SANCTIONS AGAINST RUSSIA: WHAT IMPACT?

The Russian invasion of Ukraine that began in February 2022 is now in its tenth month. Russia did not achieve any of its declared objectives. Instead, it suffered a number of humiliating defeats and now faces a military stalemate. The Kremlin must deal with the growing shortages of military munitions, unprecedented political and economic pressure, isolation abroad, and a slowly growing discontent at home.

Sanctions

Assessing the immediate economic results of Western sanctions, one must admit that the Russian economy, on a macroeconomic level, has demonstrated a certain resilience. Russian economic decline will be less than expected — between 4 and 7%, and in 2023 — around 3%. Russia’s budget deficit in 2022 is expected to be 2% of the GDP.¹ Capital flight in 2022 will be around $243 billion, according to the CBR forecast. The Russian real estate market is stagnant and the Russian retail market has decreased by around 10%. But in 2024, the Russian economy will probably rebound with around 1% growth.

One instrument of mitigating the economic consequences of sanctions is reorienting foreign trade towards countries that have not imposed sanctions on Russia, and who are willing to seize the occasion to advance their business, and in some instances, political interests. These countries are China, India, Iran, Turkey, and some South American and African countries. In June 2022, exports of goods from Turkey (a NATO member) to Russia – $791.4 million – had increased by 46% and was the highest since 2010. Turkey and Russia have agreed to bring the trade turnover to $100 billion, developing cooperation in areas like energy, trade, tourism, and agriculture. Following the meeting, the two sides agreed to start partial payment for Russian gas in regional currencies.²

India has increased its purchases of Russian coal nearly sixfold, and oil imports were 31 times higher than they were in 2021. Russia offers Indian oil importers discounts of up to 30 %. In addition, Russian sellers accept payment in Indian rupees and United Arab Emirates dirhams. China-Russia trade went up 47%, mostly as a result of Chinese purchasing of Russian oil and gas.

Another instrument of mitigating the consequences of sanctions is the import of goods into the country without the consent of the manufacturer or the copyright holder. This mechanism is dubbed “parallel import”, although it often amounts to pirating. It is significant that such imports are officially recognized by the Russian government. A special federal law was even adopted for this phenomenon that protects Russian companies from importing goods without the permission of the copyright holder.³ The so-called “law on parallel imports” was introduced in May. In August the volume of parallel imports to Russia had reached almost $6.5 billion. By the end of the year, this figure is expected to rise to $16 billion USD. Considering that in 2021 the value of goods imported to Russia was around $304 billion, the value of parallel imports amounts to just over 5% of last year’s imports volume.

Foreign Trade Surplus

In the second quarter of 2022, Russia recorded its highest-ever current-account surplus, in part resulting from a trade surplus. This reflects higher fossil-fuel revenues resulting from higher prices. However, around 50% of the Russian trade surplus is due to rapidly declining Russian imports. In March-June 2022 imports to Russia were half of the average value in the preceding four months. Russia’s imports from every country dropped in all major product categories.

From the overall $60.1 billion increase in Russia’s trade surplus with 34 countries, mineral fuels accounted for $29.4 billion, while other types of goods accounted for $30.7 billion.⁴ Almost half of the latter resulted from the drop in sales of machinery and transport equipment to Russia, which will likely impede Russia’s ability to produce advanced technological products, including military equipment.

Technological Gap

Perhaps the most sensitive are the sanctions that involve Russia’s high-tech sector. Russia traditionally lagged behind the G7 countries in areas such as electronics, communication equipment, optics, etc. Russia remains largely dependent on technological transfer from developed nations.⁵ As Russian industrial infrastructure is becoming obsolete, the continued drop in imports of machinery, IT, and other types of high-tech equipment will contribute to Russia’s technological decline.

The Global Innovation Index (GII) evaluated the current stage of Russia's innovative development (in 2021) as average, marking Russia's position as 45th out of 132 countries. The sub-index for innovation resources ranked Russia 43rd, and the sub-index for innovation outcomes ranked Russia 52nd. Institutional structure and infrastructure, investment, and venture capital indicators remain weak. In the past ten years, investment in innovative research and development programs was steadily declining: in 2010 it was 19% of the GDP, and in 2020 — it was 15.6%. The same goes for state investment in scientific research in 2010 — 0.51% of the GDP, in 2020 — 0,46%.

