Salzburg Global Fellow Anders Åslund provides an in-depth analysis of the current state of the Russian economy
After Vladimir Putin launched his second war of aggression against Ukraine in February 2022, reports about the Russian economy have swung swiftly from disaster to normal. The Russian economy has proven quite unstable, having gone through two currency crises, but it is unlikely to collapse. At present, it appears to have stabilized, but minimal growth is to be expected in the foreseeable future, and the large capital flight may cause a new sudden currency crisis. The Western sanctions are having a great impact. The two important macroeconomic sanctions are the severe financial sanctions and the energy sanctions that limit Russia’s oil and gas revenues. Russia’s GDP fell by only 2.1 percent last year and it might stagnate this year. Yet, the financial and energy sanctions limit how much Putin can spend on his military.
Putin’s Economic Legacy of Authoritarian Kleptocracy
Thanks to the eminent market reforms by President Boris Yeltsin and acting Prime Minister Yegor Gaidar in the 1990s, Putin arrived at a laid table, and Russia enjoyed an average economic growth of 7 percent a year from 1999 to 2008. The Russian economy was hit hard by the global financial crisis in 2008 and never recovered. It has barely grown since 2009 and not at all since 2014 when the West introduced its financial sanctions. The aggravated Western sanctions since 2022 have shaken the stability of the Russian economy, but so far they have not caused any significant reduction in GDP. The financial and energy sanctions restrict Russia’s possible military expenditures.
Strangely, Putin does not care about economic growth, though he is all the more concerned about financial stability. In August 1998, Russia went through a severe financial crisis. It devalued the ruble by three-quarters, defaulted on its domestic public debt, and inflation surged to 48 percent. President Yeltsin had little choice but to sack the Sergei Kirienko government one week later. Putin drew the lesson: Never again! Since then, he has insisted on fiscal and monetary austerity.
Russia’s great economic weakness is that Putin insists on his authoritarian kleptocracy. He, his business friends from St. Petersburg, the heads of the big state-owned corporations, the leading military officers, and the security policy regularly embezzle billions of dollars from the Russian state and its companies. Since Putin allows – or even encourages – his closest collaborators to pursue larceny, the Russian state functions poorly, as the Russian military has illustrated in Ukraine. The ever-harsher Russian repression hits anti-corruption activists hard. They are being sentenced to prison for up to 25 years. Transparency International ranks Russia as the 137th state out of 180 countries on its Corruption Perception Index. This means that Russia has an awful business climate, which does not permit new innovative enterprises to emerge, while established big companies benefit from limited competition.
The Impact of Western Sanctions
When Russia invaded Crimea from February to March 2014, the United States and the European Union responded with sanctions. They targeted people and enterprises responsible for the occupation. Western enterprises were prohibited from having any contact with them. While Putin belittled the sanctions, he became very upset that the US sanctioned his four old business friends from St. Petersburg, Yuri Kovalchuk, the brothers Arkady and Boris Rotenberg, and Gennady Timchenko, complaining repeatedly in public how unfair it was to sanction his friends. In July 2014, the US and EU introduced sectoral sanctions in response to Russian regular troops invading eastern Ukraine. They targeted three sectors: finance, military technology, and certain oil technologies. The financial sanctions were the most important.
The Kremlin has talked a lot about the Western sanctions. While it tried to ridicule them as ineffective, it contradicted itself by persistently calling for their abolition. The financial sanctions had a big concrete impact. The West prohibited all kinds of financial institutions from offering Russia credits. As a consequence, Russia’s total foreign debt (both public and private) fell from $729 billion at the end of 2013 to $455 billion at the end of 2018, at a time when other emerging economies increased their foreign indebtedness substantially. In March 2023, Russia’s foreign debt had fallen further to $358 billion, since nobody, including China and the Gulf states, wanted or dared to lend money to Russian subjects.
Until 2022, the sanctions remained almost unchanged. They were maintained, but they were not tightened much. In February 2022, however, the West surprised Russia by acting fast, being united, and hitting harder than expected. Once again, it focused on financial sanctions. Most big Russian banks were sanctioned and they were excluded from the global financial messaging system SWIFT, which encumbered international transactions. Altogether, the banks now sanctioned account for about 80 percent of the Russian banking assets. The biggest surprise was that the West immobilized the currency reserves of the Central Bank of Russia that were held in the West. According to the Central Bank of Russia, they amounted to as much as $316 billion at the beginning of 2022.
