International Finance
Economy Magazine

Is the Russian economy collapsing?

IFM_ Russian economy
Since the start of the war, the fall rate has been rising, and Russia's GDP has decreased by about 5% from last year

Russian President Vladimir Putin insisted that the West could never choke off Russia’s economy in April 2022, just weeks after he started the invasion of Ukraine. He informed his officials, “We can already say with confidence that this policy toward Russia… this economic blitzkrieg has failed.”

However, six months after the war’s start and the sanctions’ application, analysts are speculating whether the US-led Western bloc’s design of punishing Moscow financially has shown its real results. International observers have increased their estimates of the Russian GDP from earlier 2022. Russia’s economy has performed better than the original projections made immediately after the imposition of sanctions, partly due to factors like nimble technocratic Russian policymaking and competitive global energy markets.

However, the Russian economy is still experiencing a slower development rate than it did during the 2008 financial crisis, and it is unlikely that a post-crash recovery will follow this slowdown. Moreover, living standards are sustained by social spending, which will be challenging to maintain and require difficult budgetary decisions for the government in the upcoming years. As time goes on, the war’s price and the sanctions’ impact on regular Russians will only increase.

Russia Tightens Belt

Start by looking at some macroeconomic data to assess the state of the Russian economy. Since the start of the war, the fall rate has been rising, and Russia’s GDP has decreased by about 5% from 2021. Although the manufacturing sector has decreased by 4.5%, industrial production, including Russia’s energy industries, has reduced by just approximately 2% compared to 2021 (a reflection of the high energy costs). The inflation rate is just over 15%, a little decline from the peak of about 18% following the March collapse and subsequent recovery of the ruble. In addition, inflation-adjusted monthly salaries are down by around 6% from 2021.

Russia’s inflation statistics may not accurately reflect that purchasing some goods is now ranging from occasionally challenging to almost impossible. Similar problems in estimating the effects of a lower quality are seen with inflation statistics. The Russian government is modifying laws to permit the sale of cars without airbags or antilock brakes, which are now challenging to manufacture due to supply chain issues. Although economists won’t reflect this decline in quality in inflation statistics, Russians will soon notice it, particularly the urban, affluent section of the population who consume more of the imported goods that are now more difficult to obtain.

Even after accounting for the inflation recorded by official data, salaries drastically declined, falling by almost 6% from 2021. Inflation has been eroding social welfare payments like pensions since the Ukraine war started. To make up for this, the government raised pension payments by more than 8% in June 2022. However, if no substantial increases in social spending are made in the ensuing months, the average Russian’s income will decrease in the year’s second half. In addition, retail sales are down over 10%, which shows that consumers have already begun saving in preparation for future budget cuts.

Oil Continues To Flow

Some businesses have already been severely impacted by decreasing living standards, even if households are only now starting to experience their effects. Therefore, it is more enlightening to examine each sector independently rather than using aggregate industrial output numbers. The natural resources industry has not been significantly impacted, which is not surprising given the high prices and Western sanctions that have been put in place to maintain the free flow of primary commodities, including oil, up to this point.

The trade-in of natural resources is primarily responsible for the durability of the Russian economy. The United Kingdom and the EU have been softening sanctions set to go into effect against Russian oil exports with the covert assistance of the United States. The West has backed down from attempts to prevent Russia from diverting oil shipments to other clients, such as China and India, to prevent a spike in energy prices. As a result of recent changes to the restrictions, European businesses will now be permitted to ship Russian oil to third parties.

The volume of Russian oil exports has remained mostly steady since sanctions were put in place because the West has only recently enforced severe penalties for Russia’s energy exports and since the EU’s oil import ban won’t go into effect until December 2022. Russia is being forced by sanctions to sell oil at a discount of roughly USD 20 per barrel compared to market benchmark pricing. However, the most recent data on monthly oil tax receipts published by the Russian government indicates that the country is earning around the same amount from exports as it did in January 2022. Since the Kremlin prohibited its sale to Europe, natural gas export revenues have plummeted, far less significant to Russia than oil exports.

Troubled Industry

The output of vehicles, trucks, locomotives, and fibre optic cables has decreased by more than 50%, making them among the worst-affected industries. Businesses with less exposure to foreign ownership or complex supply networks, like textiles or food processing, have been on the flatter side or occasionally rising production compared to 2021.

