Russian Economic Resilience in the Wake of the Ukraine invasion – Gülsüm Akbulut

Russia invaded Ukraine on February 24, 2022. In response, the U.S. and EU, joined primarily by Japan, Canada, Australia, and South Korea, imposed one of the most far-reaching sanctions on Russia. While sanctions have already weakened the Russian economy following Russia’s annexation of Crimea in early 2014, the widespread suspension of economic, financial, and trade relations with the West in 2022 and 2023 appears to have significant long-term implications for maintaining the country’s economic strength.

Since the early 2000s, Russia has experienced various economic fluctuations, some of which are due to global economic conditions. Similar to other countries, the global economic crisis of 2008-2009 and the demand and supply constraints of the Covid 19 pandemic hit the Russian economy hard. In addition, Russia has faced economic challenges since 2014 due to sanctions imposed over the annexation of Crimea and the invasion of Ukraine. Average growth from 2014 to the present was 0.5 percent, with negative growth of 2.2 percent in 2022. Compared to the robust growth rates in the first half of the 2000s, which reached 8.5 percent in some years (Figure 1), it appears that the Russian economy will not reach this performance for a long time after the invasion. While the IMF estimate points to positive growth rates for 2023, other prominent international institutions and even the Russian Central Bank expect the economy to be in recession (Figure 1). On the other hand, the IMF’s expectations for the coming years are not optimistic. In March 2023, IMF Managing Director Kristalina Georgieva stated that the Russian economy is expected to contract by 7 percent in the medium term.^[1]

As Russia’s main source of revenue is energy, Russia’s economic challenges are closely linked to the volatility of prices of and demand for its energy products. In 2021, energy products accounted for more than 50 percent of export revenues, 50 percent of government revenues, and nearly 20 percent of GDP and the European Union was the main consumer of Russian energy.[2]  In 2022, major European countries, particularly Germany, continued to import oil and gas from Russia due to their heavy dependence on Russian energy, while making efforts to develop alternative energy sources. Germany increased coal production and extended the life of its remaining three nuclear power plants. ^[3] Still, Germany remained the largest importer of Russian fossil fuels after China in one year after the invasion. Germany, the Netherlands, Italy, Poland, France, Belgium, and other EU countries were still importing in 2022, but at a declining rate as Russian revenues from EU countries fell by about 85 percent. [4]

 In fact, the restriction on energy imports from Russia had a negative impact on EU countries, especially Germany. When the EU began imposing certain restrictions on exports to and imports from Russia in 2022, Russia retaliated by halting natural gas supplies to Europe by indicating equipment problems, maintenance needs, and gas leaks. ^{[5] [6]}These restrictions have hurt not only the Russian economy but also European countries. The energy restriction contributed to a decline in Germany’s growth rate in 2022, and zero growth expectation in 2023.

As can be seen in Figure 2, Russian energy exports move in tandem with oil prices. In early 2022, oil prices began to rise, and Brent oil reached $123 per barrel and Urals oil $102 in June, leading to a significant increase in Russian export revenues. However, this increase did not last throughout the year, as oil prices fell in the second half of the year, which had a negative impact on Russian revenues. In December 2022, the European Union and the United States, along with other major countries, decided to impose a $60 per barrel price cap^[7] on crude oil, which caused Urals crude oil prices to fall to $57 per barrel by the end of March 2023.[8](Figure 3). The prices of natural gas which is one of the main energy sources of Russia showed fluctuations similar to oil prices.^[9]

Recent measures such as the EU ban on imports of Russian seaborne crude oil and refined oil products , which put into effect in December 2022 and February 2023, respectively, and price caps in late 2022 and early 2023 are expected to have a negative impact on Russian revenues. Already, Russian energy exports in February 2023 are down more than 40 percent year-on-year.(Figure 3) ^{[10] [11]}

To counter these sanctions, Russia has sought alternative markets for its energy exports that did not comply with the European Union’s sanctions policy, and China has become a significant alternative market for Russia’s energy. While interdependence with the West was decreasing, Russia would become more economically and financially intertwined with China. However, the expansion of Chinese imports from Russia, India, and other countries would not compensate for the loss of European markets[12]  for some time. It seems likely that the Russian economy will continue to experience a recession in the coming years, as IMF Managing Director Georgieva indicated.

