After Russia’s full-scale invasion of Ukraine in February 2022, Western countries imposed numerous sanctions on Russian banks and companies, which significantly affected the Russian economy. Yet the economic collapse that some expected never came.
This allowed President Vladimir Putin to confidently declare at the beginning of this year: “2022 was a challenging year for us, and we managed to weather the risks that arose … quite successfully.”
Western sanctions have not undermined Russia’s economic potential to the point that the Kremlin would lose the ability to finance its war in Ukraine. The events of 2022 have confirmed that the Russian economy is inefficient but resilient and that the Kremlin is able to mitigate any destabilizing effects of the economic downturn on the political front.
The impact of sanctions
The sustainability of the Russian economy is determined by its place in the global division of labour: it is at the beginning of technological chains as a supplier of natural resources.
Since the world economy cannot grow without increasing the consumption of natural resources, the demand for Russian raw materials is maintained. This has largely protected the Russian economy from the effects of sanctions.
In 2021, Russia supplied 17.5 percent of the oil sold on the world market, 47 percent of palladium, 16.7 percent of nickel, 13 percent of aluminum (excluding China), and nearly a quarter of potash fertilizers.
Hypothetically, the world economy could give up Russian raw materials, but only at the cost of price increases and possibly years of recession, which is not in the interest of Western politicians.
The United States’ attempt to cut off Russian aluminum’s access to the world market in 2018 led to an immediate 20 percent increase in the price of this metal, forcing the White House to abandon the announced plans.
That is why in 2022 the West imposed some of the toughest sanctions on Russian export sectors, such as steel, coal and processed timber, where the global economy has capacity. The combined share of these commodities in Russian exports in 2021 was 11.7 percent, so restrictions on sales to Europe had no significant impact on the Russian economy as a whole.
However, they have had a significant impact on the economies of certain regions where these sectors are dominant. For example, in November-December 2022, the coal mines in Kemerovo, the core region of coal production in Russia, could only sell 50-60 percent of the coal extracted. In Karelia and Arkhangelsk, where there are many woodworking companies, industrial production contracted by 15.5 percent and 19.8 percent respectively. In Lipetsk it fell by 15.4 percent due to a drop in production at Russia’s largest steel producer, Novolipetsk Steel.
Western sanctions on the oil industry have focused on revenue rather than production. As a result, Russian oil production will increase by 2 percent in 2022. An EU ban on imports of refined petroleum products from Russia came into effect on 5 February, but there is no evidence yet that this has had an impact on the Russian economy. Since the beginning of 2023, gasoline and diesel production has increased by 7 percent over the previous year, which could be partly due to increased demand from the Russian military.
The decline in gas exports to Europe – which is not so much sanction-related, but a result of Putin’s “freeze and split” strategy for Europe – has had a greater impact, with production falling by 18-20 percent. If the situation does not change, gas production could shrink by another 7-8 percent in 2023.
The Russian economy in recession
The impact of the sanctions on the Russian economy was significant, but not as severe as some had expected. It shrank by 2.1 percent in 2022 – much less than the 5-6 percent forecasts made in the spring.
The fall in GDP was offset by high oil and gas prices, which generated unexpected gains. Revenues from hydrocarbon production and exports rose 28 percent from 2021, and high inflation in the first half of 2022 led to an increase in nominal tax revenues.
Financial sanctions, such as the freezing of the accounts and assets of the central bank and commercial banks, and restrictions on payments and access to capital markets, had the most direct impact on the economy.
In the spring of 2022, it took just a week for inflation in Russia to accelerate to more than two percent a week and the dollar to appreciate by 60 percent against the ruble. The Russian financial authorities were able to mitigate these initial consequences by imposing restrictions on current and capital transactions and by refusing to exchange the ruble, thereby strengthening the exchange rate and suppressing inflation.
However, gradually increasing pressure on the balance of payments due to trade restrictions in Russian hydrocarbons led to a decline in the current account balance and a weakening of the ruble by more than 20 percent in the second half of the year.
A more serious blow to the Russian economy came from the “moral sanctions” – the voluntary withdrawal of foreign companies from Russia. The main effect was the closure of car factories, which belonged to international companies. As a result, new car production in Russia fell by a factor of three and sales by 59 percent. The manufacturing industry in the Kaluga and Kaliningrad regions, where such factories were concentrated, shrank by 20 percent.
