Dear Subscribers,
“Barbershop Whispers….Russia” begins with “My Takeaways” on the main topic, followed by the main topic discussion. The last two sections of “Barbershop Whispers…Russia” will be follow-ups from previous publications and emerging events.
In last week’s BWR issue, I discussed the importance of the North Caucasus and the high price — financial and in terms of limitations on autonomy — Putin pays for the fragile peace in this part of the Russian Federation, at least for now.
This week, I will discuss the source of the Russian economy’s resilience and successful adaptation to economic sanctions: hydrocarbons and new markets.
My Takeaways:
RESILIENCE: The Russian economy's resilience reflects the crisis management of competent technocrats rather than its deep strength; sanctions risks continue to accumulate.
CURRENCIES: De-dollarization grants superficial sovereignty as Russia grows dependent on less liquid foreign currencies instead.
UNSUSTAINABLE: Though resilient presently, fundamental vulnerabilities remain if energy prices fluctuate as sanctions enforcement steadily tightens.
Background
Western economic sanctions against Russia began and have been building up since the 2014 invasion of Crimea by “Little Green Men.” Significantly more sanctions have been added since the second Ukrainian invasion of 2022. These sanctions have targeted Russian officials, state-owned companies, and private individuals broadly based on the premise they contribute, or have contributed, to the Russian budget (by way of tax revenues) used to fund Putin’s war against Ukraine.
The purpose of Western sanctions is to punish Russian aggression in Ukraine and undermine Russia's economy, and therefore the funding the war effort, by restricting access to technology, revenues, the Western financial system, and global trade—all of this to force Putin to change course while simultaneously supporting Ukraine.
As discussed in BWR’s August issue, “The Great Russian Fire Sale,” the most recent sanctions against Russian state-owned and private enterprises resulted in an accelerated sale and seizure of Russian-owned assets in Europe and North America. For example, Sberbank Europe AG, once a €14B business, was sold for €250M. Rosneft Deutschland GmbH (“Rosneft DE”), a subsidiary of PJSC Rosneft, was seized by the German government in September 2022, citing national security concerns, and placed under the fiduciary management of the Bundesnetzagentur, the government entity responsible for infrastructure (telecoms, energy, etc.)
In “Russian Oil Price Cap & New Ecosystem,” BWR discussed the price cap sanctions enacted by the West beginning in 2022, including subsequent refinements set out to achieve two objectives: 1. reduce Russia’s oil revenues, and 2. ensure adequate oil supply in global markets. Achieving both objectives would deprive Russia of revenues that would otherwise be directed towards supporting Putin’s war in Ukraine. Still, global oil markets would remain relatively stable despite the restrictions on Russian oil trade. The latter is essential because Russia represents nearly 11% of the global oil supply.
While the price cap sanctions were successful in achieving these two objectives initially, they have become much less effective over time, as Russia has adapted to them (and to other sanctions, such as those on microchips).
The Russian Economy
Despite nine years of Western economic sanctions, during which Russia has achieved the distinction of becoming the most Western-sanctioned country in the world, the Russian economy is expected to deliver GDP growth of 2.2% in 2023, and above 2.0% in 2024, respectively. A level of growth that the Europeans no doubt envy.
Russian grocery stores are filled with domestic and imported products, and unemployment is at a record low. In the big cities of St. Petersburg and Moscow, the streets are filled with new cars — albeit many more Chinese cars than Western cars today — and life seems to go on with little genuine concern.
Life may be challenging for the average Russian citizen in the provinces. Still, there are plenty of work opportunities, fully stocked grocery stores, and the occasional annual vacation in Sochi or Crimea, which is a reality. While inflation is starting to bite at the dinner table and impacting the affordability of the old mainstays of foreign travel — Turkey and Egypt – it is manageable now and evidence of Putin delivering on his social contract to maintain and improve living standards. The economy is good and likely to remain good, at least until the presidential elections in March 2024, enhancing election voter turnout.
The economy has done well under significant pressure due to several factors, beginning with the long experience and competence of the technocrats who manage Russia’s economy today. A recent paper written by Alexandra Prokopenko and published by Zentrum für Osteuropa-und international Studien (ZOÍS) proposes that significant credit for Russia’s resilient economy in the face of Western sanctions can be attributed to the application of lessons learned during nearly two decades of economic crisis management. The critical architects of applying these lessons are CBR Governor Elvira Nabiullina and Finance Minister Anton Siluanov, who have been in various positions of government authority over the past 15 years.
