02/23/2024 – 14:28
Invasion of Ukraine unleashed unprecedented wave of retaliation on Moscow's economy. However, the country not only did not collapse but also shows signs of growth. What explains this? Two years have passed since the start of Russia's full-scale invasion of Ukraine, and there is one thing economists agree on: the Russian economy has not collapsed, as many predicted when the European Union (EU) , the United States and other countries imposed unprecedented sanctions following the invasion in February 2022.
Now the debate over Russia's economy in Western capitals has taken on a more sober tone. Few still question its resilience. The point of contention is how solid the foundations are that support the country's current strong numbers.
The International Monetary Fund (IMF) recently predicted that Russia's gross domestic product (GDP) would increase by 2.6% this year, a sharp increase from its October estimate. This is on top of a growth rate of more than 3% in 2023. Meanwhile, oil revenues are growing again, and unemployment is at an all-time low.
However, doubts persist. The Kremlin has increased defense spending to such an extent that 40% of all budget spending in 2024 will go to defense and security. This is a war economy, and a dangerously overheated one, experts say.
There is a growing labor shortage and persistently high inflation. Sanctions also continue to cause harm, particularly as Western leaders seek new ways to target Moscow's purchasing power.
The continuation of the war, coupled with the death in unclear circumstances of Russian opposition leader Alexei Navalny, led the EU to issue its 13th package of sanctions this week, surpassing the mark of 2,000 individuals, institutions and companies barred from doing business with the bloc . The White House also announced, this Friday (23/02), more than 500 new sanctions.
How Russia managed to survive and prosper
Elina Ribakova, an economist at the Washington-based think tank Peterson Institute for International Economics, lists three main reasons why the Russian economy has managed to hold up so well.
The first is that the Russian financial system was sufficiently prepared to withstand the wave of banking and financial sanctions that hit the country in the first few weeks, as it had been in crisis response mode since the invasion of Crimea in 2014.
The second is that Russia was able to make massive gains from oil and gas exports in 2022 because Western powers took so long to regulate those exports, even as prices rose after the invasion.
The third reason, according to Ribakova, is that export controls have not worked well enough to prevent Russia from using other countries to obtain goods it needs for its military-industrial complex.
However, Benjamin Hilgenstock of the Kiev School of Economics says it is important to remember that although the Russian economy has fared better than expected, the sanctions have still had a big impact.
“The conclusion is still that Russia’s macroeconomic environment has deteriorated significantly and that much of this is due to the sanctions,” he says.
It highlights how Russian oil and gas export revenues fell in 2023 compared to 2022 and the fact that the Russian Central Bank had to increase interest rates to 16% due to high inflation.
Dodging sanctions
However, Russia's performance owes much to the way Moscow circumvented sanctions. Two of the most impressive are the way it bypassed export controls to continue purchasing Western products and how it continued to sell its oil around the world, despite the Western alliance introducing a cap on the price of the commodity in December 2022.
The measure aimed to restrict Western services for transporting Russian oil if it was not sold below $60 per barrel. However, for almost a year Russia has been selling its oil at prices close to market prices.
This is largely due to its so-called “ghost fleet” of ships, which has helped Russian oil reach markets in countries like China, India and Pakistan without having to be subject to this ceiling.
The United States has increasingly sanctioned single ships and entities suspected of violating the cap, something Hilgenstock says is crucial to limiting profits from Russian oil exports.
“These measures can effectively remove vessels from the ghost fleet for a considerable period of time,” he highlighted.
Regarding Russia's restriction of access to Western components through imports from other countries, Hilgenstock points to the responsibility of banks, and highlights a December order from American President Joe Biden authorizing possible sanctions against foreign banks that allow transactions that help to finance Russia's military-industrial base.
“Financial institutions have a big role to play when it comes to applying specialized controls because they can see some of these transactions on the financial side that can be very difficult to track physically,” he says.
Risks of the war economy
Another important factor in Russia's economic performance is defense spending, which has tripled since 2021. “Now you mainly have a war economy,” says Elina Ribakova. She believes this is raising GDP, while high public spending fuels the production of large quantities of missiles, artillery and drones.
“A lot of activity is recorded, but this is not productive activity in the medium term,” she says. “It’s not good for the economy. Basically, it’s something that generates waste.”
Chris Weafer, an investment consultant who has worked in Russia for more than 25 years, says there will be negative long-term consequences if additional spending is mainly on “consumable” goods rather than deeper investments in the country's industrial base. “You will deplete your reserves, and when the conflict ends, you will have a much more damaged economy, with many questions about what to do next,” he said.
He says another key element of the country's war economy is the way the job market has changed. Mandatory military service and the fact that around 1 million highly skilled workers have left Russia since 2022 have created a shortage of workers in several areas. Unemployment is almost non-existent, but wages have risen sharply throughout 2023.
“This increase in income has really been a major driver of this increase in consumer inflation”, he highlighted. “The longer they are unable to deal with this, the more challenging, the more expensive and the more damaging this labor shortage problem will be to the economy.”
How long can the economy sustain itself?
However, the Russian economy has defied dire predictions before. Weafer claims that the country's enormous resource base was consistently underestimated when sanctions were applied. He points to the continued importance of Russian oil and gas to global markets, as well as commodities like uranium, which the U.S. still buys in large quantities.
He says the EU in particular has become too involved in what he calls “political economy”.
“They will say 'the economy didn't collapse in 2022 or 2023, but it will now because of military industrial spending and that will cause the economy to collapse,'” he says. “That’s just political economy. This is wishful thinking [o que eles gostariam que acontecesse].”
For Ribakova, Ukraine's fate remains closely linked to Russia's own economic performance. She says that while sanctions will never be enough to stop Russian aggression, it is vital that the Western alliance does more to further limit the Kremlin's ability to pursue war.
“We are giving financial support to Ukraine with one hand and we are also giving it to Russia with the other hand. We are still buying their energy, we are still not fully enforcing the oil price cap and the embargo, and we are still not fully enforcing export controls,” she says. “This is a huge problem.”
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