War in Ukraine: Russian economy better than forecasts

Vladimir Putin/ Photo: EPA-EFE/RAMIL SITDIKOV/SPUTNIK/KREMLIN POOL MANDATORY CREDIT

Two years ago, Russia was hit by the harsh sanctions of the West after the attack on Ukraine. However, the predictions for the economic ruin of the country did not come true.

Two years have passed since the beginning of the Russian invasion of Ukraine, and there is one thing that economists agree on - that the Russian economy has not collapsed. And that's exactly the outcome many predicted when the EU, US and others imposed unprecedented sanctions following the invasion of Ukraine in February 2022. Now the debate about the Russian economy in Western capitals is conducted in a slightly more sober tone. Few question its resilience. Disagreement exists over how solid the foundations are for the country's current economic indicators. The International Monetary Fund recently forecast that Russia's GDP will grow by 2,6 percent this year, a big increase from its October estimate. In 2023, growth was more than 3 percent, meanwhile oil revenues are rising again and unemployment is at a historic low.

However, there are still doubts. The Kremlin has increased defense expenditures to such an extent that this year 40 percent of all budget expenditures will be spent for this purpose. It is a war economy, and a dangerously overheated one, according to experts.

There is a growing labor shortage, and high inflation has persisted. Sanctions also continue to hurt, especially as Western leaders look for new ways to hit Moscow's spending power.

How Russia survived and prospered

Elina Rybakova, an economist at the Peterson Institute for International Economics told DW that there are three main reasons why the Russian economy has held up so well. The first is that the Russian financial system was sufficiently prepared for the first wave of banking and financial sanctions that hit it in the first few weeks, given that it had been in crisis response mode since 2014 following the events in Crimea. The second reason is that Russia saw a huge windfall in oil and gas sales in 2022 because Western powers were too slow to respond to curbing exports, even after post-invasion prices spiked.

The third is that export controls have not worked sufficiently to prevent Russia from using third countries to procure the goods it needs for its military-industrial complex. But Benjamin Hilgenstock of the Kyiv School of Economics says the sanctions still had a big impact, even as the Russian economy performed better than expected.

"The conclusion still stands that the macroeconomic environment for Russia has significantly worsened and that much of it is a consequence of Western sanctions," he told DV.

Hilgenstock points out that revenues from Russian oil and gas exports are down in 2023 compared to 2022, as well as the fact that the Russian central bank had to raise interest rates to 16 percent due to inflation.

Circumvention of sanctions

However, Russia's performance is also largely due to how Moscow circumvented sanctions. Most impressive is how it circumvented export controls to continue buying Western goods and selling oil worldwide, despite the Western alliance imposing an oil price ceiling in December 2022. The goal was to limit Western oil transportation services if oil did not sell below $60 a barrel. However, for almost a year, Russia has been selling oil at prices close to market prices.

It is primarily a consequence of the fleet of the so-called shadow ships, which have helped Russian oil reach markets in China, India and Pakistan without being subject to the restrictions.

The U.S. has increasingly sanctioned individual ships and firms it believes are in violation of the cap, and Hilgenstock says that is key to curbing Russian oil export revenues.

"Such measures can effectively get shadow ships out of fleets for a significant period of time," he says.

In terms of limiting the ways in which Russia has access to Western components by importing them through third countries, banks have, according to Hildenstock, a key role. He highlighted an executive order Biden issued last December authorizing possible sanctions on foreign banks if they allow transactions that help finance Russia's military-industrial base. "Financial institutions have a big role to play when it comes to enforcement because they can see some of the financial transactions that might be very difficult to physically trace," he says.

The risks of the military economy

Another key driver of Russia's economic success is defense spending, which has tripled from 2021 to today. "Now you mainly have a military economy," says Elina Rybakova. It believes that this increases GDP, in addition to large public expenditures that encourage the production of large quantities of missiles, artillery and drones.

"Many activities are recorded, but in the medium term it is not a productive activity. That's not good for the economy. Basically, it's a waste," she concludes.

Chris Weafer, an investment adviser who has worked in radio in Russia for more than 25 years, says there will be negative long-term consequences if the additional spending is mainly on "consumable" goods rather than deeper investment in the country's industrial base.

"You're going to use up the reserves, and when the conflict is over, you're going to end up with a very damaged economy, with a lot of confusion about what to do," Wieffer tells DW, adding that another key element of the war economy is the way it changes the labor market.

Recruitment and the fact that around one million highly skilled workers have left Russia since 2022 means that there is now a labor shortage in a number of areas. Unemployment will be almost non-existent, but wages will rise significantly during 2023.

"That rise in income was really a big driver of inflation," he told DW. "The longer they are unable to deal with it, the more challenging it will be, the more expensive and the more damaging it will be to the economy," Wiefer concluded.

Is that sustainable?

However, the Russian economy has defied predictions of collapse before. Wiefer says the country's vast resource base is consistently undervalued when sanctions are imposed, pointing to the continued importance of Russian oil and gas in global markets, as well as uranium-type commodities, which the U.S. continues to procure in huge quantities. He says that the EU in particular has dealt too much with what he calls "political economy".

"They will say 'the economy didn't collapse in 2022 or 2023, but it will collapse now because of military industrial spending and that will destroy the economy.' It's just political economy, it's just wishful thinking," he says.

For Rybakova, Ukraine's fate remains closely tied to Russia's economic performance. She says it is vital that the Western alliance does more to further limit the Kremlin's capacity to wage war, although sanctions will never be enough to stop Russian aggression.

"With one hand we provide financial support to Ukraine, and with the other to Russia. We still buy their energy, we do not fully comply with the upper limits of the oil price and the embargo, the export controls are not fully implemented either," she says and adds that "it is a huge problem."

Source: Deutsche Welle/ Author: Arthur Sullivan

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