An example of an applied lesson is the shift in 2014 to a quasi-floating exchange regime that resulted in a weakening RUB, allowing the CBR to preserve liquidity and its accessible foreign reserves. The same crisis was the genesis of the de-dollarization program. As illustrated below, the percentage of loans and deposits held in dollars has dropped significantly since 2016.
While the de-dollarization of the economy creates new challenges and additional costs, it does provide the Kremlin with the much-needed perception of and craving for economic sovereignty.
Another important factor in Russia’s economic resiliency lies in weak sanctions enforcement, loopholes, and the significant arbitrage opportunity created by the sanctions. The EU is scheduled to discuss a 12th set of sanctions package to tighten up the price cap loopholes, amount other additional sanctions against Russia.
Risks & Economic Warning Signs
What could go wrong? Below the surface, the economy is more fragile and vulnerable than it appears. The CBR continues to struggle with inflation, expected to average 7.5% by the end of 2023. This has forced Nabiullina to raise the key interest rate to 15% — likely to increase to 17% by year-end — and mandate capital controls on export-driven businesses, e.g., fertilizer, grains, oil, etc. Despite these controls, capital flight remains a problem. The de-dollarization of the economy, while a feel-good and noble endeavor at economic sovereignty, leaves the Russian economy dependent on the monetary policies of countries whose currencies have limited market liquidity and unpredictable value (e.g., China, India, UAE, etc.). One example of this is the $60B in Russian-owned rupee deposits in Indian banks, which currently cannot be repatriated to Russia due to Indian currency controls. The same is happening with Russian CNY deposits in China.
The USD/RUB currency exchange rate also hovers around the psychological threshold of 100 RUB/USD. While the weakening ruble does not immediately impact domestic living standards, it does make the cost of imported goods for industry and foreign travel for everyone more expensive.
Russia has adapted well to sanctions, particularly the $60/bbl oil price cap, through knowledge transfer of evasion techniques from Iran and other sanction countries. Russia is also aided by opportunist partners (such as India and China), jurisdictions that enable insurance coverage (UAE), and limited success in sanctions enforcement.
However, the West is beginning to enforce sanctions and plug loopholes in existing restrictions. As reported by Reuters, three Greek shipping companies are refusing to transport Russian oil.
Between the two, they run a fleet of 100 tankers. The UAE is also becoming more diligent in tightening regulatory procedures and requiring documentary evidence to transfer funds.
As part of stricter price cap sanction enforcement, Denmark may begin inspecting oil tankers passing through the Danish Straits, per the Financial Times. Russia’s oil exports from its western ports on the Baltic Sea account for around 60% of all its oil shipments, which must cross the Danish straits en route to the Atlantic. Denmark could be asked to inspect oil tankers lacking Western insurance in the straits, under regulations allowing inspections on tankers that could pose oil spill and environmental threats.
Denmark only checks paperwork or inspects tankers in the straits if they pose a threat to safety at sea, and this can be grounds for checks given Moscow’s reliance on the ‘shadow fleet’ of old tankers without Western insurance. The EU has never undertaken such action, and it would be met with stiff resistance from the Kremlin.
Conclusion:
While Russia's economy has shown resilience in the face of sanctions thus far, mainly thanks to the competent economic management of key technocrats, there are signs of increasing fragility. Persistently high inflation is forcing interest rate hikes that will slow growth, and capital controls have not entirely stemmed capital flight risks. Moreover, de-dollarization increases dependence on less liquid foreign currencies, exposing Russia's risks related to de-dollarization – trade one devil for another unknown.
The ruble remains weak, making imports more expensive, and loopholes enabling sanctions evasion are being closed off as enforcement tightens worldwide. While Russia has so far ridden out the economic impacts, in part benefiting from high oil prices, it remains vulnerable to more vigorous sanctions enforcement and global energy price fluctuations.
While Russia's economy appears resilient for now, mainly on the surface, systemic risks are accumulating, and the impacts of sanctions and the breakdown of global integration will compound. Russia faces the challenge of transitioning from short-term mitigation to building sustainable, diversified economic foundations less reliant on energy exports. Action that was squandered in the early 00s when the country was flush with cash from high energy prices. While technocratic crisis management has buffered instability so far, the absence of institutional and systemic management will continue to stunt real economic growth and will continue to weaken the economy under the growing pressures of sanctions.
Follow-ups & Quick Bites:
Follow-Ups:
Nothing to report
Quick Bites:
Price Tag Protestor Sentenced to Seven Years - Seriously?
Artist Sasha Skochilenko, 33, was sentenced to seven years in a penal colony for replacing price tags in a St. Petersburg supermarket with anti-war messages and slogans.
She has been convicted of spreading “false information” about Russia’s armed forces.
Vol 1, No 21 - BWR 25.11.2023
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