Why sanctions don’t work or how to destroy the Russian economy

When the first sanctions were imposed, starting with Russia’s invasion of Ukraine (there are currently nine packages), a sharp decline in the economy and the impossibility of Russia continuing the war were expected. Nevertheless, we will show that the impact is currently insignificant, why and what to do with it.

Without a catastrophic fall

A significant downturn in the economy was expected. In 2022, it was widely predicted that both the GDP and unemployment would decrease by 15% to 20%. The unemployment rate at the end of the year was close to 4%, but now we know that the overall shrinkage was more closely related to 2.5%

The annual inflation rate, which peaked at 17% in the spring and was anticipated to nearly double, closed the year at 11.9% and is anticipated to decline even more in the coming months.

Why is this economy so hard to destroy? Resilience points

Economic structure: Almost 60% of GDP is directly or indirectly controlled by the government, a Soviet-era legacy that has not undergone many transformations. Because of the “curse of resource prosperity,” there hasn’t been any demand for significant economic reforms since 2000. Less than 25% of the GDP is made up of SMEs and business owners.

This implies that the “state anchor” does not play a role in the economy’s rapid development during good years. Nonetheless, the SME and non-government sectors have prospered throughout the years, despite being too small to affect profits significantly.

This suggests that while the headline numbers continue to fall within a restricted positive and negative range, non-public sectors demonstrate noticeably higher volatility. For example, the automotive industry experienced a 40%+ decrease in 2022.

2014 preparation: Since the spring of that year, Russia has been grappling with sanctions. Since then, the government, businesses, and investors have adjusted in response to the tightening of sanctions. In addition to adapting to the sanctions, several companies and government entities also conducted stress testing to find and fix potential future faults. No one was ready for the severity of the sanctions that will be in effect as of February 2022, but the processes and way of thinking have been fully adjusted to them. Russia will have experienced nearly 3,000 sanctions since 2014 by mid-February 2022.

Diversification: The EU warned about Russia’s influence in the energy sector in 2014 but did not act until 2022. Nonetheless, Russia also acknowledged in 2014 that the country’s economy is highly exposed to the risk of European exports. Since then, Moscow has been actively establishing new business alliances and reducing the risks associated with energy export.

Since 2014, Russia and China have constructed the 1.2 million barrels per day WTO pipeline, opened the “Power of Siberia 1” gas pipeline to China, and constructed a sizable LNG plant in Yamal. They are all still employed and not vulnerable to punishment.

High demand from the West: After February 2022, the EU chose not to impose sanctions on Russian oil, gas, coal, and other products. He depended too heavily on Soviet supply. The limitations were implemented gradually (coal starting in August, marine oil starting in December, and most recently petroleum products starting in February). This meant that before the ban, traders and other counterparties tried to purchase as many Russian goods as they could.

Localization: Despite being sporadic at best, containment efforts since 2014 have also helped the government and economy escape severe issues in 2022. For instance, around 65% of the food consumed in Russia in 2013 was imported. Nonetheless, Russia was self-sufficient in all main consumables by 2021, and it also started to export a lot of wheat and other products.

Other businesses, like the automobile or other technology sectors, have not experienced the same success.

New trade routes: In March and April, there was a notable product shortage due to the closure of conventional trade routes, and many international businesses stopped supplying Russian consumers. But by May or June, these goods began to reappear. Via Turkey, the Caucasus, Central Asia, and eventually through India and the INSTC railway line, new trade routes or existing ones grew.

Although none of these nations will process commodities that have been sanctioned, such as microchips, they permit alternate pathways to supply non-sanctioned goods. Russian exports will increase significantly in 2022, according to trade data with these nations.

Good governance?: Government departments such as the Central Bank, the Ministry of Finance, the Economy and Commerce, etc., all managed the emerging crisis relatively efficiently. Because they were accustomed to sanctions since 2014 and, more significantly, had access to resources like money and tested alternatives, there was no panic.

Collaboration with multinational companies: To maintain company continuity, it has been of utmost importance to try and keep those in core services (pharma, consumer sectors, etc.). It was done to guarantee that sizable businesses would pay and maintain their employees. Make sure the economy has a constant supply of the goods and services it needs.

There is/was no effort to attract or replace activities like suppliers of luxury consumer products like designers of clothing. New Russian business owners have often sprung up in lucrative locations (like Starbucks or McDonald’s), or customers can purchase things through illegal imports.

Vulnerability points and setbacks

Oil Sanctions: As previously indicated, Russia benefited from a windfall in exports in 2022 as importers rushed to purchase as much volume as they could before sanctions and B) imports fell during Q2 and the majority of Q3, when new parallel trade routes were no longer available. 

The majority of Russian goods and oil are currently prohibited from entering the EU, as well as the majority of Russian materials. Just 20% of the previous level is being exported in gas. As a result, export revenues will be significantly lower going forward than in 2022. This year, imports will also increase, reducing the current account surplus.

US Treasury targets routes: According to reports, the US Treasury is aggressively advising and persuading nations to permit allegedly illegal shipments into Russia to pass through their borders. It’s also too early to say if these cautions (and, in some cases, incentives) will be helpful. All the nations taking part in installing export channels to Russia benefit financially from doing so. So, it is difficult to stop or reduce these shipments.

Budget restriction: Regardless of the details of the final export trade “settlement,” it is undeniably true that the exports and budget receipts from the previous year will not be repeated for “many years.” As a result, the government will have to concentrate its budgetary efforts on the military, assisting significant companies and businesses, and assisting social programs. There won’t be much money left to fund infrastructure upgrades, new industry support, economic development, etc.

Technology: Sanctions against Russia’s access to practically all technology (the ban on dual-use technology applies to all) are arguably the most harmful. The “baseline scenario” of anticipated trade flows and budget expenditures allows the economy to continue operating and show modest growth. But, without access to technology, the economy cannot grow.

Losing access to Western technology will, at the very least, result in a growing divide between Russia and the West regarding efficiency and progress. Until the sanctions start to ease or containment efforts are practical, Russia’s economy and industrial base will stay stagnant.

Talent loss: Another issue is the migration of educated young people (mainly men) and IT professionals after February 24, particularly following the declaration of mobilization in September. Although estimates of 1.5 million appear fair based on information from other nations where Russians have relocated, it is unclear exactly how many have left the country and, more crucially, how many will stay there permanently. The government has repeatedly resisted attempts in the Duma to punish departed individuals, making it abundantly clear that it wants as many people to return as possible.

Not destruction, but stable degradation

There is no risk of an economic or financial disaster impacting Russia under any conceivable scenario. The impact of the over 11,000 individual sanctions will be a gradual drop in economic activity and efficiency and probably a steady decline in actual earnings and standards of living for Russians since 2000 (mainly urban residents). The United States’ technological disadvantage compared to the rest of the world is likely to grow and worsen but over the years rather than months.

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