Is Russia Winning The Economic War?
Vladimir Putin announced in a speech last month that Russia had weathered the worst of the Economic sanctions imposed by Western nations. He said that gloomy predictions about the Russian economy s future didn t come true and that the sanctions had hit foreign economies much harder than they had hit Russia. He added that "The weaponry of sanctions is a double-edged sword and European countries had dealt a serious blow to their own economies all on their own.
Putin boasted that Russia had gotten inflation under control at 17.6 per cent, saying that it was below the levels in some European countries. Putin's supporters in the west make similar arguments, mostly because it is easier to question how effective the sanctions are than to defend the morality of the invasion of a neighboring country. At the same conference Putin raised many eyebrows with his claim that he views the entire former Soviet Union as being a part of "historical Russia".
Economic sanctions have been a tool of statecraft for quite some time. And it is obvious why nations might favor this approach when dealing with a nuclear armed country like Russia. Sanctions are frequently criticized as being ineffective, but they still appear to have become the policy tool of choice for western nations in the post-cold war period. Russia first invaded Ukraine in 2014, annexing Crimea and has been under sanctions since then. These much milder sanctions failed to deter the full-scale invasion that we are seeing right now, so it is of course worthwhile trying to understand if this approach has a significant impact or not. In the same speech where Putin claimed that Russia is mostly unaffected by the sanctions, he described them as "a declaration of economic war".
So, we possibly need to take his claim that they are ineffective with a pinch of salt. When analyzing the effectiveness of sanctions, we also need to ask ourselves whether they should be imposed one way or another in certain situations, simply for moral reasons. Anyhow, almost seven months have passed since Russia invaded Ukraine and the additional sanctions were imposed on Russia. So, let s look at how the Russian economy is holding up? Is Europe really hurting more than Russia? How porous are the sanctions? and why has the Ruble managed to show such strength over the period? OK, so Europe and the rest of the world have been impacted by the Russian Invasion of Ukraine and the imposition of sanctions. In particular in Europe this is showing up in the inflation numbers, but the sanctions are also affecting global supply chains, and businesses that either source goods from Russia, Ukraine and Belarus, or sell goods into the region will have been significantly impacted.
I made a recent video on the European Cost of Living Crisis, that covers many of these issues. The surge in energy prices and other associated inflation means that the OECD has reduced its forecast for the eurozone s growth this year from the 4.3 per cent it had projected before the war to 2.6 per cent which is now expected for 2022. The OECD had expected eurozone growth of 2.5 per cent for 2023 and that has since been revised down to 1.6 per cent. The German economy which is particularly reliant on energy imports from Russia is expected to see a 0.3% decline in GDP next year.
The British economy began to contract in the second quarter and even the latest UK government aid announcement has barely reduced the probability of recession. The gloomy economic outlook can be seen in the Eurozone Consumer Confidence figures which look worse than they did in March 2020 and at the lows of the global financial crisis. Western central banks have blamed the conflict for exacerbating inflationary pressures by triggering sharp rises in the cost of energy and food. The sanctions mean that Europe has been starved of gas, grain and fertilizer this year. Euro area inflation is around 9% right now, which is very high, but significantly below the 15% - 20% rate that has been seen in Russia.
So, in throwing this economic punch, Europe has definitely hurt its fist, (and that should be expected there is a cost to everything) but how has Russia s economy held up to the blow? Well, to start with around 60% of Russia s Central bank reserves were frozen back in February, and that money is unavailable to Russia at present it is sitting unused at central banks around the world to eventually be unfrozen at some point. On top of that around $30 billion dollars of Russian oligarchs and officials assets that were stored outside of the country were frozen too. Both of these things will have a significant effect on Russia s economy and its ability to wage war.
We can clearly see that despite what Putin says, the Russian Economy is shrinking, and GDP is expected to contract by 6% this year and to shrink a further 3.5% in 2023. This is the worst economic upheaval that Russia has seen since the Soviet collapse in the early 1990 s. Russia has stopped publishing many economic statistics, making it difficult to judge how hard sanctions are biting, but the available data shows significant signs of distress. A lot of the data I am using for this video is from a Yale University Paper and I ll put a link to it in the video description below. In the first seven months of the year the Russian held up reasonably well and managed to run a trade surplus of around eight billion dollars. While they were selling less oil and gas, they were selling it at a higher price, and this helped the Russian economy.
