Geopolitical Report ISSN 2785-2598 Volume 27 Issue 3
Author: Antonio Graceffo

The Russian invasion of Ukraine has sparked economic sanctions, which are meant to cripple the economy while detracting from Russia’s ability to wage war. The United States National Security Advisor, Jake Sullivan, warned Beijing, shortly after the invasion, that China would face similar sanctions if they aided Russia.

Many China analysts believe that the sanctions on Russia have dissuaded China from invading Taiwan or at least delayed the Chinese invasion of the island until the economy can withstand similar sanctions. And while this is good news for Taiwan, the sanctions negatively impact Europe, as the continent faces a potential energy crisis. Europe’s suffering raises the question of how damaging the sanctions have been on Moscow. This paper will analyse the sanctions’ impact and the war on the Russian economy.

Western sanctions against the Russian Federation

One of the first sanctions placed on Russia was a prohibition against the sale of military equipment, weapons, and dual-use technologies. The U.S. export bans were even more comprehensive, forbidding the export of any hardware or software made with intellectual property or components from the US. The U.S., EU, and U.K. sanctioned several Russian banks in the financial realm, freezing reserve assets held abroad. Russia’s use of SWIFT, the American transnational payment system, has also been limited. Visa, Mastercard, and American Express independently discontinued their services with Russian banks. And more than 1,000 western companies, accounting for 24% of the total, exited Russia voluntarily.

Numerous western countries placed a moratorium on Russia’s oil, coal, and gas imports. The EU, however, is so dependent on Russian energy that it could not ban it completely. Instead, they agreed to stop buying Russian coal and curtailing the import of Russian oil.

An oil-cap coalition was formed, including the G7 countries Canada, France, Germany, Italy, Japan, the United Kingdom, the United States, the European Union, and Australia. The cap, which went into effect on December 5th, was set at $60. The coalition partners agreed not to pay more than $60 a barrel for Russian crude. Furthermore, they have also prohibited their countries’ shippers and insurers from accepting crude priced higher than $60. Therefore, if some country outside the coalition is willing to pay more than $60 for Russian crude, they will have to make their own arrangements for the shipping and insurance.

Although Russia was able to find new markets for its oil in India, China, and Turkey, it had to offer these countries a discount below the global market price. Additionally, the largest maritime insurance companies are British, European, or American, making it difficult to find coverage for the shipments. And finally, being unable to use coalition shipping companies is increasing the distance the oil has to travel, as well as driving up the cost.

In 2022, oil prices were high for most of the year, peaking in June at $106 per barrel. At the same time, Russia’s government spending increased by about a third because of the war in Ukraine. The oil income more than offset the spending, and Russia was enjoying a surplus for the first 11 months of the year. However, global oil prices have declined since summer, reaching $80.07 per barrel on January 13th. Consequently, by the end of 2022, Moscow’s budget surplus had turned into a deficit of $56 billion or 2.3% of GDP. Additionally, the Kremlin has been drawing down on its foreign currency reserves which went from $630.5 billion U.S. dollars before the invasion, to $571 billion U.S. dollars, in December.

Private citizens in Russia are facing high inflation, which as of January 2023, stood at 11.65%. The GDP did not experience as severe of a drop in 2022 as predicted, largely because Europe was unable to sever completely Moscow’s income from oil and gas. However, the GDP contracted 3-4%, which would take two years to recover from, under the best of circumstances. But the sanctions are expected to intensify, and Moscow’s spending on the war is anticipated to increase, making a recovery in 2024 very unlikely.

The sanctions are having an effect on sectors apart from oil, as well. In October, non-oil and gas revenues fell by 20%compared to a year earlier. Industrial production only contracted by 1%. However, this was because of increased military goods and equipment production. Consequently, the production of civilian goods is down considerably. Automobile production, for example, almost halved, truck manufacture is down 40%, TV and receivers by 44%, and excavators decreased by 69%.

Russia’s economy and industrial production

The impact of the sanctions is expected to be felt more acutely this year as quantities of goods, materials, and products in reserve dissipate. The entire Russian manufacturing sector, including the military, is heavily dependent on high-tech imports, which may no longer be available. A shortage of technology products has already caused factories to alter their methods, adopting import substitution and, in some cases, reverting to more primitive, less efficient means of production. And, as old technology and components wear out, they are being replaced with inferior, locally-produced models.

Domestic investment in Russia has largely come to a halt. Foreign direct investment is in contraction, hitting a low of negative 22.4 billion U.S. dollars in March, as foreign companies divested of their Russian holdings. FDI has continued to dwindle, losing about $21 billion by the end of the third quarter of 2022.

The lack of foreign investment is expected to decimate certain sectors of the economy, such as trade, mining and manufacturing, the largest recipients of FDI. Meanwhile, Russia is catabolising its own workforce, driving away many of the youngest workers and those with the most education and training. Three hundred thousand young conscripts have been called up to serve in the war, pulling them out of the civilian economy. At least 500,000 to one million people have fled the country. Some of these avoided conscription, but a large percentage were well-off, educated people who had the means to flee and the highest likelihood of obtaining residency in a foreign country.

Trade is diminishing, and even those nations willing to trade with Russia have difficulty receiving payment in Euros or Dollars. This is because of the sanctions blocking Russia-related bank accounts and preventing transfers across SWIFT and other international banking networks.

The Kremlin was expected to experience a deficit this year of 2% of GDP, but that prediction assumed an oil price of $70 a barrel. In December, however, the price of Russian oil had fallen to $50 a barrel. Meanwhile, global oil prices are also dropping. The terms of the coalition called for members to meet every two months to discuss adjusting the cap. The next meeting will be held in February, and if oil prices continue their downward trend, the cap will be lowered.

Conclusion

In short, the Russian economy is slowing. Foreign investment is drying up. Trade and revenues are shrinking. Available civilian manpower is down. When machines break, they cannot be restored. And Russia is expected to spend even more on the war this year. In December, Vladimir Putin announced his plans to expand the army, creating 17 new divisions and adding half a million soldiers.

Russia survived this first year of the war, but they relied on oil and gas revenue, plus a certain amount of savings, as well as inventories of raw materials and imported products on hand. Those reserves will be running out now. With little new money coming in, the second year of the war should be much more painful for Vladimir Putin’s economy.

Disclaimer: The views and opinions expressed in this report are those of the author and do not necessarily reflect the official policy or position of SpecialEurasia.