Russian sanctions, one year on

20 February 2023

Russia’s invasion of Ukraine was followed by the imposition of sweeping western sanctions. Russian financial markets went into freefall and an economic meltdown seemed all but inevitable. The IMF forecast that Russian GDP would contract by 8.5% in 2022 and a further 2.5% in 2023. Russia seemed to be heading into a deep crisis.

Yet a year on the rouble is stronger than it was before the invasion and the IMF thinks that the Russian economy contracted by just 2.2% last year and is likely to grow by 0.3% this year. This isn’t what was expected. Why has Russian economy proved so resilient?

Good policy has helped. Russia was broadly ready for western sanctions. It had built up a large public sector surplus and was ready to shift trade from western to emerging market economies. Russia’s central bank swiftly imposed capital controls and raised interest rates sharply, helping stop an initial sell-off in Russian assets from turning into a rout. Companies and households have been required to exchange most of their holdings of foreign currency for roubles. Russia has avoided a collapse in the value of its currency and hyperinflation, which have been the hallmark of previous emerging market crises.

High energy and other commodity prices, themselves fuelled by the invasion of Ukraine, have propped up government revenues and bolstered the rouble. Last year Russia posted a record current account surplus. The effect of high commodity prices, and reduced imports from the west, have more than made up for any loss of export earnings caused by sanctions.

Sanctions have proved less effective than the West had expected. Russia is a large economy with relatively low export exposure concentrated in commodities. And most countries do not apply western sanctions. As Russia’s trade with the West has collapsed, its trade with Asia, the Middle East, Latin America and Africa has grown. The lure of cheap raw materials from Russia is spurring sanctions avoidance on a previously unseen scale. Russian oil shunned by the EU has found ready customers in China, India and Turkey. The Economist has written of Russia dodging sanctions on “an industrial scale” through its control of a fleet of 360 tankers, equivalent to 16% of all tankers globally.

All countries faced with external shocks adjust. Russia has responded, with a vigorous policy response from the central bank and government to help soften the economic effect of sanctions. The public and private sectors have worked energetically to circumvent sanctions, keep vital imports flowing, find new export markets and switch to a war economy. The rapid growth of the armaments sector has itself helped support jobs and activity. The Economist estimates that military production now accounts for 4%-5% of all industrial production, three times pre-war levels.

Russia has blunted the impact of sanctions, but its economy has suffered grievously from western measures and the impact of the war. We should treat official Russian estimates of economic activity with a degree of scepticism. Russia has limited the flow of economic data but research by the Centre for Economic Policy Research (CEPR) suggests that official data have materially understated the scale of the economic weakness. The CEPR estimates that Russian GDP may have contracted by as much as 5.0% last year, twice as much recorded by the IMF and the Russian statistics authority.

Sanctions have damaged Russia’s industrial base, with car production falling to the lowest level since Soviet times due to shortages of western components and semiconductors. Demand for real estate has sunk on uncertainty, falling real incomes and high mortgage rates. Arrears on car loans and mortgages are rising. Government revenues are falling, forcing it to raise taxes, cut public spending and borrow more. Consumer spending is shrinking.

The outlook remains grim for the Russian economy. Lower energy and other commodity prices, and tougher western sanctions on energy exports, threaten Russia’s biggest sources of revenues and exports. According to the official count, more than 300,000 men have been conscripted and probably far more people, many of them educated and highly skilled, have left Russia to escape military service. Forbes estimates that about one-third of Russia’s IT specialists left the country in 2022. Economic decoupling from the West, the loss of skilled workers, and the redirection of the workforce, and activity, to waging war, will depress living standards. Studies of past sanctions show they tend to affect the poorest most. Much of the damage from the war and sanctions will fall on less affluent Russian households.

Sanctions may have had less impact than initially expected but they, and the effects of the war, are taking a heavy toll on the Russian economy. Our back of the envelope calculation suggests that by the end of this year the Russian economy is likely to be at least 10% smaller than it would have been in the absence of the war.

What can we conclude about sanctions from the experience of the last year? Even severe sanctions as have been deployed against Russia are not some sort of economic ‘nuclear weapon’. That said, sanctions against Russia have inflicted serious economic damage and have hampered Russia’s war effort. Rather than concluding that sanctions are ineffective, policymakers will try to devise ways of making them more effective. It is clear too that the growing power, and scale, of non-aligned countries, are eroding the power of western sanctions. Finally, any country that believes it, too, might one day be in conflict with the West has seen how planning and policy can blunt the impact of sanctions. China, for one, will have taken note.