The evacuation of Japanese, American, and European companies with plants in Russia is one reason for this industrial disruption. While some of these factories will reopen under new Russian management, running them could be challenging. Obtaining sufficient supplies is a challenge for manufacturers as well. It is now much more difficult to get components from outside because it is more difficult to obtain, ship, and pay for even goods that are not officially restricted. Regarding the challenges, his company faces in shipping and paying for imported components, the CEO of Moscow-based railroad equipment company Transmashholding told Russian media, “I cannot say we’re facing a total blockade. But there is more friction now.”

The crucial question is whether these industrial disruptions change for the better or worse in the coming months. On the one hand, Russia has had over six months to set up alternate payment and logistics systems, which should enable some essential unrestricted imports to enter the nation. However, Russian businesses, when polled, claimed that they were still using their existing inventories, suggesting that they were still having trouble finding the required components. Moreover, according to monthly data, Russian imports of industrial products and parts are still significantly below levels before the war.

Russia’s industrial sector must need to have a secure future, due to multiple reasons. First, the industry is a crucial source of employment, particularly in what the Russians call “monogamous towns,” dependent on a single factory or sector and frequently located in the Urals or Siberia. Layoffs in these cities have historically sparked large-scale riots and social unrest that have proven politically unstable. According to recent research by a Russian think group, sanctions will directly affect 50% of all monogamous towns. Given the government’s constrained budget, Russia’s government will have difficulty raising money to support hampered industries.

Since the Kremlin ceased disclosing spending information, perhaps to conceal the costs of the conflict, it has become more challenging to understand how Russia’s government finances operate. The last month for which Russia provided comprehensive data was April, and during that month, defence spending had grown by 40% annually. As a result, the Kremlin will need to set aside significant future resources to restore the massive stock of equipment lost or destroyed on Ukrainian battlefields, in addition to more substantial salaries and operating costs to pay for the attack on Ukraine. Moreover, as regional governments are requested to organise volunteer battalions, the costs of the war are mounting, not only for the central government but also for them.

Over 2023, inflationary pressure will increase due to this spending binge. As a result, the amount of money the government receives has decreased. Due to the minor dip in global oil prices since June and the vast discounts at which Russia must now sell its oil, Russia’s oil tax revenues have fallen to more typical levels than the bumper revenues it was generating in the first few months after the invasion. However, non-oil tax revenue has sharply decreased. After accounting for inflation, non-oil revenue fell by about 15% over the first seven months of 2022; this percentage is likely to rise throughout the rest of the year.

As a result, if current trends continue, Russia’s budget will be heading toward a significant deficit. Of course, this situation might significantly alter in the upcoming months if oil prices rise and tax revenue increases. But if the war rages on and living conditions drop, spending needs will not disappear.

The Kremlin will be in a difficult situation if the budget deficit increases. Although Iran had almost no debt when the war began, Western sanctions have prevented it from issuing new bonds to most foreign investors. It might allow the ruble to weaken versus the dollar, which would balance the budget since Russia’s government expenditure is in rubles. A decline in the currency, however, would increase inflation, worsen living standards as a result, and jeopardise the Kremlin’s claim that the Russian economy is solid and that the sanctions are ineffective.

A Toll Too High

The Kremlin is, in some ways, correct to claim that the Russian economy has stabilised. Most of its industries are working, as usual, its banks remain solvent, and its vital energy sector is still producing oil. Even though there aren’t many luxury cars available, there is still plenty of food on store shelves. Nevertheless, customers will put off making large purchases if they can because the production of vehicles and washing machines will be much lower than anticipated. The Kremlin’s best-case scenario is that Russians tighten their belts and manage.

Even though the first effect was less devastating than the West or Russia predicted, the consequences of the war and sanctions are still mounting. The Russian government is currently content with having lasted through six months of Western sanctions. However, the Russian industry will still have difficulty transitioning to a world without imported Western components during the course of 2023. If oil prices do not rise, the Russian government will have to make more challenging decisions on whether to maintain social expenditure while accepting budget deficits and high inflation. The Russian economy will not fall apart to the point where the Kremlin’s military efforts are put on hold. However, the country is currently experiencing a severe recession, a period of decreased living standards, and scant prospects for a speedy recovery.

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