Russia’s war economy: A disaster in the making
Von Anna Romandash
Despite the Kremlin denial, Russia is suffering major economic consequences for its invasion into Ukraine. It is now the most sanctioned country in the world with key limitations on its trade and financial operations.
More than 5,000 sanctions come from the EU, the US, and other Western powers, and they target Russia’s foreign assets, technology purchase, and media. They also open a possibility to seize frozen funds – which amount to around $300 billion – and use them for rebuilding Ukraine.
“Money is leaving Russia,” says Timothy Ash, an associate fellow in the Russia and Eurasia programme at Chatham House and a senior sovereign strategist at Bluebay Asset Management in London, “We are talking about some $180 billion that fled the country since the start of the invasion.”
Countries which didn’t sanction Russia – such as the United Arab Emirates, Turkey, and Georgia – are major receivers of those funds. Up to 200,000 Russians have left the country for good since the invasion began, with the majority being middle and upper-middle class and business owners. So there is a big entrepreneurial drain, too.
But sanctions’ full impact is yet to come
So far, the Russian technocrats have managed to keep the ruble relatively strong, but this comes at a price. For example, the Russian Central Bank has increased the interest to 20% which makes it very expensive to borrow for the remaining entrepreneurs. The state also put limits on the amount of money one can send outside of Russia, and increased demand for local currency by making foreign companies buy Russian commodities in ruble.
Further, the government stopped publishing its budget data, so it is impossible to see how much the state is spending and on what. This way, it is possible to hide the amount of funds pumped into the economy to stabilize the ruble - which can be around $40 billion.
Due to sanctions, Russia also buys less from the West, but it keeps on selling increasingly more expensive gas and oil, which also helps offset sanctions. For example, in 100 days of war, the country made around $98 billion for its fossil fuels, selling most of it to the EU and China.
But in the long run, even this will not save Russia
“Over the longer term, the sanctions will have a devastating impact on the Russian economy because it will be cut out from international financial markets, but also forcing Russia into default,” Ash says, “The technology restrictions will inhibit Russians companies ability to manufacture, and we're already seeing that in terms of auto and military production.”
Russians are likely to feel the sanctions’ biggest hit in 3 to 5 years as Russian companies won’t be able to borrow abroad, there will be no insurance for foreign companies for doing business in Russia, and there will be little incentive to invest. Already, more than a 1,000 foreign companies have exited Russia, but more will follow as the economy deteriorates. Further, the experts predict that commodity prices will drop significantly once the war is over thus cutting Russia’s revenues once more.
“Russia’s future will be similar to Iran’s,” Ash continues, “Both countries are rich in energy; but you wouldn’t call Iran, which has been sanctioned for decades, a successful country. And that’s what Russia will look like, too.”
The sanctions, however, leave many loopholes. They exclude some major Russian banks and don’t impose a full energy embargo. The latter is tricky because of Europe’s energy dependency: an immediate embargo would mean a recession and a GDP drop of up to 5% across the EU.
“Sanctions are not a silver bullet, but they do limit Putin’s ability to wage this war,” Ash says, “I hope there would be a full energy embargo, but the reality will probably be something different because there are a lot of weak politicians in Europe and people who have been bought off by Putin.”
“The transition from Russian energy will be painful, but the European countries will have to bear the cost,” Ash concludes.