The stability of the Russian economy has deteriorated with the war and the Western sanctions. The crucial issue has been the exchange rate. Since 2014, Russia has gone through three exchange rate crises – one in the spring of 2014, a second in February-April 2022, and a third in July-August 2023.
Exchange Rate Challenges
Before Russia’s occupation of Crimea and eastern Ukraine in 2014, the ruble exchange rate was relatively stable at 32 rubles per US dollar. But it halved because of Western financial sanctions in 2014. The Central Bank managed to restore stability through strict monetary policy.
Before Russia’s next invasion of Ukraine in February 2022, the exchange rate was 74 rubles per dollar, but within one month the exchange rate halved to 135 rubles per dollar because of the severe Western financial sanctions. The Central Bank of Russia reacted drastically once again. It hiked its interest rate from 9.5 percent to 20 percent, as inflation rose from 7 percent before the war to 17 percent in April 2022. Yet, the Central Bank succeeded in restoring confidence in the ruble. On June 20, 2022, the exchange rate had risen to 50 rubles per dollar. As inflation abated, the Central Bank reduced the interest rate rather fast to 7.5 percent in September. The financial crisis seemed to be over.
However, in July and August 2023, the ruble plunged again without any obvious external cause. The value of the ruble plummeted from 73 rubles per US dollar to 100 rubles per dollar, and it has stayed low. Putin’s obedient Central Bank responded by hiking its interest rate from 7.5 percent to 12 percent. That will hardly be enough.
If the ruble behaves like a yoyo, financial stability is fragile. Nor is it obvious that the Central Bank saved Russia through its drastic interest rate hike in 2022. It mattered more that the European energy market panicked, from which Russia benefited greatly. Oil prices rose because of the war and gas prices skyrocketed, boosting Russia’s total export revenues from a paltry $382 billion in 2020 to $628 billion in 2022.
Russia usually has a large current account surplus, but it is matched by a substantial net capital outflow of about $40 billion a year. In 2022, Russia’s current account surplus spiked at $236 billion, while the net capital outflow rose correspondingly to $239 billion. During the first half of this year, the Russian Central Bank assessed the current account surplus at only $23 billion and the net capital outflow at $27 billion.
Energy Sanctions
It took some time for the West to design and agree on effective energy sanctions. The US prohibited all imports of Russian energy early on, but it was more difficult for Europe. Energy supplies and prices are of great importance to the European economy, so Europe adopted different approaches to oil and natural gas, respectively.
The EU recognized that Russia (Gazprom) was too unreliable as a gas supplier and that alternative suppliers existed. It prohibited most EU gas imports by pipeline in 2023. As a result, the EU has reduced its gas imports from Russia from 40 percent to approximately 7 percent, primarily to Hungary, Slovakia, and Czechia. Instead, the EU imports much more LNG (liquefied natural gas) from primarily the US, Qatar, and Australia, as well as piped gas from Norway. This transformation has taken place faster and with less trouble than anybody had anticipated. The European gas price fell by 90 percent from an extreme peak in August 2022 to a normal level in August 2023.
Given that Russia produces 11 percent of all oil in the world, a Western consensus was formed that the goal was not to reduce Russia’s oil exports, because that would cause high oil prices from which Russia would benefit. Instead, the collective West decided to try to set a cap on Russia’s oil exports to reduce their value, though the Western world committed itself not to buy Russian oil. In December 2022, the West introduced a price ceiling for Russian oil and two months later also for oil products. Initially, these Western sanctions drove the Russian (Urals) oil price down to $50 dollar per barrel, while the Brent price hovered around $85 dollar per barrel. Russia’s three big remaining customers – China, India, and Turkey – are grateful for the much lower price.
Together, these two energy sanctions can reduce Russia’s export revenues by at least $100 billion and perhaps as much as $200 billion in 2023. Since oil and gas have accounted for a bit more than half of Russia’s total exports, its total export revenues could fall by about one quarter toward $470 billion in 2023. Moreover, these two products comprise about half of the federal state revenues. With one quarter of the state revenues gone, it becomes more difficult for Putin to finance his war.
