Russia is facing “economic oblivion” in the long-term because of international sanctions and the flight of businesses, several economists have said.
The International Monetary Fund last week upgraded Russia’s gross domestic product estimate for 2022 by 2.5 percentage points, meaning the economy is now projected to contract by 6% this year. The IMF said the economy seemed to be weathering the barrage of economic sanctions better than expected.
The Central Bank of Russia surprised markets in late July by cutting its key interest rate back to 8%, below its pre-war level, citing cooling inflation, a strong currency and the risk of recession.
The ruble recovered from historic early losses in the aftermath of the invasion of Ukraine to become a top performer on the global foreign exchange market this year, prompting Russian President Vladimir Putin to declare that Western sanctions had failed.
Meanwhile, Russia has continued to export energy and other commodities while leveraging Europe’s dependency on its gas supplies.
However, many economists see long-lasting costs to the Russian economy from the exit of foreign firms – which will hit production capacity and capital and result in a “brain drain” – along with the loss of its long-term oil and gas markets and diminished access to critical imports of technology and inputs.
Ian Bremmer, president of Eurasia Group, told CNBC on Monday that while short-term disruptions from sanctions are less than originally anticipated, the real debate goes beyond 2022.
“Anecdotal evidence suggests the manufacturing dislocations are rising as inventories are depleted and scarcity of foreign parts becomes binding. Chips and transport are among the sectors cited, in some cases reflecting dual-use military demand,” Bremmer said.
“Governmental arrears may be contributing to broader shortages. Imports of consumer goods are increasing, but less so intermediate/investment goods.”
Bremmer highlighted that as sanctions intensify and popular discontent grows, the educated are leaving Russia, underscoring the importance of trade sanctions on sensitive technologies and the “longer timeline by which sanctions undermine trend productivity and growth.”
“Brain drain leads to a direct decline in the working age population, especially high-productivity workers, reducing GDP,” he said.
“It affects overall productivity, reducing innovation and affects overall confidence in the economy, reducing investment and savings.”
Eurasia Group projects a sustained, long-term decline in economic activity to eventually result in a 30-50% contraction in Russian GDP from its pre-war level.
A Yale University study published last month, which analyzed high-frequency consumer, trade and shipping data that its author’s claim presents a truer picture than the Kremlin is presenting, argued that rumors of Russia’s economic survival had been greatly exaggerated.
The paper suggested international sanctions and an exodus of more than 1,000 global companies are “catastrophically crippling” the Russian economy.
“Russia’s strategic positioning as a commodities exporter has irrevocably deteriorated, as it now deals from a position of weakness with the loss of its erstwhile main markets, and faces steep challenges executing a ‘pivot to Asia’ with non-fungible exports such as piped gas,” the Yale economists said.
They added that despite some “lingering leakiness,” Russian imports have “largely collapsed,” with Moscow now facing challenges in securing inputs, parts and technology from increasingly jittery trade partners and as a result, seeing widespread supply shortages in its domestic economy.
“Despite Putin’s delusions of self-sufficiency and import substitution, Russian domestic production has come to a complete standstill with no capacity to replace lost businesses, products and talent; the hollowing out of Russia’s domestic innovation and production base has led to soaring prices and consumer angst,” the report said.
“As a result of the business retreat, Russia has lost companies representing ~40% of its GDP, reversing nearly all of three decades worth of foreign investment and buttressing unprecedented simultaneous capital and population flight in a mass exodus of Russia’s economic base.”
No path out of ‘economic oblivion’
The apparent resilience of the Russian economy and the resurgence of the ruble was largely attributed to soaring energy prices and strict capital control measures – implemented by the Kremlin to limit the amount of foreign currency leaving the country – along with sanctions restricting its capacity to import.
Russia is the world’s largest exporter of gas and second-largest exporter of oil, and thus the hit to GDP from the war and associated sanctions has been softened by high commodity prices and Europe’s continued dependence on Russian energy for the time being.
Russia has now relaxed some of its capital controls and cut interest rates in a bid to bring the currency down and shore up its fiscal account.
“Putin is resorting to patently unsustainable, dramatic fiscal and monetary intervention to smooth over these structural economic weaknesses, which has already sent his government budget into deficit for the first time in years and drained his foreign reserves even with high energy prices – and Kremlin finances are in much, much more dire straits than conventionally understood,” the Yale economists said.
They also noted that Russia’s domestic financial markets were the worst performing markets in the world so far this year despite the strict capital controls, with investors pricing in “sustained, persistent weakness within the economy with liquidity and credit contracting,” along with Russia’s effective ostracization from international financial markets.
“Looking ahead, there is no path out of economic oblivion for Russia as long as the allied countries remain unified in maintaining and increasing sanctions pressure against Russia,” the report concluded.
“Defeatist headlines arguing that Russia’s economy has bounced back are simply not factual – the facts are that, by any metric and on any level, the Russian economy is reeling, and now is not the time to step on the brakes.”