cap of 60 dollars per barrel applied by the G7, EU and Australia, as well as the EU's ban on Russian crude imports may be promising measures to tighten Russia's current account, once that Europe is the principal client of Russia regarding those products. By March 2023, the year-on-year variation of the Russian oil and natural gas prices was deeply negative (of 30% and 40%, respectively and approximately). Also, if the ruble continues to depreciate against the dollar, the Central Bank of Russia may reintroduce interest rate hikes to keep inflation stable. An interest rate increase and a potential shrinking of the current account surplus may contribute to a deep economic recession in Russia in 2023.

In the short term, sanctions did not have the desired impact on Russia’s economy. However, the situation is expected to worsen in the foreseeable future. The decrease in trade and knowledge flows is isolating Russia from the international community. Perhaps, this exclusion from the global sphere will lead to its collapse, as it did for the Soviet Union.

Manuel Varela