Russia was starting to boom in October. Economic growth was surprisingly strong in the post-coronacrisis bounce back. Inflation was uncomfortably high, but the Central Bank of Russia (CBR) string of aggressive hikes over the previous year had curtailed the growth and the rate was expected to fall back to its target rate of 4% this year. And unemployment was back at post-Soviet lows, while real incomes had began to grow again for the first time since 2014.
And then it all went wrong. The extreme sanctions that have cascaded down on Russia following Russian President Vladimir Putin’s decision to attack Ukraine on February 24 are unprecedented in scale and designed to do as much damage to the Russian economy as humanly possible. The economy is expect to give all the gains it has made in the last 15 years. Particularly debilitating is the SWIFT sanctions that effectively cut Russia off from using dollars and the total unforeseen sanctions on the Central Bank of Russia’s gross international reserves (GIR) on February 27 that have deprived it of half its $634bn cash pile.
Signs of stress were already showing in March as things like sugar and office paper disappeared from shelves. The ruble also crashed to around RUB134 to the dollar before stabilising at around RUB100 to the dollar, but has already lost a third of its value. The stock market has crashed as well and the RTS index was frozen at 937 at the time of writing, while yields on Russian Ministry of Finance ruble-denominated OFZ treasury bills have doubled to around 12%.
But the scale of the damage will only become clear in the coming months. Analysts are tentatively predicting between an 8% to 15% contraction this year, although some say it could be worse. Imports have already crashed and have been made worse by sanctions. Russia’s Production Manufacturing Index has also crashed in March to the low levels of the start of the coronavirus pandemic. Planes are running out of spare parts and the fall in both imports and exports will be dramatic. However, it is expected fall in incomes and so consumption that makes up about half of GDP that will do the most damage. At the end of March the government was drawing up a damage control plan designed to prevent soaring unemployment and support the most vulnerable.
Private consumption should contract this year to levels of a decade ago as high inflation (likely at least 20 % p.a.) chews through real household incomes. The distress in companies will reduce employment and cut real wages. Fixed investment should contract to levels of roughly 15 years ago. Foreign firms operating in Russia will cut their capital investments to a minimum (the share of fully or partly foreign-owned firms has been 15 % of total fixed investment in Russia). Public investment is likely to increase, but its impact should be fairly limited. The reduction in inventories will sharply exacerbate the contractions in GDP and imports.
Going forward this year is going to be bad and next year Russia’s economy could shrink by another 3% according to the early estimates, but long-term it could be doomed to stagnation, as the sanctions will severely limit its ability to grow. Before the sanctions Russia’s economic growth potential was already limited to around 2% say economists after Russian President Vladimir Putin siphoned off so many resources to build his fiscal fortress. Now that potential is going to be reduced again and was already way below the global growth rates. Russia will almost certainly fall further and further behind the rest of the world.
The one piece of good news for the economy is Russia could end the year with a record surplus of $240B from energy exports. Due to record oil and gas prices, the main products of Russian exports, even with reduced energy sales, the aggressor state will receive about $321bn in revenue. This is more than a third more than in 2021. This will lead to a current record account surplus, which, according to the Institute of International Finance, could reach $240bn. However, the calculus may change entirely in the event of an embargo on energy sales. And even without it, Russia’s oil exports and output are already falling, with the International Energy Agency predicting it may lose nearly a quarter of its crude production this month. Oil and gas account for about half of Russia's exports and about 40% of last year's budget revenues. And Russia's ability to sell them may be the only thing keeping the economy from getting worse. The IIF estimates that the energy embargo by the EU, Britain, and the US will cut supplies by more than 20% and cost Russia up to $300bn in export earnings.
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