That budget surplus however almost entirely evaporated this August when Russia ran a 6-billion-dollar budget deficit. This was mostly caused by a sharp drop in energy exports. That situation will be worsening right now since the closure of the Nord Stream 1 pipeline. On top of this, there are additional European sanctions scheduled to kick in in December of this year, and again in February next year that include a complete ban on all Russian seaborne crude oil and petroleum products.
This is a big deal for Russia as the country s export earnings mostly come from commodities and raw materials. Energy revenue makes up almost 60% of total Russian government revenue. Besides oil and gas, other revenues within Russia (from January August of this year) fell by 37 per cent year on year. Imports are down 35% and Exports are down 31%.
Manufacturing of automobiles and other goods has collapsed because Russian companies can't import the necessary components. You can see this getting worse and worse on a month-by-month basis. Airlines have slashed international flights and are laying off pilots. When they do need to repair airplanes, they cannibalize parts that they can no longer import from other grounded planes in the country. Car production according to Russia s state statistics agency fell by almost 62 percent in the first half of the year.
The Lada factory stood idle for months before resuming production in June with an "anti-sanctions" car model that has no air bags, no anti-lock braking systems, no air conditioning or emission controls. There has been an absolute collapse in vehicle sales in the country as most of the models are no longer available. Pretty much every industry is showing much lower production this year. The sanctions are hampering Russia s ability to re-stock high tech weapons due to the unavailability of computer chips and semiconductors that are used in advanced military equipment. Right now, Russia is restocking with weapons bought in from Iran and North Korea. Countries not noted for their technology.
To keep the unemployment rate stable at 4 percent, the Kremlin has been pushing distressed Russian companies to put workers on partially paid leave or to shorten their hours instead of laying them off. Automobile manufacturing for example - used to employ 600,000 people in Russia. Many of those workers have been furloughed and are being paid two-thirds of their usual salaries.
This strategy might help prevent unrest in the short term, but it is not sustainable in the long term. Tikhvin is a small two-factory town in Russia, around 100 miles east of St. Petersburg. Both the Ikea factory and the Freight Car Plant the main employers in the town - have halted production due to sanctions. This has led to mass layoffs and furloughed workers. Other small businesses in the town that supported these factories like trucking firms and caterers are short of work too.
Retail sales in Russia have fallen 20 percent compared with a year ago as Russians slashed their spending. About 1,000 western companies, accounting for almost 40 per cent of Russian GDP, have curtailed operations in the country. Consumer confidence is at its lowest level since 2015, and surveys show that 78 percent of Russians no longer plan on making any major purchases in the near future.
Both cars and parts to repair cars are especially difficult to source in Russia at present, secondhand parts sellers on social media are filling some of that gap, importing used car parts from Kazakhstan and Belarus at huge markups. The official sanctions are not the only thing impacting Russia s economy. International traders are reluctant to deal with non-sanctioned Russian commodities, both for reputational reasons and for fear that they will become sanctioned while in storage.
Urals crude the Russian grade of crude oil - often sells at as much as a $35 per barrel discount to international crude oil prices. So, there is no way around it, sanctions are definitely impacting the Russian economy, and Russia is suffering significantly more than the western nations that are imposing these sanctions. That should probably be fairly obvious anyhow, but it doesn't hurt to dig through the numbers. In many ways though, Russia s economy is holding up better than many including me - had expected.
Some quick moves by Russia s central bank to impose capital controls and sharply hike interest rates partially stabilized the ruble. Higher global oil prices, offset the "Russia discount", and rising sales to China, India and Turkey helped to offset declining exports to the EU. It is estimated that Russian oil revenues are only down 18% year on year over the January-August period. An important question that I am often asked is, why has the ruble managed to stay so strong in this situation? Well, there are a few reasons for the ruble s strength.
In February as soon as sanctions were announced - the Russian Central Bank increased interest rates to 20%, incentivizing Russians to keep their money in Russia and in Russian banks. The less rubles that are being sold by the public, the less downward pressure there is on the currency. Next up, the Russian government began forcing Russian businesses to convert 80% of any money that they earn overseas into rubles. Many Russian companies are still doing business with foreign companies, earning euros, dollars and yen.
