The EU has imposed an unprecedented set of sanctions on Russia following the country’s invasion of Ukraine in February 2022. But what impact are these sanctions having on the Russian economy? Gubad Ibadoghlu writes that while Russia managed to weather the economic storm during 2022, the coming months and years are likely to prove substantially more challenging.
The EU recently adopted a tenth package of sanctions against Russia and those who support it in its illegal aggression against Ukraine. The package includes new trade and financial sanctions. These new bans and restrictions cover EU exports worth €11.4 billion (2021 data). They come on top of the €32.5 billion worth of exports already sanctioned in the previous packages.
With this latest package, the EU has sanctioned nearly half (49%) of its 2021 exports to Russia. At the same time, the EU has also imposed bans on the import of high-revenue Russian goods. These new import bans cover EU imports worth almost €1.3 billion, and they come on top of €90 billion already sanctioned, representing 58% of the EU’s 2021 imports altogether. But what impact are these sanctions having on the Russian economy?
Initial economic gains
On 5 December last year, when Russian President Vladimir Putin signed the Law on the Federal Budget for 2023, the state of the Russian economy was much better than it is now. This is because the Russian economy initially benefited from several factors following the invasion of Ukraine.
These gains can be classified into several groups, but broadly incorporate extra revenues from a rise in the price of energy, value added from parallel imports from alternative markets and import-substituting domestic production, additional incomes from the expansion of the local service sector and domestic tourism, and a de-dollarisation process that led to increased gold reserves, and an appreciation of the rouble.
Rising energy revenues
As outlined in a statement by the Deputy Prime Minister of Russia, Alexander Novak, revenues from the oil and gas industry increased by 28% in 2022. This was not only due to a rise in prices on the world market, but also due to an increase in oil production in Russia by 2% and an increase in oil exports by 7%, despite the imposition of sanctions.
According to Rosstat, total gas production in Russia decreased by 12% in 2022 and commodity gas production decreased by 13.4%. The volume of liquefied natural gas production in Russia increased by 8.1% to 32.5 million tons in 2022, which is a record. As for coal production, despite the EU embargo on the coal industry, coal production in Russia increased by 0.3% compared to 2021 and reached a record level of 442 million tons.
Sanctions imposed after Russia’s occupation of Crimea in 2014 incentivised domestic production. This production is aimed at replacing imports and is not based on modern equipment and new technology. From then on, the development of the processing industry, which was based on agricultural production, accelerated.
One consequence of this is that prior to Russia’s invasion of Ukraine in February 2022, the level of self-sufficiency in essential food products in Russia was relatively high. For instance, according to Rosstat, in 2020, the level of self-sufficiency in potatoes in Russia was 89.2%, 84% for milk, over 100% for meat, 86.3% for vegetables and melons, and 42.4% for fruits and berries.
Thus, Russia substantially improved its position in the Global Food Security Index of The Economist Intelligence Unit in 2020, sitting behind only Belarus among the CIS countries in terms of food security. The sanctions applied against Russia since 2014 played an important role in achieving this. Increased demand for local products in the domestic market led to 6.6% economic growth in agriculture, forestry, hunting, and fishing in 2022.
Since Russia’s invasion of Ukraine in February 2022, the collective western sanctions against Russia, as well as the voluntary suspension or restriction of trade by western companies, have led to a fundamental restructuring of domestic and foreign trade. Russia has managed to comprehensively expand parallel import operations from new markets.
According to the Federal Customs Service, Russia’s leading trade partners in 2022 were China, Turkey, and the Netherlands. In 2022, Russia’s trade turnover with China increased by 28% compared to the previous year, trade with Turkey increased by 84%, and with Belarus by 10%. Meanwhile, trade decreased with Germany by 23% and the Netherlands by 0.1%. In the nine months of 2022, the trade turnover between Russia and the CIS countries increased by 6.8% compared to the same period in 2021 and reached 72.6 billion dollars.
Tourism and services
Travel bans imposed on Russian citizens during the war in Ukraine has stimulated the development of domestic tourism and the service sector, as well as the growth of investments in the construction sector. Thus, according to Rosstat, there was an increase of 5% recorded in construction in 2022, an increase of 4.3% in the activity of hotels and catering establishments, and an increase of 0.6% in the activity of information and communication services.
After initially falling, the rouble strengthened considerably in the aftermath of the February 2022 invasion. Russia has been searching for alternatives to the euro and the dollar since 2014 and as the world’s second-largest gold producer, increasing the country’s gold reserves has proven to be an effective tool for mitigating the impact of sanctions and managing associated risks.
The Russian government has therefore increased investment in this field over the past year. In 2022, the country nearly tripled the size of its gold reserves. Gold transfers from Russia to China were also expected to have increased by 67% (with a 30% price reduction) during 2022.
Are sanctions starting to bite?
Following these initial positive effects on the Russian economy, the picture began to change at the end of 2022. The increase in oil production in 2022 continued until 5 December, when the G7 approved a cap on the price of Russian oil. As a result, Russia’s average daily oil production in December was 9.96 million barrels per day, which is approximately 520,000 barrels per day lower than the daily production quota set by Russia for November 2022 to December 2023, according to the OPEC+ agreement.
Serious deviations from forecasts have already been recorded in January 2023. Russia’s oil and gas export revenues were $18.5 billion in January, 38% lower than the $30 billion Moscow received in January 2022, a month before its invasion of Ukraine, according to IEA numbers shared with Reuters. This will have negative implications for Russia’s federal budget moving forward.
According to a preliminary estimate, federal budget revenues in January 2023 amounted to 1.356 billion roubles, 35 percent less than compared to the same indicator in January 2022. In the first month of the year, oil and gas revenues in the budget amounted to 426 billion roubles, and a 46 percent decrease in revenues from this source when compared to January 2022, primarily due to the decline in quotations for Urals oil and a reduction in natural gas exports.
According to preliminary estimates, federal budget expenditures in January 2023 exceeded those of the same period last year by 59 percent. Thus, in the first month of 2023, the federal budget deficit was 1,760 billion roubles (about 25 billion dollars). However, according to the Law on the Federal Budget from 2022, the total deficit for the year was put at -2,925 billion roubles. Apparently, within just one month, the budget deficit exceeded 60 percent of the predicted indicator for the year. Let’s not forget that there are still eleven months of the year ahead.
Russia has planned defence expenditures for 2023 of 4,981 billion roubles (66.41 billion dollars), which is 302.9 billion roubles more than in 2022. At the same time, the changing nature of the war and the supply of defensive as well as offensive weapons to Ukraine suggest the conflict will be increasingly expensive for both sides.
While these expenses for Ukraine are intended to be covered by financial assistance and military support from the West and international financial institutions, Russia will have to cover the cost from its internal resources and reserves. Since the G7 and its allies have approved a cap on the price of Russian oil, these extra expenses will have to be met against the background of a decrease in oil and gas revenues. This poses new risks for the country’s finances and the rouble.
Given the low business activity in Russia, there is likely to be little option for the government than to spend foreign exchange reserves and the assets of the National Welfare Fund. All of this suggests that while the Russian economy managed to navigate the first year of the war in Ukraine, the coming months and years could prove substantially more challenging.
Note: This article gives the views of the author, not the position of EUROPP – European Politics and Policy or the London School of Economics. Featured image credit: kremlin.ru / Krasilnikov Stanislav, TASS Photo Host Agency