Looking at the decline in industrial production and services, we should note that in the past year many foreign companies have sold their assets to Russian companies. This process, especially if we are talking about large production facilities, takes several months and requires the permission of the Russian government.
During this time, current activities may cease, but after the transaction is legally formalized, the companies may resume business. This means that the economic downturn, which is to some extent reflected in a shrinking gross domestic product (GDP) before 2022, can be partially offset in 2023.
The Russian government was also able to mitigate the effect of the sanctions on the general population by increasing spending. Government spending increased by 32 percent of the planned 2022 budget or $113 billion.
About half of the extra budget went to the military, but much of the rest was spent on new social programs, including additional indexation of pensions, increased benefits for families with children, payroll tax deferrals, etc.
The Russian government was able to cover the extra expenditure from the fiscal reserve built up in previous years, the National Wealth Fund (NWF). At the beginning of 2022, its liquid portion was $113.5 billion or 7.3 percent of GDP. It financed the entire 2022 budget deficit, which was equivalent to 3.3 trillion rubles ($50 billion). It is likely that in 2023 the fiscal reserve – now down to 4.6 percent of GDP or $87 billion – will be used to cover the budget deficit again.
The pressure on the Russian government budget will inevitably increase in the coming years because the faltering economy cannot generate sufficient income. As a result, the fiscal reserve could disappear completely by 2025-2026, but that will not lead to a fiscal crisis. Russia’s total public debt is less than 20 percent of GDP, allowing the government to borrow money from the domestic market.
The long-term outlook
It seems that the past year of sanctions and economic downturn continues a trend of stagnation in the Russian economy, rather than starting a new one.
In the first eight years of Putin’s presidency (2000-2008), the Russian economy grew by an average of 7 percent per year as a result of the economic reforms of the 1990s, high oil prices and extensive foreign borrowing.
In contrast, the Russian economy grew by an average of 1.4 percent between 2012 and 2021. This slow growth had much to do with Putin’s authoritarian approach to political and economic decision-making after returning to the presidency in 2012.
While suppressing political competition, he also dismantled the progressive system of arbitration courts, which had provided corporations with a much higher level of legal protection. Putin also launched a massive program to rearm the military at the expense of investment in human capital development.
Following the annexation of Crimea in 2014 and the unleashing of armed conflict in eastern Ukraine, sanctions against Russia were imposed, limiting many companies’ access to modern technology. The research and development sector was also undermined, especially by criminal cases brought against Russian scientists, who were accused of treason. These factors have seriously worsened the business climate in the country and reduced economic growth.
In the short term, the Kremlin will do its best to protect the Russian people from the consequences of the economic crisis.
It is already trying to offset declining revenues from declining oil and gas prices (43 percent lower for October 2022 – January 2023 compared to January – March 2022) by implementing changes in oil tax rates. Putin also stated that he wants Russian companies to contribute voluntary payments to the budget to increase revenues.
This additional income will be used not only to fund the Russian army, but also to fund the families of regular and mobilized soldiers. Other social benefits and programs will also be maintained.
This will ensure that when it comes time for the presidential elections in March 2024, a significant part of the population will not mind if Putin is re-elected with 70-75 percent of the vote.
In the longer term, the Russian economy is still unlikely to collapse. Because even the toughest sanctions have a limited effect. Iran is a good example of this. The country has been under US sanctions since 1987, but GDP grew by an average of 3.3 percent between 1990 and 2020.
Like Iran, Russia will gradually lag behind the world economy and will not achieve more than 1.5-2 percent annual growth.
In the long run, the sanctions will have serious consequences for the technological development of the Russian economy. For ordinary Russians, this would mean a gradual decline in the quality of goods on store shelves and the inaccessibility of services that were common until the war.
However, economic stagnation is unlikely to lead to social or political unrest. The fall in living standards will be very slow and uneven, while repression of dissidents and political opposition will increase, making the cost of protest very high.
The views expressed in this article are those of the author and do not necessarily reflect the editorial view of Al Jazeera.