LONDON (CNN) When Russia launched its all-out invasion of Ukraine a year ago, Western countries hit back with unprecedented sanctions to punish Moscow and put pressure on President Vladimir Putin. The goal: to deal such a severe economic blow that Putin reconsiders his brutal war.
As a result, Russia’s economy weakened. But it also showed surprising resilience. As demand for Russian oil fell in Europe, Moscow diverted its casks to Asia. The country’s central bank fended off a currency crisis with aggressive capital controls and rate hikes. Military spending supported the industrial sector while the struggle to replace Western equipment and technology boosted investment.
“Russia’s economy and system of government have turned out to be much stronger than the West believed.” Putin said in a speech to the Russian Parliament Tuesday.
Still, cracks are starting to appear that will widen over the next 12 months. The European Union, which spent more than $100 billion on Russian fossil fuels in 2021, has made big strides in phasing out purchases. The bloc, which had drastically reduced its reliance on Russian natural gas over the past year, officially banned most imports of Russian crude by sea in December. It issued a similar block for refined oil products this month.
These measures are already straining Russia’s finances as it struggles to find replacement customers. The government reported a budget deficit of about 1,761 billion rubles ($23.5 billion) for January. Spending rose 59% year over year while revenue fell 35%. Deputy Prime Minister Alexander Novak announced that Russia will cut oil production by about 5% from March.
“The era of windfall gains from the oil and gas market for Russia is over,” Janis Kluge, an expert on Russia’s economy at the German Society for International Politics and Security, told CNN.
Birds fly over buildings of an oil refinery in the Siberian city of Omsk, Russia, on February 8, 2023.
Meanwhile, the ruble has fallen to its weakest level against the US dollar since last April. The weakness of the currency has contributed to high inflation. And most companies say they can’t envision growth amid high economic uncertainty right now, according to a recent survey by a Russian think tank.
This dynamic is putting the country’s economy on a downward spiral. And they will force Putin to choose between increasing military spending and investing in social goods such as housing and education – a choice that could have consequences both for the war and for Russian public support.
“This year could really be the key test,” said Timothy Ash, an associate fellow in Chatham House’s Russia and Eurasia program, a think tank.
Hold
To calm Russia down on its aggression, Western countries have used their hold on the global financial system, imposing more than 11,300 sanctions since the invasion and freezing about $300 billion of the country’s foreign exchange reserves. At the same time more than 1,000 companies, ranging from bp (bp) To MC Donalds (MCD) And Starbucks (SEX)have suspended or curtailed their operations in the country, citing resistance to the war and new logistical challenges.
According to a provisional estimate by the government, Russia’s economic output shrank by 2.1% last year. But the hit was more limited than forecasters initially anticipated. When the first sanctions were imposed, some economists were predicting a 10% or 15% drop.
One reason for Russia’s unexpected courage was his after Putin’s annexation of Crimea from Ukraine in 2014 toward self-sufficiency. Through a policy known as “Fortress Russia,” the government increased domestic food production and policymakers forced banks to build up their reserves. That created a degree of “durability,” Chatham House’s Ash said.
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Rapid intervention by the Russian central bank, which raised interest rates to 20% after the invasion and imposed currency controls to support the ruble, also had a stabilizing effect. Likewise, there was a need for factories to increase production of military goods and replace items imported from the West.
But the biggest support came from high energy prices and the world’s continued thirst for oil and other commodities.
Russia, the world’s second largest crude oil exporter, has been able to send barrels that would have gone to Europe to countries like China and India. The European Union, which imported an average of 3.3 million barrels a day of Russian crude oil and oil products in 2021, was also still buying 2.3 million barrels a day in November, according to the International Energy Agency.
“It’s a question of natural resources,” Sergei Aleksashenko, Russia’s former deputy finance minister, said last month at an event hosted by the Center for Strategic and International Studies, a think tank. That meant the economy experienced a slowdown but “not a collapse,” he added.
Russia’s oil problem
In fact, Russia’s export earnings from oil have increased over the past year. However, a repeat is unlikely, heralding increasingly difficult choices for Putin.
The price of a barrel of Ural crude, Russia’s main blend, fell to an average of $49.50 in January after Europe’s oil embargo – as well as a Group of Seven price cap – came into effect. In comparison, the global benchmark was around $82. That suggests customers like India and China are seeing a smaller group of interested buyers negotiate larger discounts. Russia’s 2023 budget is based on a Ural price of more than $70 a barrel.
It will also not be easy to find new buyers for processed oil products, which are also subject to new embargoes and price caps. China and India have their own network of refineries and prefer to buy crude oil, noted Ben McWilliams, energy adviser at Bruegel.
Meanwhile, gas exports to Europe have plummeted since Russia closed its Nord Stream 1 pipeline.
A motorcyclist drives past an oil depot in New Delhi, India on Sunday June 12, 2022.
The Russian government relied on the oil and gas sector for 45% of its budget in 2021. As it plans to maximize defense spending, lower revenues inevitably mean trade-offs. The spending plans for 2023 finalized in December included a decrease in spending on housing and healthcare, and a category that includes public infrastructure.
“Whatever energy resources are extracted, they are spent for military purposes,” said Gulnaz Sharafutdinova, acting director of the Russia Institute at King’s College London.
on the decline
The International Monetary Fund continues to expect Russia’s economy to grow by 0.3% this year and 2.1% this year next. But any outlook depends on what is happening in Ukraine.
“Whether the economy will contract or expand in 2023 will be determined by developments in the war,” wrote Tatiana Orlova, economist at Oxford Economics, in a note to clients on Tuesday. Labor shortages coupled with conscription and brain drain are key risks, she noted.
The impact of Western sanctions will develop into a crisis over time. Bloomberg Economics estimates that Putin’s war in Ukraine will cut Russia’s by $190 billion Gross domestic product by 2026 compared to the country’s pre-war path.
Sectors that rely on imports were particularly vulnerable. Domestic automakers like Avtovaz, which makes the iconic Ladas, are struggling with shortages of key components and materials.
A man talks on the phone near a closed H&M store in Moscow, Russia, on December 15, 2022.
Russia’s auto industry was already weakened after companies such as Volkswagen (VLKAF), Renault (RNLSY), ford (f) And Nissan (NSANF) ceased production and began selling its local assets last year. Chinese firms have increased their presence, part of a broader trend. Still, new car sales fell 63% year over year in January, according to the Association of European Businesses.
Across all industries, companies find it difficult to plan for the future. A survey of more than 1,000 Russian companies in November by the Stolypin Institute of Economic Growth found that almost half plan to maintain production for the next year or two and are not thinking about growth. The group said this contributes to a high risk of “long-term stagnation in the Russian economy”.
Given Putin’s ideological commitment to Ukraine’s subjugation, he is unlikely to back down, according to King’s College London’s Sharafutdinova. But his war chest “is probably going to inevitably diminish,” she added.
Prioritizing military spending will also come with social costs, with a “slow and creeping” erosion of living standards, she added.
“In normal times we might have said that the population would protest against it,” said Sharafutdinova. “But of course these are not normal times.”
— Clare Sebastian and Olesya Dmitracova contributed to the coverage.
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