Sanctions will not bring the Russian economy to its knees

Last week I wrote here about the effectiveness of the trade embargoes imposed on Russia. I showed that although German exports to Russia have fallen by about 75%, exports to some other countries have increased noticeably. If you add it all up, it seems that the decline in German exports to Russia has been largely offset by exports to those other countries. You have to suspect that the goods in question will still end up in Russia via a detour.

Since the purpose of the sanctions is to damage the Russian economy, it is useful to see how Russia is doing economically. That's what I'm focusing on today.

I am dependent on figures that I obtain from my data supplier, Macrobond. In most cases they get the figures from Russian sources. Some skepticism and caution are therefore appropriate. After all, the Russians may be falsifying the statistics. It is said that a notorious liar must have a very good memory, otherwise he will become entangled in the inconsistency of all his lies. It is the same with economic statistics. The individual statistics must together form a consistent picture. Anyone who falsifies statistics indiscriminately runs the risk of inconsistencies. My impression is that the statistics available on the Russian economy paint a consistent and therefore fairly truthful picture.

When the sanctions were imposed, the expectation – or perhaps the hope – was that the Russian economy would shrink sharply. A contraction of 8% was predicted for 2022, which is painful. As the first chart shows, GDP fell sharply in the second quarter of last year, by almost 5% compared to the previous quarter. However, growth subsequently recovered. A contraction of 2022% is now in the books for 1,3, a lot less painful than the predicted -8%. The graph also shows that the Russian economy has grown faster than that of the eurozone in every quarter since the third quarter of last year. This undoubtedly has to do with the expenditure that the Russian government has made for the war. The consequences for public finances are discussed below.

The following chart shows the year-on-year growth of the Eurozone and Russia. While the eurozone economy is stagnating, Russian growth is picking up.

Russian consumer confidence was hit by the outbreak of war (vertical line in the following graphs), but has since recovered remarkably. It looks like the Russian consumer is quite happy.

The purchasing managers' indices show the same picture: a sharp dip after the outbreak of war, but a healthy recovery afterwards. These indices are well above 50 in both industry and services, which indicates growth. Recall that in the Eurozone these indices were 44,2 and 48,7 for the industrial and service sectors respectively.

Unemployment is low and falling. The labor market is therefore tight in Russia. Unfortunately, this partly has to do with the number of people who are called into arms and perhaps also with the people who leave the country to stay out of the army.

Car sales are often an interesting indicator of economic activity. These sales were already somewhat down during the pandemic. After the outbreak of war they collapsed, but since the middle of this year there has been a clear recovery.

So far, the picture is that the Russian economy took a hit when the war broke out, but that it quickly recovered. Of course, that does not mean that everything is going smoothly in the Russian economy.

Naturally, this was at the expense of public finances. In 2021, the country still had a budget surplus: +0,8%. This changed to a deficit of 2022% in 2,3. Government expenditure will increase by no less than 2022% in 25. Government income was approximately 10% higher than in 2021. In 2023, expenditure will again increase faster than income: up to and including November +11,7% for expenditure and +4,8% for income. If these figures are correct, one must conclude that although public finances have deteriorated, they do not currently pose a major challenge to the Putin regime.

Inflation immediately increased sharply after the outbreak of the war. However, alert policy by the central bank and perhaps also the economic contraction in the second quarter of last year quickly pushed inflation down again. However, inflation has been rising again since April this year. In November this amounted to 7,5%, well above the central bank's 4% target.

When war broke out, the value of the ruble on the foreign exchange market halved in a short time. The central bank took swift action. Interest rates were raised very sharply and a regime of exchange regulations was introduced, making it much more difficult for Russian citizens and companies to move money out of the country. This policy was extremely effective. The ruble recovered quickly and for a while was even stronger than before the war. Because inflation also fell, the central bank was able to reduce interest rates again at a reasonably rapid pace over the course of 2022.

However, the economic recovery also led to growth in imports. This year, the ruble has again come under pressure and the central bank has increased interest rates in four steps since July. That policy appears to be successful. The weakening of the ruble has been halted and the currency has recovered somewhat, although not to the levels seen in the middle of last year.

Russia has long enjoyed a comfortable position on the current account of the balance of payments, with annual surpluses. In 2022, that surplus would even rise to approximately 10% of GDP. This was because – partly due to our trade embargoes – import values ​​fell significantly while rising oil prices allowed revenues to grow, despite Russia having to sell its oil at a discount to countries like India and China. This year the picture has been reversed. The import value is growing while the export value is declining. However, there do not appear to be any acute balance of payments problems.

Finally, a look at the foreign exchange reserves. The foreign exchange reserve is of great importance, especially for countries such as Russia, because it fulfills a buffer function. This can be taken into account in the event of external financial problems. This then provides scope for the necessary economic adjustments to take place gradually rather than through painful shocks.

The last picture shows that the country indeed depleted its foreign exchange reserves after the outbreak of war. However, around the Crimean War, the foreign exchange supply shrank much more sharply. The difference suggests that the Russians have fewer financial problems this time than then. This is undoubtedly partly due to the fact that Western countries have frozen the Russian foreign exchange reserves, insofar as they are held in the West, so that the Russians cannot use them at all. Nevertheless, I conclude that the small decline in foreign exchange reserves indicates that Russian policymakers are managing the situation successfully and that no major problems are arising.

What is not taken into account here - because I have no insight into it - is that the growth capacity of the Russian economy in the longer term may be affected by our measures to no longer export certain products to the country, such as machine parts, aircraft, etc. Naturally, the Russians have looked for alternative suppliers and undoubtedly found them in Asia. It is unclear how many problems this switch will cause.

Ready to see how Snowflake works?
I don't know whether we can believe all the figures presented. My impression is that the figures paint such a consistent picture that the message we can get from them is quite truthful.

The figures show that the Russian economy took a hit after the outbreak of war, but has now made a remarkable recovery. However, it is not without problems. Inflation is rising again. In addition, the economy is still busy redirecting oil and gas exports from the west to the east. There is a shortage of workers, partly because people have to join the army or flee the country. And government spending exceeds revenue. Yet you have to conclude that the blow that our sanctions have dealt to the Russian economy is much less severe than we had hoped. It is impossible to say whether the effects of our sanctions will be greater in the longer term.

Bear with me, I am not against the sanctions. But euphoria about setting it up seems completely misplaced to me. When war broke out and sanctions were imposed, I started looking for scientific opinions on the effectiveness of such measures. That didn't yield much. The research I found was not very encouraging. But no one wanted to hear that economic sanctions have been ineffective in the past.

Hans de Jong

Han de Jong is a former chief economist at ABN Amro and now a resident economist at BNR Nieuwsradio, among others. His comments can also be found on Crystalcleareconomics.nl

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