For the latest charts and data on health and economics, visit our Economics Monitor:
https://www2.deloitte.com/uk/en/pages/finance/articles/covid-19-economics-monitor.html

OUR REVIEW OF LAST WEEK’S NEWS
The UK FTSE 100 equity index ended the week up 1.6% at 8,004. UK equities rose last week due to positive earnings news from energy companies and better than expected UK inflation and retail sales figures.

Economics

In an unexpected reversal of the post-pandemic trend in the UK, a record number of people moved out of ‘economic inactivity’, which is defined as people not looking for work, between July and December, as more people got into jobs
European natural gas prices fell below €50 per megawatt hour for the first time in 18 months; markets now believe that Europe is likely to avoid shortages this year
Oil prices fell last week after the US announced plans to release supplies from its strategic reserves, countering the rise in prices due to a pick-up in Chinese economic activity
UK annual inflation fell more than expected to 10.1% in January due to lower prices of fuel and cost of eating out. Core inflation also slowed
UK wage growth grew by 6.7% in the final quarter of 2022, boosted by private sector pay and bonuses
Bank of England chief economist Huw Pill said that it would be “premature to declare victory” on inflation as the labour market remains tight
UK monthly retail sales volume rebounded unexpectedly in January after falling in December
Low consumer and investor confidence led UK savers to stick with cash and steer away from funds and shares in 2022, the UK’s largest investment platform Hargreaves Lansdown reported
UK rail unions announced four more days of strikes in March, while Royal Mail workers voted to prolong strike action as disputes over conditions and pay continue
US annual inflation fell to 6.4%, above economists’ expectations and likely to keep the US Federal Reserve from loosening monetary policy
In a sign of growing financial stress, arrears among US borrowers with low credit scores rose to the highest level since 2010
US jobless claims remained under 200,000 last week indicating a tight US labour market
US monthly retail sales rebounded more than expected in January

Business

British Gas’s parent company Centrica reported a tripling of profits in 2022 to more than £3bn due to high energy prices
France’s EDF Group posted €18bn of losses last year due to nuclear power plant outages. Its UK arm saw profits of £1.1bn over the same period
Barclays posted a 4% drop in profits in Q4 2022 despite benefitting from higher interest rates. A slowdown in deal-making revenues and equity trading reduced margins
NatWest reported a tripling of profits in Q4 2022 on the back of rising interest rates and higher revenues from its consumer lending business
The FT reported that UK businesses face an energy cliff edge in April when the winding down of government support will lead to a jump in energy bills
Luxury brand owner Kering Group reported falling sales in Q4 2022 as its biggest brand Gucci struggled with sales due to COVID-19 and lockdowns in China
Adani Group chairman Gautam Adani dismissed current falls in its share price as “temporary volatility”, following a 50% drop since the start of the year
The travel agents TUI Group reported that UK summer holiday bookings have exceeded pre-pandemic levels despite the cost-of-living crisis
The Wall Street Journal separately reported a strong trend in travel bookings and activity in the US
Estate agent Purplebricks announced it is up for sale after warning of bigger than expected losses this year

Global and political developments

The death toll from earthquakes in Turkey and Syria has exceeded 41,000, according to latest estimates
Turkey’s earthquake losses may exceed $20bn, according to Verisk, one of the world’s biggest risk-modelling companies
New Zealand declared a state of emergency after a cyclone hit the country last Monday
The US warned China not to supply lethal weapons to Russia
Russia fired a further barrage of missiles on Ukrainian cities after NATO pledged additional tanks and military assistance to Kyiv
The EU announced further sanctions on Moscow totalling €11bn by restricting exports of electronic components used in Russian drones, missiles and helicopters
Finland and Sweden will join NATO separately, the NATO secretary general Jens Stoltenberg confirmed
UK defence secretary Ben Wallace called for higher military spending as inflation is biting into the defence budget
Nicola Sturgeon resigned after eight years as Scotland’s first minister, following rising tensions within the SNP about independence and the gender reform bill
In 2022, Germany experienced a record rise in net migration from Ukraine due to Russia’s invasion, a bigger increase than during the refugee crisis in 2014–16

And finally… California’s housing shortage has led California Polytechnic Humboldt, a college in Northern California, to announce that it is considering housing students in a floating barge – Barge-set Boulevard

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