The far-reaching sanctions against Russia have had a significant impact on the country’s financial system. Several Russian banks were excluded from the global financial system, the assets of oligarchs with close ties to the Russian government were seized, and a significant portion of Russia’s $300 billion in foreign exchange reserves out of $476 billion (excluding gold) held in banks in the U.S. and EU were frozen. These measures led to a loss of confidence in the Russian financial system and a 50% devaluation of the Russian ruble in just a month and a half. [13]  In response to these measures, Russia announced in late March 2022 that “unfriendly” countries would have to pay for Russian gas in rubles. This decision prevented further devaluation of the ruble, and the ruble appreciated by mid-2022. To counter further blocking of its international reserves, Russia has increased its holdings of yuan and expanded its efforts to develop a digital currency. In fact, Russian de-dollarization policy has started before the invasion, mainly after the annexation of Crimea. Today, due to the sanctions, and Russian’s promotion of yuan; Dollar and Euro share in external transactions declined and the yuan’s share increased.

Foreign direct investment (FDI) in Russia had reached a substantial level of about $500 billion before the invasion, with various Western countries investing in the country. After the invasion, however, many of these countries expressed their intention to withdraw from Russia without sanctions requirements. In particular, large foreign companies that had invested in the energy and banking sectors either left the country or expressed their intention to do so. For example, BP, which owns 19.75 percent of Rosneft, Exxon, which had a significant joint venture with Rosneft in Sakhalin, and Shell, which was involved with Gazprom in the Sakhalin project, either transferred their ownership to the Russian government or to the oligarchs who have close ties to Putin, or declared their intention to do so. In addition, France’s Total Energies, which had invested in Novatek, and Societe Generale, which had a partnership with Rosbank, wanted to withdraw from these partnerships. It is likely that the transfer of their shares was or will be agreed on more favorable terms for the Russian partners. On the other hand, Russian companies have been forced to sell their subsidiaries in Europe, such as Gazprom’s gas storage facilities in Germany, Rosneft’s oil refinery in Germany, and Lukoil’s oil refinery in Sicily (Aslund, February 4, 2023). ^[14]

Overall, the invasion of Ukraine and the economic sanctions imposed on Russia by the U.S., the EU, and other countries have had notable impacts on the Russian economy. The sanctions mainly targeted Russia’s energy exports and financial system, leading to a decline in export revenues and a loss of confidence in the financial system. Russia has tried to develop alternative markets and solutions in response to Western sanctions, but it appears that new markets and new financial systems, which are mostly inclined to China and India, are not a cure for its economic strength. Even if the military conflict is resolved, the anticipation of a new Cold War era between West and East suggests that a return to pre-invasion economic conditions may not be possible. The long-term impact of sanctions on Russia’s economic strength remains uncertain, but it is clear that the country’s economic resilience has been tested. Therefore, it is critical for the third parties to gain a comprehensive understanding of the long-term impact of the recent conflict and the consequences of the EU and U.S. responses on the Russian economy in order to adapt to the new economic and political dynamics.

Gülsüm Akbulut

Director of Global and Turkish Economic Studies

Foreign Policy Institute

3 April 2023

Figure 1: Russian Economic Growth

Figure 2 Russian Exports and Oil Prices[1]

[1] Source: https://data.worldbank.org/indicator/NE.EXP.GNFS.CD?locations=RU

Figure 3: Oil Prices and Russian Exports (Monthly)

[1] https://edition.cnn.com/2023/03/08/economy/imf-kristalina-georgieva-interview/index.html

[2] https://insights.som.yale.edu/insights/year-after-the-invasion-the-russian-economy-is-self-immolating

[3] https://www.reuters.com/business/energy/germany-create-legal-basis-extend-lifespan-three-nuclear-plants-letter-2022-10-17/

[4] https://www.visualcapitalist.com/which-countries-are-buying-russian-fossil-fuels/

[5] https://www.bbc.com/news/world-europe-60131520

[6]https://www.theguardian.com/business/2022/sep/02/nord-stream-1-gazprom-announces-indefinite-shutdown-of-pipeline

[7] https://www.consilium.europa.eu/en/press/press-releases/2023/02/04/eu-agrees-on-level-of-price-caps-for-russian-petroleum-products/

[8] https://tradingeconomics.com/commodity/urals-oil

[9] https://www.macrotrends.net/2478/natural-gas-prices-historical-chart#:~:text=The%20prices%20shown%20are%20in,March%2021%2C%202023%20is%20%241.93.

[10] https://nypost.com/2023/03/03/russian-energy-revenue-rebounds-by-22-5-in-february/

[11] https://www.vox.com/world/2022/12/6/23490654/price-cap-60-russian-oil-european-union-ban-group-of-seven-united-states

[12] https://www.aa.com.tr/en/economy/china-is-set-to-become-russias-main-gas-importer-to-replace-eu/2762421

[13] https://www.investing.com/currencies/usd-rub

[14] https://www.project-syndicate.org/commentary/russia-war-redistribution-concentrating-assets-with-putin-and-cronies-by-anders-aslund-2023-02