Needless to say, Russia tries to dilute the energy sanctions. It has turned its energy exports toward Asia and gradually managed to extract higher prices. Meanwhile, the world market price of oil has risen. Russia has bought a large shadow fleet of old oil tankers, which transport Russian oil without international insurances, thought that implies an obvious risk for the environment. The West needs to tighten its energy sanctions to make sure they hold.
Export Controls
In July 2014, the US and the EU introduced a first round of export controls against military technology and certain oil technology. Many electronic products, such as chips, have dual applications for both civilian and military purposes. The Ukrainians track which Western electronics the Russians use in their missiles and pass on that information to the American Department of Commerce, which bans ever more products. US diplomacy follows up with suspected intermediaries and threatens them with secondary sanctions.
The US has a long tradition of export control for electronics under its Department of Commerce, which has now been activated. Soon after World War II, the US and the West established the Coordinating Committee for Multilateral Export Controls (COCOM). COCOM prohibited almost all exports of high technology to the Soviet Block. After the collapse of the USSR, it became evident how effective COCOM had been since the USSR lacked almost all modern technology. COCOM was formally abolished in 1994, but the US maintained its export control and now COCOM is being revived.
There are many ways to circumvent the Western export controls. Neighboring countries that do not participate in the sanctions, such as China, Turkey, Kazakhstan, and Armenia, are perceived as especially important roads for the smuggling of technology to Russia, but the West is not blind. The US and the EU have sanctioned hundreds of enterprises and people that have violated the sanction regime, and such secondary sanctions are devastating for those hit. Serious actors, such as the big Chinese state-owned enterprises, tend to be cautious. In order to avoid Western secondary sanctions, they obey Western sanctions. The ever-tighter export controls will degrade Russian arms technology, as happened in the USSR.
Financial Constraints and Economic Outlook Amidst the Ukraine War
Putin has transformed the Russian economic policy since he started the war. Boris Grozovski at the Kennan Institute in Washington assesses that Russia’s military expenditures have tripled since the time before the war and will reach $160 billion, or more than 10 percent of Russia’s GDP, in 2023. The traditionally conservative Stockholm International Peace Research Institute (SIPRI) assessed Russia’s military expenditures at $87 billion, 4.1 percent of Russia’s GDP in 2022. Considerable uncertainty reigns because Russia has gradually expanded the classified part of its budget, and this is presumed to go to the military and the security apparatus. After the start of the war, Russia has sharply reduced the statistics it publishes and the ruble fluctuations impact the dollar values.
Can Russia afford such large military expenditures? Before his war, Putin had a policy of a balanced budget. Now he has accepted a budget deficit, but it remains small. Last year, Russia had an official federal budget deficit of 2.1 percent of GDP. It might become slightly larger this year, but hardly much because Russia cannot finance a big deficit. Russia has a small public debt of 15 percent of GDP, but nobody will lend Russia any money because of the Western financial sanctions. At the end of September, the Russian Minister of Finance Anton Siluanov said that the state would borrow $42 billion this year and that only $69 billion would be left in the Russian national welfare fund. For a Western country, these sums are small, but Russia can no longer raise any funds abroad. The Western sanctions restrict Putin’s rearmament. Putin faces the choice between tanking the ruble or limiting his rearmament. My guess is that he will limit his rearmament.
Most international forecasts predict that the Russian economy will grow 0-2 percent this year, but all caution that their prognoses are suffering from great uncertainty since Russia is at war. The most apparent risk to the Russian growth – and financial stability – is the capital flight. Russia’s greatest chance of improving its financial situation is if it succeeds in breaking the Western oil price cap.
Anders Åslund is a leading specialist on economic policy in Russia, Ukraine, and Eastern Europe, and has served as an economic advisor to the governments of Russia and Ukraine. He is a Senior Fellow at the Stockholm Free World Forum and an Adjunct Professor at Georgetown University. He was a professor at the Stockholm School of Economics and the founding director of the Stockholm Institute of Transition Economics. He is the author of 15 books, including “Russia’s Crony Capitalism: The Path from Market Economy to Kleptocracy” (Yale UP).
Anders attended the Salzburg Global Pathways to Peace Initiative titled “Bear With Us: What Is to Be Done About Russia?” in October 2023. This program enabled experts to convene at Salzburg Global Seminar for a high-level dialogue exploring scenarios and questions about what options exist to engage, contain, and hold Russia accountable in a post-war context.
