A personal view from Ian Stewart, Deloitte’s Chief Economist in the UK. To subscribe and/or view previous editions just google ‘Deloitte Monday Briefing’.
Russia’s invasion of Ukraine was followed by the imposition of sweeping western sanctions. Russian financial markets went into freefall and an economic meltdown seemed all but inevitable. The IMF forecast that Russian GDP would contract by 8.5% in 2022 and a further 2.5% in 2023. Russia seemed to be heading into a deep crisis.
Yet a year on the rouble is stronger than it was before the invasion and the IMF thinks that the Russian economy contracted by just 2.2% last year and is likely to grow by 0.3% this year. This isn’t what was expected. Why has Russian economy proved so resilient?
Good policy has helped. Russia was broadly ready for western sanctions. It had built up a large public sector surplus and was ready to shift trade from western to emerging market economies. Russia’s central bank swiftly imposed capital controls and raised interest rates sharply, helping stop an initial sell-off in Russian assets from turning into a rout. Companies and households have been required to exchange most of their holdings of foreign currency for roubles. Russia has avoided a collapse in the value of its currency and hyperinflation, which have been the hallmark of previous emerging market crises.
High energy and other commodity prices, themselves fuelled by the invasion of Ukraine, have propped up government revenues and bolstered the rouble. Last year Russia posted a record current account surplus. The effect of high commodity prices, and reduced imports from the west, have more than made up for any loss of export earnings caused by sanctions.
Sanctions have proved less effective than the West had expected. Russia is a large economy with relatively low export exposure concentrated in commodities. And most countries do not apply western sanctions. As Russia’s trade with the West has collapsed, its trade with Asia, the Middle East, Latin America and Africa has grown. The lure of cheap raw materials from Russia is spurring sanctions avoidance on a previously unseen scale. Russian oil shunned by the EU has found ready customers in China, India and Turkey. The Economist has written of Russia dodging sanctions on “an industrial scale” through its control of a fleet of 360 tankers, equivalent to 16% of all tankers globally.
All countries faced with external shocks adjust. Russia has responded, with a vigorous policy response from the central bank and government to help soften the economic effect of sanctions. The public and private sectors have worked energetically to circumvent sanctions, keep vital imports flowing, find new export markets and switch to a war economy. The rapid growth of the armaments sector has itself helped support jobs and activity. The Economist estimates that military production now accounts for 4% to 5% of all industrial production, three times pre-war levels.
Russia has blunted the impact of sanctions, but its economy has suffered grievously from western measures and the impact of the war. We should treat official Russian estimates of economic activity with a degree of scepticism. Russia has limited the flow of economic data but research by the Centre for Economic Policy Research (CEPR) suggests that official data has materially understated the scale of the economic weakness. The CEPR estimates that Russian GDP may have contracted by as much as 5.0% last year, twice as much recorded by the IMF and the Russian statistics authority.
Sanctions have damaged Russia’s industrial base, with car production falling to the lowest level since Soviet times due to shortages of western components and semiconductors. Demand for real estate has sunk on uncertainty, falling real incomes and high mortgage rates. Arrears on car loans and mortgages are rising. Government revenues are falling, forcing it to raise taxes, cut public spending and borrow more. Consumer spending is shrinking.
The outlook remains grim for the Russian economy. Lower energy and other commodity prices, and tougher western sanctions on energy exports, threaten Russia’s biggest sources of revenues and exports. According to the official count, more than 300,000 men have been conscripted and probably far more people, many of them educated and highly skilled, have left Russia to escape military service. Forbes estimates that about one-third of Russia’s IT specialists left the country in 2022. Economic decoupling from the West, the loss of skilled workers, and the redirection of the workforce, and activity, to waging war, will depress living standards. Studies of past sanctions show they tend to affect the poorest most. Much of the damage from the war and sanctions will fall on less affluent Russian households.
Sanctions may have had less impact than initially expected but they, and the effects of the war, are taking a heavy toll on the Russian economy. Our back of the envelope calculation suggests that by the end of this year the Russian economy is likely to be at least 10% smaller than it would have been in the absence of the war.
What can we conclude about sanctions from the experience of the last year? Even severe sanctions as have been deployed against Russia are not some sort of economic ‘nuclear weapon’. That said, sanctions against Russia have inflicted serious economic damage and have hampered Russia’s war effort. Rather than concluding that sanctions are ineffective, policymakers will try to devise ways of making them more effective. It is clear too that the growing power, and scale, of non-aligned countries, are eroding the power of western sanctions. Finally, any country that believes it, too, might one day be in conflict with the West has seen how planning and policy can blunt the impact of sanctions. China, for one, will have taken note.
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