In September 2022, Russia’s Industry and Trade Ministry openly recognized that the country is facing a serious technological lag, dependence on foreign technologies and products, and an acute shortage of qualified personnel.⁶ The last point is significant as it denotes continuous brain drain. During the first nine months of 2022, Russia could have lost 1.1 million people or up to 1.5% to 2% of its workforce — to emigration.⁷ The shortage of qualified personnel has already reached record proportions since 1993: every third Russian company complains about a shortage of workers, and every second company states the impossibility of increasing output due to the lack of personnel, even if there is demand.⁸ The lack of qualified personnel, in its turn, will also contribute to Russia’s technological demise.

Oil

Russian technological backlog will contribute to its deepening dependency on raw material exports while facing the shrinking market. In April, the Russian oil industry experienced the largest production decline this year - up to 9.97 million (mln) barrels per day. Although Russia increased its oil production in November 2022 by around 2% compared to October, (to 10.8 mln barrels per day), it still failed to reach the production level of February-March, when it reached 10.9 mln barrels per day. Since the beginning of the year, Russia produced about 3.4 billion (bln) barrels in 11 months. If the current production level is maintained, Russia's oil production may approach 3.5 bln barrels by the year-end (in 2021 it was 3.7 bln barrels).

Anticipating the December 5^th EU embargo on Russian oil shipments, European nations began to reduce the purchase of Russian oil in advance: export in November dropped by about 4%. JP Morgan estimates that the effect of oil export restrictions will lead to a reduction of oil production in Russia by 500 thousand barrels per day in the first quarter of 2023. The International Energy Agency makes an estimate of 1.4 mln barrels a day. About 70% of Russia’s crude oil exports are transported by sea; refusing to ensure tankers carrying Russian oil may deal an additional blow to Russian oil revenues.

What sort of outcome of these initiatives will be for the oil market is not yet clear. Russia remains one of the largest oil producers in the world: according to the International Energy Agency, in December 2021 Russian oil constituted about 8% of global oil production. Its complete exclusion from the market could have unintended consequences and lead to a global crisis.

Gas

Russia's natural gas sector seems to be a better short-term survivor than the oil sector. In 2021 it accounted for almost 40% of European Union gas demand. This share has increased in recent years, as European domestic natural gas production has declined. Germany, Turkey, and Italy were the largest importers of Russian natural gas. Russia has been expanding its liquefied natural gas (LNG) capacity. In 2021, it exported 40 bcm of Liquified natural gas (LNG), making it the world’s 4th largest LNG exporter and accounting for approximately 8% of the global LNG supply.

In 2021, the European Union imported an average of over 380 million cubic meters (mcm) per day of gas by pipeline from Russia, or around 140 billion cubic meters (bcm) for the year as a whole. As well as that, around 15 bcm was delivered in the form of liquefied natural gas (LNG). The total 155 bcm imported from Russia accounted for around 45% of the EU’s gas imports in 2021 and almost 40% of its total gas consumption. Record gas prices meant that the Russian natural gas industry was still able to post record revenues and net profit, despite the fact that Russian gas exports to Europe have slumped 31% from the same 2021 period.

Since the introduction of sanctions, Russia’s energy exports have been redirected towards India and China, though the EU still accounted for more than half of Russian energy export revenues in June 2022. In late 2019, Russia launched a Power of Siberia gas pipeline to transport gas to China. In 2021, Gazprom exported over 10 bcm of natural gas via the Power of Siberia pipeline. Now Russia is looking to develop the Power of Siberia-2 pipeline, with a capacity of 50 bcm/year to supply China.

Systemic Turbulence

Economic war between Russia and the EU/US informal alliance is damaging to both parties. Although everyone suffers from the conflict, considering the economic and technological capabilities of the alliance, as well as Russia’s lack of ideological coherence, the inability to construct an efficient communications strategy, incompetence, and corruption, Russia appears as the most likely loser in this confrontation.

