Between a rock and a hard place: Russia’s economy in times of war
After western sanctions, the most pessimistic predictions about Russia's economy have failed to come true. So what’s really going on?
By Olga Shamina and Victoria Safronova
This week, the Russian invasion of Ukraine reached its six-month milestone. When the war began, and western sanctions were introduced, there were doom-laden predictions about what lay in wait for the Russian economy. A sharp drop in GDP; a 200-rouble dollar; hyperinflation; scarcity of goods - and much more.
But the most pessimistic predictions have failed to come true. At first glance this summer, the economy is in good shape. So what’s really going on?
In the second quarter of the year, during which Russia was at war throughout, GDP fell only by 4%. It’s a serious drop that could throw the economy back a few years - but it isn’t catastrophic.
On the Moscow exchange, the rouble is worth against the dollar and euro roughly what it was at the start of 2018 - when sanctions were far lighter, foreign investors and companies had yet to quit the country, and nobody was seriously talking about going to war. From April this year, the dollar and euro have weakened against the rouble more than 27%.
The consumer panic that gripped Russians at the end of February and beginning of March has calmed down. And along with that, inflation has begun to drop: year on year, price growth is slowing, and month on month its actually falling.
It even seems that business confidence is on the rise, at least when it comes to the service sector. The RMI index is built upon company surveys and is considered a reliable indicator of the health of the economy. In July, in the service sector, it rose to 54.7 points – anything over 50 speaks of sectoral growth and economic well-being as a whole. This reflects growing demand within the country.
To be sure, industrial companies, according to the survey, are nothing like as optimistic. Output is being cut back, and there are complaints about shortages of raw materials and low demand for what they produce.
Even household incomes, expected to collapse with the devaluation of the rouble in March and high inflation, have not fallen significantly if state statistics can be believed. No more than 0.8% of disposable income, accounting for inflation and basic bills.
There are even indicators that consumer demand is on the rise.
Overall, the scenario allows Russia’s authorities to state that the country’s economy is stabilising and rebuilding following the initial crisis.
“The economic blitzkrieg against Russia had no chance of success from the very start”, as President Vladimir Putin described the sanctions regime at the St Petersburg Economic Forum.
But economists think differently: the Russian economy is in crisis, but the fall isn’t sudden and sharp, but slow and gradual, and will last several years.
“It’s not great news to be between a rock and hard place” is how the rector of the Russian School of Economics Ruben Yenikolopov puts it.
A drawn-out decline
“Those who thought that economies are like lightbulbs – you can just switch them off – don’t understand how economies work”, says Konstantin Sonin, from the University of Chicago. “Even in the deep crisis of the 90s, life over two years changed barely noticeably. Crises don’t happen overnight.”
In March and April, many genuinely thought the ‘lights would go out’, even if only for a while. Sonin recalls that the most gloomy prognosis came from the Bank of International Settlements – GDP to be hit by 15-20%.
That said, in the spring, Russian officials were also in pessimistic mood. Alexei Kudrin, head of the Accounts Chamber, stated that according to the Ministry of Economic Development, Russian GDP would fall by 10% in 2022.
Yet in May, the ministry was anticipating 7.8%, while last week the media was talking about a new estimate of no more than 4.2% this year.
The Central Bank has also improved its forecast. In April, it expected a 8-10% fall in GDP for 2022, with inflation by year end at 18-23%. The next forecast was much more optimistic: GDP down 4-6% and inflation at 12-15%.
“A market economy flexibly adjusts to changing conditions,” says Yenikolopov. “That’s what in my view accounts for why despite unprecedented pressure, the Russian economy didn’t contract as catastrophically as many expected.”
There were other reasons why the ‘lights didn’t go out’, in his opinion. For example, Europe didn’t stop buying Russian energy resources as quickly as some had expected. Plus, Russian companies were to some extent ready for a crisis of this kind following the pandemic. They had surpluses in their warehouses in case of supply chain problems.
“They were getting ready for a logistical meltdown following the lockdown of somewhere like Shanghai, for example,” Yenikolopov believes. “Suddenly, then, we had sanctions – but the outcome was the same: you get by on your savings.”
