After Russia invaded Ukraine, Western leaders proclaimed a sanctions regime to cripple Russia’s war machine.
Joe Biden said Russia’s economy would “be cut in half”, while Boris Johnson talked of extracting it “piece-by-piece”.
Although it has been a year since the last time we saw this great promise, it has taken a while for it to come true.
In a speech delivered to the nation’s parliament Tuesday, President Vladimir Putin stated that “the Russian economy and system for government have proven to be stronger than the West believed.”
He also displayed his muscle at the economic cabinet meeting last month. “Remember, some experts here in this country – I don’t even speak for Western experts – believed [gross Domestic Product] would fall by 10% or 15%, or even 20%.”
Russia’s economy shrank by 2.2%, and is expected to grow by 0.3% in the coming year, according to International Monetary Fund.
This means that the nation, which is currently under sanctions, will be able to outperform Britain.
These predictions are not good news for Western leaders.
Despite the fact that sanctions fell on Russia’s economy over the past year, most economists were surprised to see that it survived the storm.
This is due to Russia’s vast oil and gas resources. While Europe was hostile to Russian energy exports in Europe, Russia was able exploit delays in imposing the ban which helped boost its public finances.
Due to an increase in global energy prices and a successful reorientation to China and India, revenues held strong.
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Russia was already seated on a cushion.
After years of fiscal conservatism, record high trade surpluses were achieved following the invasion. This was after the country amassed a large fund that it will use in its war against Ukraine.
For years, the country has quietly been sanitizing its economy.
Russians have experienced record low unemployment and have seen their wages grow, which has allowed them to weather rising inflation.
They are still cautious about spending in times of economic uncertainty. However, the government is doing its best to encourage them with increased minimum wages and pensions.
Although economic data isn’t always reliable or complete, it does give a good picture of the strains Russia is facing. However, the domestic economy is not in danger of collapsing as some predicted.
Although President Putin seems to be in a winning mood, it could not last long as cracks are beginning to show.
Western countries have placed a price limit on Russian Urals, Russia’s main crude oil export blend. Oil revenues are now falling and the country’s public finances are suffering.
Russia is also increasing its military spending, and relies on foreign currency sales – the Chinese yuan – to support its rouble. Although last year was a success, the sting from Western sanctions is just beginning to feel.
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Record high wages and low unemployment have supported Russia’s living standards.
Analysts expected mass job losses when the war broke out.
Instead, unemployment plummeted to 3.7%, as Western companies handed their businesses over to local partners. This helped to keep jobs.
The headline unemployment rate hides a dramatic drop in the size and employment of the workforce.
Many thousands of skilled workers have fled Russia to find work or fight elsewhere. The numbers are estimated to be between 0.4% and 1.4%. This is impacting economic growth. Russia’s central bank recently warned that the “capacity to expand production in Russia is largely limited” by labour market conditions.
Russia’s future will depend on the recovery of its workforce, just as in Britain.
Tatiana Orlova from Oxford Economics said that there is some evidence that people who fled in panic in March and September are returning. This could be because they were unable to find a job abroad, or because they have family or property back in Russia.
A tight labor market has resulted in robust wage growth, especially for IT professionals, construction workers, and hospitality staff. This is helping to improve living standards. Russia’s wage growth is nearly at the same pace as inflation. The government has increased pensions and the minimum wage national, which will increase by 10% next year after increasing by 20% last year.
Although oil revenues are the focus of much attention, consumer spending remains the main part of the country’s economy. The government hopes that the additional money will encourage Russians and other foreigners to spend more. This is something they have been very cautious about doing over the past year.
However, it may face a difficult task. Many analysts believe Russia will launch a new offensive to seize the entire Donbas. If Russia’s leadership announces a new wave in mobilisation, consumer confidence will likely plummet again. This will cause households to prioritize saving over spending.
“The savings-to-disposable income ratio will rise again and stay elevated until the fighting abates, hampering authorities’ efforts to revive household demand,” Ms Orlova said.
Investment in business
Business confidence could be affected by another round of mobilization. Early on in the conflict, economists believed that business investment would plummet at the fastest rate in decades. However, this did not happen.
Fixed investment increased by 6% in 2021 due to bumper profits from oil, gas, and fertiliser producers.
Russia’s energy exports to Asia were diverted by Russia, which required an enormous increase in infrastructure.
Although not all of this helped the country’s manufacturing industry, it did help. Last year saw the collapse of the country’s auto industry as it was unable to obtain key components and tools from west. Others have found ways to access parts from Turkey, but Turkey is not yet participating in the international sanctions.
Oil and Gas
Russia’s attempts to strangle its economy were instantly thwarted by Europe’s dependence on Russian oil and gaz exports, which account for around 40% of its revenues.
This was successfully exploited by Russia.
The nine-month period it took to implement an EU-wide ban on Russian oil exports saw Putin’s regime enjoy record fiscal surpluses. This was due to the country’s high wholesale prices. Its current account surplus jumped by 86% to $227.4bn.
This provided Russia with a huge cushion to finance the war effort. It also strengthened Russia’s currency, which helped keep imports affordable and dampen inflation.
The country was also able, during this period, to redirect supply to India or China. Last month, its total crude and fuel oil exports hit a record high at 1.66 million barrels per day.
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This year is going to be even more difficult.
As lower oil prices impact revenues, the country’s public finances are already beginning to decline. The $60 per barrel price cap on Russian crude oil, imposed by Australia, the EU and G7 in December, means that the country will have to sell oil at a significantly lower price than the Brent benchmark.
Recently, the cap was extended to include refined petroleum products.
Russia’s January budget deficit was PS20.8bn. This is due to a decrease in oil and gas income of 46%. During the same period, government spending rose by 59%.
These were identified by economists as early signs that the country was in trouble. The country had to issue more local debt and sell more Chinese currency to sustain itself.
They were nevertheless optimistic about the country’s future prospects.
Sofya Donts, chief Russia economist at Renaissance Capital said that the fiscal deficit grew in 2022, but remained moderate at 2%, below the levels of the pandemic and the great financial crises.
She said: “With the public deficit below 20% of GDP, financing is not an immediate source for stress. However, a sustained decline in oil and gas revenues will require a medium-term fiscal consolidation. We believe that non-oil tax increases are necessary.
We assume that this consolidation is not yet urgent and could be delayed for up to two years.
Analysts believe that the country could increase its tax intake by lowering the windfall tax on fertiliser and energy producers.
Importantly, Russia can meet its financing requirements at home.
Both the government as well as corporations have low levels of external borrowing. The government also has a strong sovereign wealth fund.
Liam Peach, Capital Economics, stated that Russia spent 10 years sanitizing its economy.
“All this meant was that global capital markets were closed to all corporates and governments. Sanctions on banks, government, and other corporations didn’t have any impact on their financial needs because they were very low. Russia’s government could, for instance, go eight months without issuing debt.