Russia’s centers of power and business in the capital city of Moscow: In the foreground, the towers of the Kremlin. In the background, the skyscrapers of the “Moscow City” business district
Foto: Grigory Dukor / REUTERS
The Russian economy probably isn’t suffering as much as many had hoped from the West’s punitive measures. But they are causing some sectors to lag far behind technologically. Vladimir Putin’s army, in particular, has been hard hit by the sanctions.
Russian President Vladimir Putin has a favorite new term, one he has borrowed it from the Russians’ collective memory of World War II. He calls the sanctions imposed by the West an “economic blitzkrieg.”
It’s his way of managing expectations. If Russians believe the Kremlin is fending off an attempt at economic annihilation, they will grumble less about the real, but not total, decline of the Russian economy. And yet it the problems are still considerable. According to the Kremlin, 230,000 industrial jobs are already at stake. Tax revenues have collapsed: Russia’s budget surplus, still impressive at the beginning of the year, sank to almost zero over the summer.
Will the sanctions bring Moscow’s rulers to their knees after all, despite Russia’s gigantic profits from the sale of oil and gas? Assessments of the Russian economy have recently been extremely divergent. The Russian government is forecasting that its economy will shrink by only 4.2 percent this year, compared predictions of -7.8 percent in the spring. The International Monetary Fund (IMF) has also revised its forecast for Russia, from -8 percent in April to -6 percent. Data from the “Macromonitor” of the Moscow Higher School of Economics suggest that the Russian economy has stabilized since spring.
The German government, on the other hand, reaffirmed in mid-August that it is expecting a more severe slump. It is forecasting a 6- to 15-percent decline in Russia’s gross domestic product (GDP). To put that into perspective, the Russian economy never once fell by 15 percent in a single year in the early 1990s, when the Soviet planned economy collapsed. But which forecast is more likely?
What we do know is this: The sanctions imposed by the West in the spring have worked in two ways. For one, they are direct: Certain goods may no longer be traded, and transactions with certain banks, companies and individuals may no longer be conducted. Alongside this, there is also the psychological effect: The sanctions initially sowed panic and chaos in Russia and among Russia’s trading partners because no one could accurately assess the consequences. According to European Union estimates, around 28 percent of European exports to Russia are directly targeted by sanctions, but Russia’s imports from the EU have actually fallen by more than 50 percent.
But this “overshooting effect” loses its force over time. Many firms now see more clearly what they are still allowed to do and what they are not. The initial moral outrage in the West over companies that continue to do business in Russia has subsided. And the panic of spring has given way to a new routine. In fact, Germany’s exports to Russia have even risen slightly in recent weeks.
Will the Sanctions Work in the Longer Term?
Some of the Western retaliation is aimed at cutting Russia off from technologies over the long term. Russian auto production has suffered especially drastically as a result and many Western factories have halted production. The assembly lines at Lada, Russia’s best-known carmaker, stood still for many weeks.
Lada has since resumed building cars. But that doesn’t necessarily mean that the sanctions are losing their effectiveness. Buyers of new vehicles sometimes have to make do with a significantly lower level of technology. For example, vehicles will be coming off the production line without ABS for the foreseeable future. The company has been unable to find alternative suppliers for around 1,500 out of 4,500 components. Meanwhile, prices for new cars have risen. In spring, the price of Lada’s Vesta model was still around 1 million rubles, but it can now cost as much as 3 million rubles (50,000 euros). “Russia is becoming poorer and more backward,” says Janis Kluge, an expert on the Russian economy at the German Institute for International and Security Affairs (SWP) in Berlin.
Overall, technology imports have declined significantly, according to an assessment by the the Bank of Finland, the country’s central bank. They shrank by 41 percent in machinery, 61 percent in electronic equipment and 30 percent in optical and medical equipment. So far, Russian manufacturers haven’t succeeded in plugging the gaps. An analysis by the Russian Economics Ministry in Moscow has put the country’s backlog in microelectronics at 10 to 15 years. It also states that domestic production is difficult because of high costs and an “acute shortage of skilled workers.”
Across the board, though, the situation currently appears to be less dramatic than expected. Experts like Moscow-based economist Nikolai Kulbaka or economics professor Andrei Yakovlev, who has since moved to Harvard, believed that the sanctions would first really start taking effect in autumn, when stocks of critical components would slowly run out. Now, Kulbaka admits that he may have been “mistaken to a certain extent” and underestimated the “free-market character” of the Russian economy and its adaptability. Many supply chains have been broken, to be sure. But Russian managers have been able to procure replacements on the world market. “There’s an army of smart people working to stabilize the situation – and it’s still impossible to say how much success they might have,” says SWP expert Kluge.
