Author: Inozemtsev, a famous Russian economist
Russia's invasion of Ukraine raises questions about Russia's economy that are urgent and life-or-death. How will the Russian economy survive and function during military operations? How will it withstand Sanctions from Western countries and the general confusion among investors and consumers?
My view is that the Russian Treasury Ministry has no reason to panic, and for Russia the economic consequences of war are still much smaller than those of foreign policy.
My assessment is based on the fact that russia had already begun to form an economic system that was more independent of external factors before Crimea entered Russia in 2014. The economy during this period became more primitive; while imports fell, it also shifted the direction of major imports to China; and the elasticity of demand was greatly reduced.
External funding has been largely replaced by internal funding; the stock market remains a speculative tool, but it cannot achieve long-term preservation (when the stock price reached its lowest level on February 24, investors lost $500 billion, or 30% of GDP, but this did not have any serious negative impact on the real economic sector).
The impact of exchange rates on inflation levels has decreased markedly. Russian banks now have all the necessary supporting tools for the market (from allowing financial institutions not to reflect losses on securities revaluation on their balance sheets to their ability to intervene in the foreign exchange market and provide rubles and currency liquidity to banks).
The results of this shift are already being felt during the COVID-19 crisis of 2020-2021 and the resulting downturn in the oil market. With little government support for the economy, Russia's GDP grew by 2.0 percent, on par with the United States (2.2 percent), far exceeding the eurozone figure (-1.7 percent), which used 20 percent of GDP to support the economy. Therefore, the consequences of Russia's military intervention must be considered in this context: the recent frenzied dive in stock prices and the panic in the foreign exchange market are not important factors affecting the real economic sector.
As we recently pointed out, the Russian economy looks satisfactory from a macroeconomic point of view: last year profits in the corporate and banking sectors reached record levels; the foreign trade surplus grew by almost 90% in one year, the balance of payments increased by 3.3 times; the budget deficit was reduced by 0.2 trillion rubles.
The national debt does not exceed 20 per cent of GDP, and more than three quarters of the debt is paid by reserve funds. Although consumer demand remains problematic, it can be partially offset by substantial government investment. Putin's risky actions have had a serious negative impact on stock and currency markets, but have little impact on the real sector, and growth is bound to resume after the situation is normalized.
So while the fighting in Ukraine means a reshuffle, it's unlikely to fundamentally change the overall picture in the short term. In the medium term, economic sanctions by Western countries will affect some of Russia's largest banks, whose customers are now difficult or impossible to settle in foreign currency. It's a serious blow — Russian financial institutions trade nearly $50 billion a day in foreign currency, a significant portion of which will now have to be abandoned.
Customers will not be able to settle in dollars on their cards; as a result, cross-border e-commerce and service payments (e.g., airline tickets) will be hit. However, this is likely to only lead to the flow of importers from large state-owned banks to medium-sized private banks – and these companies can continue to use loans to settle internationally through banks not on the sanctions list. Large state-owned companies in the energy sector have also been sanctioned, prohibiting them from borrowing abroad. However, we should not overestimate the threat posed by sanctions again, as devalued debt securities can be redeemed by borrowers themselves with funds raised domestically.
The ban on domestic debt manipulation has led to a delay in the issuance of new federal debt bonds (in this market, the share of foreign investors was about 23% in early February, and its peak was about 34-35%). With current budget revenues, the Treasury does not need new borrowings. Most likely, a ban on imports of a wide range of electronics, as well as aviation equipment and cars, will soon take effect, with some companies refusing to cooperate with Russia. I think the dozens of Western companies that are now operating in Russia will also be shut down.
International air travel is taking a serious hit: there have been reports that Aeroflot's flights to the UK are restricted. This could also affect other areas, such as a ban on the delivery of new aircraft. There will even be a closure of the airspace of Aeroflot (it is not excluded that the Russian side will also refuse foreign aircraft to pass through Russia).
