In the aftermath of Russia’s invasion of Ukraine, Western leaders heralded a sanctions regime that would cripple the country’s war machine.
Joe Biden claimed Russia’s economy would be “cut in half”, while Boris Johnson spoke of squeezing it “piece by piece.”
A year has passed, but that great promise has been slow to deliver.
“The Russian economy and system of government have turned out to be much stronger than the West believed,” President Vladimir Putin said in a speech to the country’s parliament on Tuesday.
He was also flexing his muscles at an economic cabinet meeting last month: “Remember, some of our experts here in the country – I’m not even talking about Western experts – thought [gross domestic product] would fall by 10%, 15%, even 20%.”
Instead, Russia shrunk by a relatively modest 2.2% and it is expected to grow by 0.3% this year, according to the International Monetary Fund.
It means the sanctions-hit country will outperform Britain.
Among Western leaders, these predictions will make for unpleasant reading.
Over the past year, sanctions have descended on Russia’s economy but, to the surprise of most economists, it has weathered the storm.
This is largely down to the country’s oil and gas reserves. Although Europe turned its back on Russian energy exports, the country was able to exploit delays in imposing the ban, which helped bolster its public finances.
Revenues held up strongly thanks to a global spike in energy prices and a successful reorientation of trade to China and India.
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Russia was already sitting on a comfortable cushion.
Record high trade surpluses following the invasion came after years of conservative fiscal policies which allowed the country to amass a fund that it is now deploying in the war against Ukraine.
The country has been quietly sanctions proofing its economy for years.
Russians are enjoying record low unemployment and wage growth that has helped them to weather the worst of rising inflation.
They’re still cautious about spending during times of economic uncertainty, but the government is trying its best to encourage them by hiking minimum wages and pensions.
While economic data is not wholly reliable, nor does it provide a full view of the strains Russian society is under, the domestic economy has not collapsed in the way some had warned.
President Putin is in a triumphant mood but it may not last for long as cracks are starting to show.
Oil revenues are slipping now that Western countries have introduced a price cap on Russian Urals, its main crude export blend, and the country’s public finances are deteriorating as a result.
At the same time Russia is having to ramp up military spending and is relying on sales of foreign currency – Chinese yuan – to support the rouble. Last year may have exceeded expectations, but the sting of Western sanctions is only just starting to be felt.
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Living standards in Russia have been supported by record high wage growth and low unemployment.
When the war first broke out, analysts expected the departure of foreign companies to lead to mass job losses.
Instead, unemployment fell to a record low of 3.7% as Western firms handed over their businesses to local partners, which helped to maintain employment.
However, the headline unemployment rate is disguising a massive drop in the size of the workforce.
Hundreds and thousands of skilled workers have left or fled the country, either to fight or find work elsewhere – estimates range from 0.4% to 1.4% of Russia’s workforce. This is weighing on economic growth, with the country’s central bank warning recently: “The capacity to expand production in the Russian economy is largely limited by the labour market conditions.”
As in Britain, where a shrinking labour market is affecting the country’s economic outlook and putting pressure on inflation, Russia’s fortunes will also depend on how well the size of its workforce recovers.
Tatiana Orlova, economist at Oxford Economics, said: “There is anecdotal evidence that some of those who left in panic in March or September have since returned, due perhaps to their being unable to find an equivalent job abroad or because they still had family and property back in Russia.”
The tight labour market has led to robust wage growth – especially for IT professionals, construction workers and hospitality staff – which is boosting living standards. Wage growth in Russia is almost keeping pace with inflation and the government is hiking pensions and the national minimum wage, which will go up by another 10% next January after rising by 20% last year.
Oil revenues get a lot of attention but consumer spending is still the dominant part of the country’s economy and the government is hoping that the extra money will encourage Russians to go out and spend, something they have been cautious about indulging in over the past year.
It may have a large task on its hands, however. Many analysts expect Russia to launch a new offensive in the coming weeks in an effort to capture the whole of Donbas. If the country’s leadership announce a new wave of mobilisation then consumer confidence will likely drop again, causing households to prioritise saving over spending.
“The savings-to-disposable income ratio will rise again and stay elevated until the fighting abates, hampering authorities’ efforts to revive household demand,” Ms Orlova said.
Another round of mobilisation could also start weighing on business confidence. In the early days of the conflict economists were convinced that business investment would collapse at its fastest pace in decades but that did not happen.
Bumper profits for oil, gas and fertiliser producers helped fund business plans, with fixed investment increasing by 6% in 2021.
As Russia diverted its energy exports to Asia, the country required a massive increase in infrastructure.
This also helped boost the country’s manufacturing sector, although not uniformly. The country’s car industry, for example, collapsed last year as manufacturers struggled to access key component parts and tools from the west. Others are coping by accessing parts from Turkey, which is yet to participate in the international sanctions.
Oil and gas
Attempts to strangle Russia’s economy were immediately stifled by Europe’s heavy reliance on Russian oil and gas exports, which make up about 40% of the country’s revenues.
Russia successfully exploited this.
In the nine months that it took for the EU to agree and implement a bloc-wide ban on Russian oil exports, Putin’s regime enjoyed record fiscal surpluses as the country benefited from soaring wholesale prices, with its current account surplus jumping by 86% to $227.4bn.
This gave Russia a giant cushion to help fund the war effort and strengthened its currency, helping keep the price of imports low and dampening inflation.
During this time the country was also able to redirect supply to India and China, where its overall crude and fuel oil exports reached a record high of 1.66 million barrels a day last month.
A more challenging 2023
This year will be more challenging.
The country’s public finances are already starting to weaken as lower energy prices weigh on revenues. A $60 a barrel price cap on Russian crude oil – imposed by the EU, G7 and Australia in December – means the country is being forced to sell oil at a considerably discounted price compared to the global Brent benchmark.
The cap was recently extended to refined petroleum products as well.
Russia’s budget deficit came in at £20.8bn in January as income from oil and gas fell by 46% over the year. At the same time, government spending increased by 59% over the year.
Economists identified these as early signs of strain, with the country having to sell more Chinese currency and issue local debt to support itself.
However, they were still relatively sanguine about the country’s prospects.
Sofya Donets, chief Russia economist at Renaissance Capital, said: “The fiscal deficit expanded in 2022 but remained still moderate at 2% – below the pandemic or the great financial crisis levels.”
She added: “With the public debt below 20% of GDP the financing is hardly an immediate source of the stress, though a sustainable decrease in oil and gas revenues will call for a medium-term fiscal consolidation and non-oil tax increase, we believe.
“This consolidation, however, is yet not that urgent and could be delayed by up to two years, we assume.”
Analysts said the country had scope to increase the tax intake by levelling windfall tax on energy and fertiliser producers.
Crucially, Russia is able to meet its financing needs comfortably at home.
Both the government and corporations have very low levels of external debt and the government has built up a robust sovereign wealth fund.
“We need to remember Russia has spent the best part of 10 years sanctions proofing its economy,” said Liam Peach of Capital Economics.
“What all this meant was being cut out of global capital markets and sanctions on various corporates, banks and the government didn’t really have much of an impact on their financial needs, because they were quite low. So Russia’s government, for example, could go eight months without issuing any debt.”