The loyalist camp is split between those who blindly accept Putin’s way of conducting this war and those who are critical of the Commander-in-Chief and his General Staff. The latter becomes more and more vociferous. The recent brutal exchange between Igor Strelkov, former defense minister of the separatist People’s Donetsk Republic, an ardent right-wing critic of the Kremlin, and the chief Kremlin propagandist Vladimir Soloviev, demonstrates not only the quality of public discussion but shows the rising contradictions within the loyalist camp.⁹ In the same vein, Evgenyi Prigozhin, the owner of the Wagner PMC, in November 2022, publicly attacked Alexander Beglov, the Governor of Saint Petersburg, and a former Deputy Head of the Presidential Administration. The public conflict that was unthinkable before February 2022, had become a reality now. Prigozhin orchestrated a massive media campaign against Beglov and filed a formal complaint with the FSB and the State Prosecutor's Office, accusing Beglov of “high treason” and other crimes. So far, these accusations did not lead anywhere, but the mere fact that such a conflict become public attests to a changing political landscape in Russia. The fact that Beglov, a political heavyweight in charge of Putin's native city (and the second largest city in Russia), was publicly denigrated by a former convict, a recent political nobody, points to a transforming power politics landscape. Prigozhin, due to his military resource, is acquiring a new role in Russian public life. Most recently he refused an invitation from the chairman of the Liberal-Democratic Party Leonid Slutskiy to a party conference and publicly insulted Slutskiy.

This shift in behavior takes place against the background of the changing public mood related to the war. According to recent opinion polls conducted by Russian Field, a Moscow-based research center, from April to December, the number of respondents who consider the course of the "military operation" to be successful has decreased by 10% (from 60% to 50%). At the same time, the number of Russians who consider the “military operation” unsuccessful has increased by 11% (from 22% to 33%). Since April the number of supporters of peace talks has increased by 9%, from 35% to 44%. At the same time, the share of respondents in favor of continuing the “military operation” decreased from 54% to 45%. The Russian political system is gradually losing its stability and may enter a period of turbulence.

Conclusions

Although Russia was able to mitigate the short-term impact of sanctions through its record energy sector revenues, their long term-effect will be felt by the end of 2023. Russia will soon face the hard truth of the war: living standards decline, technological backlog, continuous brain-drain, increasing levels of violence, crime, and political radicalization at home. Against the background of international isolation, the Russian economy will have to abandon any plans for modernization, while Russian society will vacillate between apathy, angst, and, eventually, anger. And the longer this war drags on, the stronger the chances that Russia will slide into Hobbesian chaos.

NOTES:

1. This is the official estimate, although, in reality, it may double. In comparison, in Europe seasonally adjusted government deficit is at 2.1% of GDP in the euro, area and 1.8% of GDP in the EU.

2. According to experts from The Center for Macroeconomic Analysis and Short-Term Forecasting (CMASTF), an independent Moscow non-profit research center that specializes in the analysis of macroeconomic processes in Russia,

3. According to Erdogan's statement, following a meeting with President Putin on August 5, 2022. Such an indicator appears in the road map for economic cooperation between the two countries.

4. The Ministry of Industry and Trade has approved a list of goods that will be included in parallel imports. So far it contains about 100 categories and includes brands like BMW, Toyota, Audi, Renault, Nissan, Apple, Samsung, Sony, HP, Intel, and AMD, as well as equipment for different industries, clothes, shoes, and cosmetics., etc.

5. The EU, China, South Korea, Japan, India, the US, the UK, and Turkey. These countries accounted for around 75% of Russia’s exports and imports in 2019. Data collected by the Brussels-based Bruegel think tank.

6. Russia's foreign trade turnover of goods and technologies was characterized by a high share of imports. In 2021 the overall turnover amounted to $785 billion for goods and $9.7 billion for technologies, of which the share of imported goods reached 37.4% ($293.4 billion) and of imported technologies 51.5% ($5 billion), respectively.

7. Only 18% of Russian enterprises are using CNC machines (numerically controlled), while in Japan the share exceeds 90%, in the U.S. - over 80%, in Germany - over 75%, in China - almost 30%.

8. According to the Russian Alfa-Bank Center for Macroeconomic Analysis.

9. When Strelkov challenged Soloviev to a debate, Soloviev refused and called him a traitor. Strelkov retaliated by calling Soloviev a scumbag.