Russia’s economy can withstand a long war, but not a more intense one Analysis by The Economist

In an article published in The Economist, the authors ponder on Russia's ability to withstand sanction regimes and ability to wage the war. Caliber.Az reprints the article.

A week after Russia invaded Ukraine last year, Antony Blinken, America’s secretary of state, crowed, “The value of the ruble has plummeted; the Russian stockmarket closed as fear of capital flight rose; interest rates more than doubled; Russia’s credit rating has been cut to junk status.” American authorities clearly hoped that the “massive, unprecedented consequences” they and their allies had imposed on Russia, including “severe and lasting economic costs”, would help bring the war to a speedy conclusion. Yet over the following year, despite the repeated tightening of Western sanctions, Russia’s economy recovered its poise. The IMF expects it to grow by 0.7% this year–on a par with France, and even as the British and German economies shrink. The hope that the state of Russia’s economy will provide any sort of constraint on the war has faded.

Such despair, however, is as misguided as Mr Blinken’s initial euphoria. By the admission of none other than Vladimir Putin, Russia’s president, “The illegitimate restrictions imposed on the Russian economy in the medium term may indeed have a negative impact on it.” The question is not so much whether Russia can endure an even longer war of attrition (it can), but whether it can support the sort of intensification of the conflict Russia will probably need to transform its prospects on the battlefield. That looks almost impossible.

Russia’s economic managers have achieved three feats over the past 14 months. They have found ways to withstand the fusillade of sanctions that Mr Blinken heralded. They have supplied enough men and materiel to propel Russia’s invasion. And all this has been done without a sharp decline in living standards, which might prompt popular unrest. But any attempt to escalate the conflict would inevitably undo these successes.

Russia is having to cope with the broadest array of sanctions ever imposed on a big country, including on individuals associated with the war, on financial transactions involving Russian entities, on exports of certain goods to Russia and on imports of most goods from Russia. Yet this economic assault has yielded disappointing results, in part because there were always big holes in the sanctions regime and in part because Russia has found ways around some of the restrictions that did initially hem it in.

Some of the showiest measures have targeted oligarchs and other cronies of Mr Putin’s regime. World-Check, a data firm, reckons that 2,215 individuals with close ties to the government can no longer travel to some or all Western countries, or access their possessions there, or both. Some wealthy Russians have complained about their lost social standing. A few have left Russia and renounced their citizenship.

Despite the reports of impounded superyachts, however, most kleptocrats are still putting caviar on the table. Foreign governments have frozen about $100bn-worth of private Russian assets—only about a quarter of the $400bn that Russian households have abroad. The biggest imposition on many rich Russians relates to their holidays. The French Riviera is off-limits; Dubai and Antalya are the main substitutes. Sanctions, perversely, may pave the way for the creation of a new generation of oligarchs. With Western firms leaving the country en masse, there are hundreds of billions of dollars worth of assets up for grabs. If the intention behind the measures was to cause discomfort among Mr Putin’s inner circle, there is little sign of it.

Financial sanctions, too, have had a limited effect. After Russia invaded Ukraine, ten Russian lenders were kicked out of Swift, which more than 11,000 banks around the world use for cross-border payments. Close to two-thirds of Russia’s banking system can no longer process transactions in euros or dollars.

But Western countries have not cut off Russian banks entirely, as they need to pay for the Russian oil and gas they continue to import. Gazprombank, which processes these payments, remains a member of Swift. What is more, new financial pipes are being built to replace Western ones. Average daily transactions using CIPS, China’s alternative to Swift, have increased by 50% since the invasion began. This past December 16% of Russia’s exports were paid for in yuan, up from almost none before the war. The narrow gap between the price at which Russian banks sell their customers yuan and the price at which they buy yuan suggests a liquid market. Some international transactions are also settled, with difficulty, in Indian rupees and Emirati dirhams.

Restrictions on exports of certain goods to Russia have also disappointed. America and its allies have banned sales to Russia of thousands of high-tech items, while many Western firms that used to operate in Russia have voluntarily pulled out. Of about 3,000 global firms with a Russian presence tracked by the KSE Institute at the Kyiv School of Economics, roughly half have curtailed operations there in some way. Last year the stock of foreign direct investment in Russia fell by a quarter.

