Russia avoided economic collapse, but recession has begun

“I’m driving around Moscow, and there are the same traffic jams as before,” says Andrey Nechaev, who was Russia’s economy minister in the early 1990s.

The willingness of China and India to buy up cheap Russian oil has helped, but Nechaev and other analysts say the Russian economy has begun to decline and is likely to face a long period of stagnation due to Western sanctions.

The exodus of Western business and wave after wave of punitive Western sanctions against Russia’s vital energy exports and its financial system are having an impact, but not in the way many expected.

Nechaev, who presided over some of Russia’s most tumultuous economic times and helped steer its transition to a market economy, attributes this in part to the central bank.
The ruble did indeed fall to a record low against the US dollar earlier this year after being invaded when the West froze about half of Russia’s $600 billion in foreign exchange reserves. But it has since recovered to its strongest level against the US dollar since 2018. (Remember President Joe Biden’s threat to lower it to “rubble”?)

This is largely the result of aggressive capital controls and interest rate hikes in the spring, most of which have now been reversed. Interest rates are now lower than before the war, and the central bank says inflation, which peaked at nearly 18% in April, is slowing down to between 12% and 15% for the full year.

The central bank also raised its GDP forecast for the year and now expects it to contract by 4-6%. In April, a contraction of 8% to 10% was forecast. The International Monetary Fund also predicts a contraction of 6%.

It helped that the Kremlin had eight years to prepare, prompted by sanctions imposed by the West after Moscow annexed Crimea in 2014.

“The exit of Mastercard, Visa had almost no effect on domestic payments, because the Central Bank had its own alternative payment system,” says Nechaev.

Russia created the Mir credit card and its own transaction processing system in 2017.

And there’s a reason Russian McDonalds and Starbucks fans can still eat fast food, says Chris Weafer, founding partner of Macro Advisory Ltd, a consulting firm that advises multinational companies in Russia and Eurasia.

Since 2014, many Western brands in Russia have succumbed to government pressure and localized some or all of their supply chains. Therefore, when these companies left, it was relatively easy for Russian buyers to buy them and continue to operate them, simply by changing the wrapping and packaging.

“Same people, same products, same supplies,” Weafer says.

However, this is not a completely flawless strategy.

Rebranded McDonald’s stores reported a shortage of French fries in mid-July, when Russia’s potato crop fell and foreign suppliers were unable to fill the gap due to sanctions.

Can the energy boom in Russia continue?

Fast food continuity is one thing. Russia’s long-term stability depends on its energy sector, which is still the largest source of government revenue.

To say that high energy prices have isolated Russia so far would be an understatement.

The International Energy Agency reports that Russia’s revenues from selling oil and gas to Europe doubled between March and July this year compared to the average in recent years. And this despite the decline in volumes. IEA data show that gas supplies to Europe have fallen by about 75% over the past 12 months.

Oil is another matter. The IEA’s March forecast that 3 million barrels a day of Russian oil would leave the market from April due to sanctions or the threat of them did not come true. Exports remained at the same level, although Rystad Energy analysts note a slight drop in the summer.

The main factor was Russia’s ability to find new markets in Asia.

Since the start of the war, most of Russia’s oil exports by sea have been destined for Asia, according to Humayun Falakshali of commodities consultancy Kpler. In July, this share was 56% compared to 37% in July 2021.

Russian offshore oil exports to Asia have soared this year.
Between January and July this year, China increased offshore imports of Russian Urals oil at a discount of 40% compared to the same period last year, according to Kpler data. This is despite China’s initial attempts to avoid the appearance of Russia’s involvement in the war against Ukraine. According to Kpler, India’s maritime imports from Russia grew by more than 1,700% over the same period. Russia is also increasing gas exports to China via the Siberian gas pipeline.

What happens when the European embargo on 90% of Russian oil goes into effect in December will be crucial. An estimated 2 million barrels of Russian oil per day will be in limbo, and while some of that oil is likely to go to Asia, experts doubt that demand will be high enough to absorb it all.

Russia burns millions of dollars worth of gas every day.  That's why

Falakshali says China can’t buy much more Russian oil than it has already bought because of slowing domestic demand and because it simply doesn’t need more of the grade Russia exports.

The price will also play a decisive role in whether Russia can afford discounts to win new markets.

“A 30% discount off $120 per barrel is one thing,” Nechaev notes. “A $70 discount is another matter.”

“Slower burning”

While global inflation is helping the Russian energy sector, it is hurting its population. Like the rest of Europe, Russians are already experiencing a cost-of-living crisis exacerbated by the war in Ukraine.

Nechaev, who helped Russia survive a much more dramatic economic collapse in the 1990s, is concerned.

“In terms of living standards, as measured by real incomes, we are about 10 years behind,” he says.

The Russian government is spending money to try and fight this. In May, a 10% increase in pensions and the minimum wage was announced.

A system has been created under which employees of companies that have “suspended their activities” can temporarily transfer to another employer without terminating their employment contract. And it is spending 17 billion rubles ($280 million) buying bonds from Russian airlines hit by flight bans and sanctions that prevent foreign manufacturers from supplying maintenance and parts.

Technological sanctions, such as those affecting the aviation industry, could have the most profound impact on Russia’s long-term economic prospects. In June, US Commerce Secretary Gina Raimondo said global semiconductor exports to Russia had fallen by 90% since the start of the war. This hurts the production of everything from cars to computers and, according to experts, will further fall behind in the global technology race.

“The impact of the sanctions will be slow rather than fast,” Weafer says. “Now Russia is facing a potentially long period of stagnation.”

Nechaev is even more definite. “Now the recession has begun,” he says.

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