Sanctions-proof Russia shows signs of stress


Seven weeks after the start of the war, how is the Russian economy doing? The short answer is: well below expectations and the worst is yet to come.

Before the war, the Russian economy stagnated but was supposedly immune to macroeconomic crises. To use an image commonly used by economists: she was stuck in a bog and therefore unlikely to fall off a cliff.

On the one hand, since 2013, Russia’s GDP has grown by an average of around 1% per year. Corruption, a heavy state, politically captive businessmen and isolation from the global economy have combined to undermine the country’s growth potential.

On the other hand, low sovereign debt, a substantial sovereign wealth fund and large foreign exchange reserves ensured the country’s macroeconomic stability. The conservative fiscal rule and modern inflation-targeting monetary policies have also contributed to modest and steady growth.

Thus, in the run-up to war, economists would usually describe the Russian macroeconomics as a sanctions-proof “Russian fortress”. The country’s economic policymakers believed that the worst damage the West could inflict would be to disconnect Russia’s financial system from the global interbank payment system SWIFT.

After the United States threatened to cut Russia off from SWIFT in 2014, the country began to develop a national alternative, SPFS (System for Transferring Financial Messages). Although imperfect and limited to Russia, it has been functional since 2017.

The West is targeting Fortress Russia

Once the war started, however, the West responded with much stronger sanctions. The main tower of “Fortress Russia” was reduced to rubble. The sanctions also targeted the Russian Central Bank, freezing foreign currency reserves that included the sovereign wealth fund.

The ensuing financial panic prompted the Central Bank to tighten capital controls, raise its policy rate from 9.5% to 20% and close financial markets for several weeks. The government has also asked major fossil fuel exporters to repatriate 80% of their ruble export earnings.

Despite this, inflation soared to 2% per week in the first three weeks of the war, then to 1% per week thereafter – 1% per week equals 68% per year.

Export controls and the boycott of the Russian market by Western companies have further separated Russia from the global economy. The United States and Canada banned the purchase of Russian oil, and many European companies followed their example on their own.

More importantly, the United States and Europe have banned the export of advanced technologies to Russia, with the private sector also joining the embargo. Companies ranging from Ikea and McDonald’s to Airbus and Boeing have suspended operations in the country.

It turns out that most Russian industries are critically dependent on Western technology and inputs. For example, the Russian automotive sector came to a halt, as it suddenly discovered its extreme dependence on imported components.

Car sales in March 2022 were three times lower than in March 2021. This is all the more striking since during periods of high inflation, households tend to try to buy durable goods.

The head of the Central Bank of Russia, Elvira Nabiullina, orchestrated Russia’s monetary strategy in the face of Western sanctions. Photo: Supplied

Collect clouds

It is therefore not surprising that the 2022 GDP forecasts were immediately revised downwards. Before the war, Russian GDP was expected to grow by 3% in 2022 as it recovers from the pandemic-induced recession.

Today, the Central Bank’s forecast is for an 8% cut. The European Bank for Reconstruction and Development expects a 10% drop. The Washington-based Institute for International Finance predicts a 15% drop.

A 10% drop – and that forecast is backed by many investment banks – would make it Russia’s worst recession since the early 1990s.

However, the worst is yet to come. Although the Russian economy may eventually adjust to a new equilibrium within a year or two, it will not return to pre-war levels anytime soon; Russia will continue to lag behind developed economies.

First, the sanctions will keep it out of the global capital market and cutting-edge technology. Second, he has moved to a highly repressive regime that will destroy opportunities for domestic entrepreneurs.

Third, in the first weeks of the war, it had already lost hundreds of thousands of skilled workers, who understood that staying in Russia was neither safe nor conducive to their careers. These are trained professionals, computer scientists, researchers, engineers and doctors.

Russia’s loss of its best human capital will continue, undermining its growth prospects.

Finally, the West is likely to impose additional sanctions. As evidence of alleged Russian war crimes continues to mount, European politicians are under increasing pressure to target the backbone of Russia’s economy: hydrocarbons.

In recent years, oil and gas alone accounted for 35-40% of federal budget revenue and 60% of Russian exports. The European Parliament has already passed a resolution calling for an embargo on Russian imports of fossil fuels.

Pipe systems and shut-off devices at a Nord Stream 2 gas landing station. Photo: AFP / dpa / Jens Buttner

And the EU’s top diplomat, Josep Borrell, said “sooner or later – I hope sooner – it will happen”. When the European oil and gas embargo is introduced, Russia will face major fiscal challenges, which will further reduce its growth potential.

Moreover, as Europe joins the United States and Canada, the united West will increase the pressure on China – thus eliminating Russia’s hopes that China’s money and technology can replace those of China. the West.

Even as Central Bank capital and currency controls help strengthen the ruble and ultimately slow inflation, the above fundamental factors will certainly make Russia’s recovery to pre-war levels unlikely – not to mention catching up with its neighbours.

No one knows how long this economic shock will lead to political change. But eventually, Putin will run out of resources to pay his soldiers, propagandists, mercenaries and police to keep the increasingly disgruntled Russians in check.

Sergei Guriev, professor of economics, Sciences Po.

This article is republished from The Conversation under a Creative Commons license. Read the original article.

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