This conversion requirement creates a significant demand for the Russian currency, thus helping to prop it up. Most importantly though Russian citizens were prevented from converting more than $10,000 of their money into foreign currencies through the end of this year. So, there is a high interest rate, forced buying of the ruble and the currency is close to impossible to sell.
This actually means that we don t really know the true exchange rate. The currency can only be bought and can't really be sold in significant size. The chart you can see right now shows how trading volume in the ruble have dried right up this year, as it is no longer being freely transacted.
Grigory Potemkin is a historic figure who was appointed governor of Crimea in 1784 when Catherine the Great annexed the region. In order to demonstrate how successful, he had been in resettling Crimea with Russian villagers, he took the Empress on a boat tour 1787. Potemkin is said to have built and populated a mobile facade of a village that he had assembled, disassembled and then reassembled repeatedly along her route down the river as she inspected the region. As long as the villages were viewed from a reasonable distance, it appeared that the Russian resettlement had been a great success. In many ways, the Russian central bank has created a Potemkin currency and economy for Putin.
Using a range of tools, they have made the Ruble appear to have more value than it actually has, as few people outside Russia would want to buy a single ruble unless they were forced to and most Russians who might want to get their money out of the country are unable to sell their rubles. The protectionist measures put in place by the Russian Central Bank could (in theory) work as a bridge for the ruble. If some sort of resolution to the situation occurred and the sanctions were withdrawn and trade relations were then resumed with the West, the measures could (in theory) be slowly withdrawn with the ruble having been stabilized throughout the whole situation. But, if the measures are withdrawn without that type of resolution, the ruble could be expected to collapse, causing enormous economic pain to the Russian people. Russian Oligarchs have been particularly impacted by the sanctions, as we have all seen in the press. Many who used to enjoy spending time in the west are now forced to stay in Russia.
There's little sign that the sanctions have pressured the oligarchs into starting any sort of "palace coup" against Putin. I guess he always does keep them at a table s length distance. Many of the oligarchs are opposed to Putin's war, as there is no upside for them, and they are reported to be resentful that the war and resulting sanctions have ruined their fortunes.
It is worth noting that they are also upset with western governments, who they believe have scapegoated them for events that are outside their control. "To do a palace coup and overthrow the tsar, you need to be in the palace first". a Russian businessman under sanctions is quoted as saying to the Financial Times. None of these people are there. Many of the newer cohort of Oligarchs who are closest to Putin are very rich, but the reason they are rich is because they are close to Putin, and they have no urge to pressure him to stop the war.
They don t wish to be cut off. They equally don t wish to accidentally fall out of windows, which seems to be a growing problem in Russia and that probably relates to issues with building codes. I dunno. Some of the Russian business oligarchs are reported to have offered to turn over a significant portion of their wealth to Ukraine to help rebuild the country in exchange for having the sanctions lifted on them individually. The Ukrainian government has shown no interest in this as a remedy. Taking the pressure off the oligarchs would likely reduce the pressure on Putin.
I should say that many of the oligarchs who are alleged to have made these offers, deny having made them. It's not just the oligarchs that are affected. The sanctions have also impacted moderately wealthy Russians, wiping millions of dollars off their wealth. According to Putin this vindicates his warnings that "Russians were taking too many risks by snapping up assets in the west. Real success is possible only when you tie your future and your children's future to the motherland", he has said.
Europe has managed - at great cost - to stock up on gas over the last six months. Gas storage at facilities in the EU has reached 82 per cent of capacity, ahead of the 80 per cent target the bloc set for the end of October. Member states have diversified supplies, increasing pipeline imports from Norway, Algeria and Azerbaijan and LNG from the US and other producers.
Manoj Pradhan at Talking Heads Macro argues that European gas reserves can be thought of as being like foreign exchange reserves in emerging markets. All is good while the stockpiles rise, but that changes dramatically if reserve levels start falling, even if they are doing exactly what they were designed to do. Before its invasion of Ukraine, Russia accounted for 46 per cent of the EU s gas imports, that has since fallen to 9 per cent.