Yet Russia continues to import almost as much as it did before the invasion. New trading partners have sprung up to replace the West. China now sells twice as much to Russia as it did in 2019.

“Parallel” imports—unauthorised sales from the West to Russia via a third country of everything from fizzy drinks to computer chips—have soared. In 2022 imports from the eu to Armenia mysteriously doubled, even as Armenian exports to Russia tripled. Serbia’s exports of phones to Russia rose from $8,518 in 2021 to $37m in 2022. Shipments of washing machines from Kazakhstan to Russia rose from zero in 2021 to nearly 100,000 units last year.

These arrangements have drawbacks. Russia’s economic hubs are nearer to Brussels than to Beijing. Higher transport costs mean higher prices. People also have fewer choices than before (one Muscovite complains about the difficulty of finding mortadella). According to a recent survey by Romir, a Russian market research firm, two-thirds of Russians reckon the quality of the products they buy is deteriorating.

What is more, not all goods can be obtained in sufficient quantities through back channels. Many Russian-made medications, which depend on imported raw materials, are in short supply. The car industry, meanwhile, is struggling with a shortage of imported semiconductors. Production was down 70% in January-February, compared to the same period a year before.

Yet even if Russia cannot make as many cars any more, it can still import them. After Lada, a Soviet stalwart, the most popular brand in Russia is now Haval, a mid-range Chinese marque. Its monthly sales have increased 331% over the past year.

Russia also seems to be getting hold of the parts it needs to keep its civilian planes airborne, somehow. Hackers have been stealing updates of aircraft software that Russian firms can no longer buy. Crashes, although frequent by Western standards, have not increased.
The impact of sanctions on Russia’s exports has been bigger–but Western countries always shied away from making them too severe for fear of pushing up energy prices for their own consumers to unbearable levels. The EU’s imports of Russian gas have fallen dramatically. Russia has limited capacity to divert the exports to China, since the pipeline linking the two countries is small.
Shipping more by sea requires new liquefaction plants which take time to build and need sophisticated tech. Rystad Energy, a consultancy, forecasts that Russia’s gas sales will dwindle to 136bn cubic metres (bcm) in 2023 from 241bcm in 2021.

Oil, however, is more fungible. In December the EU, which in 2021 bought more than 40% of Russia’s crude exports, imposed an import ban. It also forbade its shipping firms, insurers and financiers from facilitating the sale of Russian crude to buyers in other countries unless the price per barrel was below $60. In February a similar package of sanctions came into force on Russia’s refined oil, a smaller but profitable export, much of which also went to Europe before the war.Consumer prices did rise by 12% last year, in large part because of a depreciation of the rouble in the spring. Average pay at medium-sized and large companies, which include many state-owned entities, rose marginally last year even after accounting for inflation. The value of people’s savings has fallen only slightly, central-bank statistics suggest. Inflation fell back to 3.5% in March.

Overall, the Russian economy has proved resilient. Real gdp fell by only 2-3% last year—far less than the 10-15% decline that many economists had predicted.

All this suggests that Mr Putin should be able to maintain the war effort for some time to come. Expanding it, however, is another matter. Some on the right are calling for Mr Putin to spend more than a few percentage points of gdp on the invasion. After all, Russia has embraced total war before—including in 1942 and 1943, when it spent an astonishing 60% of its gdp on the military, according to “Accounting for War”, a book by Mark Harrison published in 1996.

It’s unclear that spending vastly more money would achieve the desired results anyway. Russia’s economy has become more centralised, but it is not the planned, command-and-control apparatus of the Soviet times. Converting a budgetary bazooka into weapons of a more conventional sort would thus, at best, take time. The effort would exacerbate the bottlenecks that are already constricting Russia’s military output, in machinery subject to sanctions, for example, and in skilled workers. Much would depend on the continued assistance of China, the Gulf states and other countries through which Russian capital and imports flow–and they might be nervous about abetting a big Russian escalation.

Throwing the kitchen sink at Ukraine, therefore, looks out of the question. “Considering Russia’s existing capabilities and limitations, it will likely opt for a slower-paced attritional campaign in Ukraine,” asserts the CSIS report. Mr Putin has succeeded in insulating the Russian economy from the worst effects of war and sanctions – but in a way that makes the war hard to win.