To understand how Russia is being affected by the west’s sanctions, I have been listening to a lot of experts on the country’s economy and on how sanctions work. They include the Bank of Finland’s institute for emerging economies, or Bofit, which I mentioned last week and which should be one of your go-to places for information about the Russian economy. This week I also moderated a fascinating discussion on the sanctions hosted by Queen Mary University of London’s Global Policy Institute. You can watch the recording here.
Here are the main things I have learned:
Knowledge is power. There is little good to say about Russian governance, but Russian economic statistics have long been at the international gold standard. But since the war started this has been changing. My Bofit interlocutors said data on individual banks are no longer published. Nor are detailed oil production data, according to Sergey Aleksashenko, a former Russian deputy finance minister and deputy central bank governor. Expect other statistics to be discontinued if the Kremlin determines they give too much visibility of economic strength and weaknesses.
So what do we know? We know that the Russian economy has been isolated from the rich world in very little time. Imports seem to have collapsed. This reflects at least three things — a steep downturn in gross domestic product, constraints on financial flows with the outside world, and sanctions on trading specific goods, in particular high-tech inputs. Estimates of Russia’s GDP collapse this year range from just under 10 per cent to 15 per cent. The flip side is inflation. “Russia now counts inflation per week,” says Sergei Guriev, economics professor at Sciences Po in Paris. But the rate has fallen from 2 per cent per week just after financial sanctions were imposed to 0.25 per cent per week now.
How bad is the hit? Russian real incomes are clearly going to suffer. But the impact may be felt quite differently across different sectors, and it can be hard to distinguish the effects of sanctions and of hoarding by consumers. A Bofit report notes: “March retail sales were still up by 2 per cent year on year, largely on foodstuff purchases. Inventories of many staple items such as vegetable oil and sugar were drawn down to exceptionally low levels. Most of the growth spike in non-food goods sales took place already in February, and sales were falling by March.” But car sales fell by nearly two-thirds, and air freight volumes have fallen by more than 80 per cent.
It’s the complexity that kills you. We have learned from the pandemic that supply chains are complex and can be disrupted in surprising ways. In Russia, the constraints on importing manufacturing parts and high-tech components may be the sanctions with the most damaging effects. Car manufacturing fell by half year on year in March, writes Bofit. Industrial sanctions could directly limit Russia’s ability to wage war: as my FT colleagues report, its army may be running short of precision missiles.
Very interestingly, this sort of effect is teaching us that China cannot substitute for western technology, says Guriev. And we haven’t seen everything yet. Aleksashenko points out that Russian companies often stockpile components, so it may not be until the end of the year that we see the full impact of denying Russia high-tech goods and software. By then, problems could also emerge in oil production.
These observations expose the limits of the import-substitution policy Moscow has pursued for the past decade or so. It was always more perception than reality, says Aleksashenko. And some experts suggest that by pursuing domestic production of finished goods through economic planning, the government may paradoxically have made Russia more vulnerable to a disruption of imported inputs, components and machinery.
Financial sanctions are hard to understand. There is a lot of confusion around how the financial sanctions work. Much is made of cutting Russian banks from the Swift messaging system for cross-border bank transfers, for example. But banks have other ways to communicate. It is the right to transact in hard currencies, through so-called “correspondent” banks in the jurisdiction of the currency in question, that matters — and that could be placed under sanctions. But because the EU still wants to be able to pay for energy, it has not cut all Russian banks off from euro-denominated correspondent banking.
Similarly, the bust-up over Russia’s demand to be paid for energy in roubles is more important for political and legal contracting reasons than for giving the Kremlin “access” to euros. Recall that the Russian government’s budget is denominated in roubles. State-owned gas and oil companies, while paid in hard currency, draw up their account and calculate their taxes in roubles, and they will have no problem exchanging their euros for roubles with other, non-sanctioned, Russian companies or individuals in private currency markets, regardless of sanctions on the central bank.
As a result, the government budget remains robust, and its expenditures are of course in roubles. (This is why ending purchases of Russian energy is more important than how hard currency earnings are converted.)
Sanctions are leaky and enforcement is key. As a result, financial sanctions are not going to directly affect what the Russian government can do at home. As opposed to what it can buy for its foreign currency earnings abroad, its domestic financial power largely depends on the development of the real (non-financial) Russian economy. But since that, of course, depends hugely on how it can or cannot transact with the outside world, financial sanctions matter. The point is simply that they may not be as constraining as sometimes thought. But they could be tightened and applied to more people and entities, and above all, they could be strictly enforced.
And for enforcement, it makes a difference if Russia’s energy earnings are kept in accounts that western intelligence can monitor. It is hard to know, but one hopes western governments keep a close eye on movements in and out of, say, Gazprom’s accounts in EU-based banks or its correspondent banks there. The new transatlantic task force for sanctions enforcement will be crucial.
It’s a long game. What all of this means is that patience is essential. The effect of sanctions will change over time. They also have to be sustained and therefore need political support in the sanctioning countries. But beware of arguments along the line that “sanctions haven’t changed Putin’s motivations, so what’s the point of damaging ourselves”. Economic sanctions can also work through attrition and denying the other side important capabilities — indeed much like military warfare itself.
Other readables
To understand how Germany became so dependent on Russian energy, read the New York Times’s interview with former chancellor Gerhard Schröder.
The Bank for International Settlements has issued a proposal for reforming data governance to give more control to those who generate data in the first place.
The US college-educated working class is not happy.
I moonlight as a speechwriter in a piece on how western leaders must prepare their citizens for a war economy.
Numbers news
The Federal Reserve raised its policy rate by half a percentage point. Meanwhile, fears of stagflation are increasing around the world.
In a devastating piece of reporting, the AP estimates that some 600 people died in the Russian bombing of a theatre in Mariupol, many more than previously feared.
Source: Economy - ft.com