Confidence is growing in Europe that they can get through the winter without severe economic problems or energy rationing. Both the war and the sanctions have led to changes in global energy flows. Russia has diverted a large share of exports to India and China who are still willing to buy from them but of course at a discount. The discount on Russian crude is greater than it has ever been. Europe has increased purchases from West Africa and Latin America.
Analysts point out that Russia will only be able to divert so much of its oil and gas flow to the east, due to the lack of spare capacity in pipelines going to the Pacific and China. The Yale University paper shows that when it comes to Natural Gas, Russia is far more dependent on Europe than vice versa. The authors argue that Russia s pivot to the east will be difficult to execute. Last year China bought less than 10% of the oil from Russia that Europe bought. A lot has been made in the press of the partnership between Russia and China, but we must wonder how happy China actually is with the ongoing situation.
China has a lot of outstanding loans to Russia, Ukraine and Belarus. In fact, the three countries combined make up one fifth of Chinas overseas lending. The loans to Ukraine are likely worthless right now, and any infrastructure that was built has likely been destroyed in the war. Many of the other international loans that China has made to emerging markets as part of their belt and road initiative are rapidly deteriorating in credit quality as the impact of the war is causing problems like food inflation in emerging markets. The rise in global energy prices is doing nothing to help the slowing Chinese economy either.
According to the most recent Chinese trade data, Chinese exports to Russia have halved since the start of the year to April and it s reported that Chinese banks have halted all loans and financing to Russia this year. If Russia does pivot to trading mostly with China, they will be in a weak negotiating position, as China will be very aware that Russia has few other customers. While China is Russia s most important trade partner, Russia is a small customer to China, falling below The Netherlands, Vietnam, Mexico and the UK in terms of export volumes. Beyond the practical difficulties of building gas pipelines to China, there are likely limits as to how much China wishes to engage with Russia. One of the key principles of Chinese energy policy in recent years has been supply diversification.
Beijing will see the current situation not just as an opportunity to pick up cheap energy resources, but also as a cautionary tale of over-reliance on one supplier. It is difficult to imagine that Xi is very happy with Putin right now despite their "no limits" friendship that was declared last year. Xi would most likely rather focus on domestic issues in China and not have to deal with the international problems that have been churned up due to the Russian invasion of Ukraine. Any slowdown in Europe would affect China as Europeans buy a lot of Chinese manufactured goods. The sanctions on Russia were carefully constructed from the very beginning to avoid hitting the Russian energy sector. This was done because Europe had become increasingly and excessively - reliant on Russia for its energy needs.
The sanctions allowed Russia to sell oil and gas to Europe and allowed Russian banks who process energy payments continued access to the Swift messaging system used to organize international transfers. Energy was, and is the biggest hole in the sanctions, and this hole allowed Russia to continue selling oil and gas to keep its economy alive and fund Putin s war in Ukraine. While the challenges in getting by without Russian gas are extreme for Europe, Russia is actually more reliant on Europe than Europe is reliant on Russia. Europe bought 46% of their natural gas from Russia before the war. But Russia sold 83% of their gas to Europe. Russia (and the Russian economy) is far more dependent on Europe than vice versa.
So where does all of this leave us? The recent economic data tells us that the defeatist headlines arguing that Russia s economy has bounced back are simply untrue the data shows that the Russian economy is in tatters. It is a lot like the anti-sanctions Lada, in rough shape, stumbling along with a lot of important components missing. I can't really offer an informed opinion as to how the war is likely to conclude. In fact, I have been amazed by how well the Ukrainians have done against what appeared to be much stronger and better equipped army at the start of the invasion. So far, this has not just been a failure for Putin personally, it is also a political, and economic disaster for all of Russia.
The former Russian oligarch Mikhail Khodorkovsky called on the international community last month to step up arms supplies to Ukraine saying that the issue can only be solved by force. He says there is no point in negotiating with Putin. It's very difficult to imagine at this point what a conclusion to this conflict might look like.
Would Putin even remain in power if Russia is defeated? and under what circumstances might sanctions against Russia be lifted? It is impossible to know. If you found this video interesting, you should watch my video on the Russian Oligarchs next. It explains how a small group of people ended up grabbing all of Russia s wealth and resources in the chaos that occurred when the Soviet Union collapsed. Have a great day and see you again soon. Bye.