At the same time, Russia's main "link" with the world – the supply of oil and gas – has not been affected. On top of that, at least for now, the country is still connected to the SWIFT system, although this is still subject to change. No restrictions are imposed on most Russian citizens abroad (except for the prohibition of placing more than £50,000 on deposit accounts in the UK or €100,000 in EU countries).
In other words, the issue of sanctions today is much the same as it was before the troops were sent. Western governments are trying to crack down on large Russian companies that are close to the government, but will not ban their own companies from trading with Russia. They generally avoid taking measures that could lead to the complete suspension of foreign companies in Russia (don't forget that at the end of 2021, Russia's trade with countries outside the post-Soviet space and China was $556 billion, and Western investment in Russia was more than $500 billion). And all of this means that in the near future there may be compromises for trading and settling.
In a word, within the foreseeable range, the Russian stock market will come to a standstill (the political risk is so great that serious investors are unlikely to remain in the stock market). Putin's most enthusiastic "de-dollarization" is likely to be further pursued by Western efforts. Russia's imports of high-tech products will also be restricted. The main consequences of this series of measures will be reduced investment, limited credit markets, and lower demand and prices for real estate and other investment commodities – as a result, the annual growth rate will be reduced by 0.5-1.5%.
In addition, according to the results of the initial stages of the crisis, the ruble exchange rate will fall by 15-20% compared to the end of last year, which will increase inflation by 2-2.5% per year. Out of desire to get rid of ruble assets, the key interest rate of Russian banks still needs to be further raised. Inflation, interest rate hikes and uncertainty about the future of entrepreneurs, all of which will cause economic growth to fall to zero by the end of the year, with real incomes falling by 2-4%. This is the direct cost of conflict, but in the future, the isolation of the Russian economy from the world economy will create additional difficulties.
Here, however, we enter the realm of uncertainty, and further predictions seem like a difficult thing to do. Several factors will be key.
First, it is the duration, scale, losses of all parties and legal consequences of the war. As the vicious events of the bombing and occupation increase, it is also increasingly likely that Moscow will have to take responsibility for them (it is now certain that Ukraine has filed a lawsuit with the International Tribunal and, if the results come out, may freeze the accounts and assets of Russian institutions abroad on a large scale).
Second, Russia's counter-sanctions against international sanctions (so far they have only reflected some of the Western sanctions). We are well aware that what really pains the Russian people is the anti-sanctions imposed by Russia in the field of food, not the restrictions imposed by Western countries.
Third, it is important to understand how severe further sanctions can be and to what extent other countries will join them (in particular, to what extent China will comply with U.S. sanctions).
Finally, it is impossible to calculate the overall trajectory of the global economic recovery in the coming years and the new trends that may arise in the financial and commodity markets associated with it.
The Russian economy will weather the tests associated with the war in Ukraine very well. There will be no debt defaults, no need to freeze deposits or force conversions, and no return to the era of allocating food according to quotas. At the same time, all financial investments will face more risks, and the price of Russian assets will be greatly adjusted.
The domestic market will be more isolated from the world market: some Western brands will disappear, international airlines will leave, the range of electronic products offered will be reduced, and most importantly, payments for foreign travel and transactions on the Internet will become more complex.
High interest rates will severely reduce the housing market and consumption of cars and other durable goods; inflation in 2022-2024 will be well above 10%, the economy will stop growing, and real incomes will decrease, even if maintained at the same level, only due to the increased share of welfare and one-off subsidies in the overall income structure.
Since the early 2010s, Russia has to some extent ceased to be a "catch-up" country, but has entered the category of "backwardness.". The war in Ukraine would not only exacerbate this situation, but would also significantly create new backwardness, especially as global politics adapted to new financial realities, underwent technological revolutions and prepared for the energy transition. President Putin's foreign policy restored the image and practices of the 19th century, keeping the Russian economy stuck in the 20th century, although the world is almost already looking forward to the 22nd century ...
The original title of the article "Inozemtsev: How long can the Russian economy support under sanctions", the article comes from the public account "Eurasian New Observation"