How Badly Has the Military Been Hit?
The real aim of the sanctions wasn’t to wreck the Russian economy or even bring about regime change, anyway, says James O’Brien, the sanctions coordinator for the U.S. State Department. “We simply want to limit the resources for him to carry out imperial wars, and I think that’s where we’re seeing success.”
Russia is waging an outmoded war of the kind seen in the 1970s, says O’Brien. “It has not established air superiority. It does not have an effective drone capacity, does not appear to have artificial intelligence and military grade targeting equipment.” Instead, Putin’s force has a “large supply of dumb Howitzer rounds.”
There is also a link here with the sanctions. O’Brien says that when it comes to high tech, dual-use technology, “it is very hard for Russia to obtain enough of that at a price that’s predictable and through channels that are predictable.” Moscow is now forced to replace military equipment with inferior parts from the electronics market, he says. “That’s, you know, great DIY,” the diplomat scoffs, “but not a way to run a modern armed conflict.”
Both NATO and the British government are reporting that Russia is increasingly turning to Iranian combat drones. “Russia is almost certainly increasingly sourcing weaponry from other heavily sanctioned states like Iran and North Korea as its own stocks dwindle,” the British Defense Ministry tweeted on Sept. 14. Moscow had just procured artillery ammunition on a large scale from North Korea – again, not exactly precision ordinance.
Is Russia Finding Alternative Sources?
The Russian economy’s hopes of switching to alternative suppliers from Asia in civilian sectors have not been fulfilled. Unlike in the past, Taiwan, Japan and South Korea have all supported the sanctions against Russia this time around. Even China is exporting less goods to Russia than before the war, as are India, Brazil and Vietnam. This, too, can be seen by the data from the Bank of Finland. In Moscow, official trade statistics are now classified information.
As such, the Kremlin is relying on “parallel imports,” the import of goods through a third country without the consent of the original seller. But such gray market imports “usually aren’t suitable for large-scale serial production,” says Moscow economist Kulbaka. Suppliers are always exposed to the risk of becoming targets of “secondary sanctions” by the West themselves, he says, and have little interest in large-scale supplies and long-term contracts. As a result, the Chinese credit card provider UnionPay has already all but discontinued its service in Russia.
What Role Does the Strong Ruble Play?
The Russian currency initially depreciated drastically at the end of February. Following intervention by the central bank, it stabilized again – and it has recently been even stronger than before the onset of the crisis. The ruble exchange rate is an important factor in reassuring the country’s own population, which has been accustomed to regularly checking the ubiquitous exchange rate signs of currency exchange offices and banks since the turmoil of the 1990s. A strong ruble is seen by many Russians, falsely, as proof that sanctions can’t harm their country.
Still, it does “dampen the effect of the sanctions,” explains SWP economist Kluge. The strong ruble “makes imports cheaper that are now difficult for many companies to obtain.” In other words: If Russians still had to pay 120 rubles for one dollar, as they did in March, instead of the current 60 ruble exchange rate, they would have greater problems finding suppliers in Asia.
Without the strong ruble, the inflation rate in Russia also probably would have risen further. In July, inflation in Russia slowed to 15 percent.
What Happens Next?
Economically, a battle of attrition has developed between the West and Russia. The goal of cutting Moscow off from technology imports has largely been achieved. Russia’s government revenues, on the other hand, continue to flow thanks to high energy prices. The oil price cap agreed on by the G-7 is aimed at changing that. If the G-7 succeeds in pushing the price of Russian Urals oil to $60, it would reduce Russia’s tax revenues by 33 percent, the analysts at Capital Economics believe, a circumstance that could widen the government deficit of 2 percent of GDP.
But that wouldn’t necessarily lead to a crash of the economy. The more pressure exerted on the Kremlin, the greater the likelihood of a scenario in which Putin can no longer compensate for and control developments. So far, the Russian government has managed to stabilize large parts of the economy with state money, says economist Kluge. At Lada, for example, jobs and salaries have been secured for the time being. He says it is still difficult to estimate exactly how badly the economy is doing. Kluge says it isn’t even out of the question that the Russian economy could grow again as early as 2023. And that it is absolutely “possible that things could turn out differently than we have so far thought.”
At NATO, the hope is that Russia’s ability to wage wars of aggression will at least suffer in the long run. One senior NATO officials says that the sanctions are having a considerable impact. “The sanctions,” he says, “have already had a bite, and I think it is increasingly clear that there will be a snowball effect in the longer run on Russia’s ability to reconstitute the force after the war is over.”