He thinks the newly invigorated economy can be explained by the fact that Russian’s have got used to things. People tend to react to a sudden rise in unpredictability by ceasing purchases and increasing their savings. “Russian consumers have calmed down, and that accounts for the signs of renewal”, he believes.
But he doesn’t think the crisis has gone away. While forecasts for 2022 figures may be improving, part of the contraction is simply being carried over to 2023.
And that’s confirmed by official prognoses. The Central Bank has worsened its forecast for next year to a fall of 1-4%, while the economic development ministry, according to media reports, puts the figure at 2.7%.
“My forecast is a fall in GDP of 8-10%, with another drop next year,” says Konstantin Sonin.
“And even if next year it’s only one per cent, that’s already worse than 2008-9. If we then see further negative growth in the third year, then it starts to feel like the recession of the 90s.”
“We’ve escaped the apocalyptic scenarios, and I think they’re now behind us,” says Sofia Donets, chief economist at Renaissance Capital. Her ‘broad spectrum’ estimate for GDP contraction in 2022 was previously 6-10%.
Now she puts it at 4.7% this year - and 3.5% in 2023. But as early as this autumn, she points out, companies are going to start shutting their doors, which will lead to an increase in unemployment – to date, unaffected by the crisis.
“We think that 2023 could perhaps be more difficult than 2022,” she says.
A hidden crisis
“There are illusions at play – people talk about inflation and the rouble rate as signifying that all’s well with Russia’s economy. But I disagree. Right now, these are signs of problems,” says Yenikolopov.
The rouble rate is high because imports have dropped off strongly while oil and gas profits are still up. Inflation is going down because the population’s ability to pay is affecting demand, he explains.
If on a yearly basis inflation is slowing down, then month on month, starting from June, prices in Russia have actually been falling – a process known as deflation, which can be a sign of serious problems.
Prices tend to lower in Russia in August in tandem with the appearance of the new harvest of fruit and vegetables. It’s true of some goods, too, like clothing and electronics.
But deflation is a dangerous economic phenomenon. If consumers buy less, prices go down and producers stop purchasing and then output drops – leading to economic decline.
Meanwhile, economists are talking of other ‘hidden’ signs of crisis, not least the gradual decline in the quality of goods, alongside the loss of certain services following the exit of western companies, and problems with export.
“So you might say that phones are still being sold for $1000, but you are forgetting about the quality,” says Yenikolopov. “Everything is kind of the same, and consumption the same, but the quality of goods is declining, prompted by the departure of big western companies. Maybe you ate a burger for the same amount of money, but it isn’t a McDonalds burger anymore.”
There’s another factor to be considered, says Donets – people’s expectations. “We’re in an atypical situation in which mood is recovering more slowly than the situation itself. Usually, when there’s a recovery, people expect things to get better still. But now, despite the good indicators, confidence remains low.”
People fear uncertainty – what if there’s ‘another wave, or another lowpoint?’
The slide into poverty
But it’s not consumer or business confidence that troubles economists: it’s the sanctions.
The economy as a whole has coped with the imposition of financial sanctions, and a deep crisis may have been avoided, but the exit of western companies along with technological embargoes will lead to Russia falling behind.
“You can see it already,” says Sonin. “Cars manufactured in Russia in 2022 are less advanced than those produced a year earlier.”
Yenikolopov believes the real problem doesn’t lie in consumer goods but in the means of production. You can live without a new iPhone, but a lack of machine tools will hit business hard.
“Trade sanctions haven’t fully played out yet,” notes Donets. She isn’t certain that some businesses will be able to ‘reproduce the production cycle’ without the help of imported technology. And technological setbacks will lead to changes in the economy itself – more primitive production techniques and lower quality goods.
“The Russian economy is at the beginning of a move towards a different configuration,” says Sonin. “Previously, it was a market economy orientated on catching up with leading countries. Now, it’s heading to a centralised economy. One that will be impoverished and stagnant. And that’s just the start of it.”
By his calculation, it will take ten years to get back to the pre-war manufacturing and consumer indices of 2021.
Translated by Chris Boot.
Read this story in Russian here.