Russian Economy Is Struggling To Start 2023

Dislocations From Sanctions Are Deep And Significant

While the increasingly parlous state of the US economy quite rightly captures a lion’s share of the attention of late, the US is still only one nation among many, and only one economy among many.

With war in Ukraine still raging, and with peace nowhere in sight, we should take a moment to see where Russia’s economy stands. What are the practical impacts of the sanctions the West has imposed on Russia? How much damage is being done?

Let us be clear: The sanctions are hurting. Even Vladimir Putin has conceded as much many times.

Russian President Vladimir Putin at the meeting said that in the future sanctions could adversely affect the state of affairs in the country's economy, so we need to work on demand issues.

"The illegitimate restrictions imposed on the Russian economy in the medium term may indeed have a negative impact on it. In this regard, we need to ensure a steady increase in domestic demand," Putin said at a meeting with members of the government.

With Rosstat (Russia’s official statistics agency) having released its latest economic data for January and February, we can quantify what some of that damage actually is.

At first glance, Russia’s real GDP estimates suggest that the sanctions regime imposed by the EU and NATO nations have not been as impactful as hoped, as the first estimate indicates a GDP decline of approximately 2.1%.

To call that a devastating economic blow would be giving far too much credit to the sanctions regime. Still, when we delve a bit deeper, we can see where there has been significant and even catastrophic economic contraction.

Most significantly, Russia’s industrial production has declined year on year, even as the demands of the Russo-Ukrainian War continue to mount.

A shrinking industrial base is not how a country sustains an invading army while across the border. Yet with January and February output printing at 97.8% of the year-ago totals, Russia is, overall, making fewer things than before it invaded Ukraine.

Moreover, Rosstat’s data confirms that Russia’ industrial output has been declining practically since the start of the war, with declines posting every single month since April of last year.

If this trend continues, the overall impact to Russia’s industrial base will be nothing short of devastating. Continued contraction in the manufacturing sector means fewer factories in use, fewer jobs over the long term, and potentially a permanent reduction in GDP, as idled factories remain idle too long for easy restart.

Moreover, key economic sectors for Russia are struggling, even at a time when the demands of modern warfare arguably opens the door for greater output in response to greatly increased government demand—a war machine tends to have an insatiable appetite. In particular—and somewhat at odds with some media reports over the past year—Russia’s mining and extracting industries have declined.

Russia’s oil output, by Rosstat’s own estimates, is not only down 1.8% from February of 2022, it is down a substantial 8.3% from this past January (2023).

A decline in oil production means less refined products necessary for prosecuting a modern war. A decline in oil production means less revenue both for the economy and for the government at a time when revenue is of especial importance (wars are expensive, as a general rule).

Manufacturing has also declined, with January and February of 2023 printing at 98.3% of January and February of 2022.

While there appears to be a seasonal drop from December to January each year, the drop was from a lower peak at December of 2022 and reached a lower trough in January of 2023.

The decline is not universal, and some manufacturing sectors are printing above their January/February 2022 levels. Those include items which could have potential military significance, such as computers and electronics, as well as the production of certain classes of vehicles and equipment.

However, the production of rubber and plastic products, which includes items such as tires, has declined, and tires specifically have declined 45% for passenger car tires, 37.6% for bus and truck tires, and 46.2% for agricultural machinery tires.

A decline in tire production across the board means fewer tires for military vehicles as well, which does not augur well for any future offensive operations in eastern Ukraine.

What Russia is producing in greater quantities now than before the war is computer and electrical components, with radar and radio navigation equipment production printing at 174% of January-February 2022 levels.

Electrical equipment production has largely held steady, although certain types of equipment are being produced in greater numbers while other types are being produced in greatly reduced numbers.

While the Rosstat reporting does not specifically state the increases are the results of military-based production, that is the likely interpretation of the numbers, and indicates that Russia has at least to some degree shifted into a wartime economic mode, with military goods being favored over civilian consumer goods.

If that transition has taken place, then ordinary Russians are finding themselves with fewer goods that people in western countries take for granted, such as refrigerators, freezers, and washing machines.

Where production has quite simply crashed is in motor vehicles themselves.

If the decline is due to shifting towards the production of military vehicles, that output is embedded elsewhere in the statistics, although it at first glance it is difficult to see where else that output would be recorded. If the decline is not due to a wartime shift to military production, the ramifications for the logistics of the Russian military are nothing short of grim—armies need trucks to move men and material to the front lines.

Also in steep decline is the production of railway transport pieces. Only electrically powered train engines are showing at production levels above January-February of 2022.

Taken as a whole, Russia’s manufacturing base is showing significant decline—declines which do not bode well for the future of their military efforts both in Ukraine and elsewhere.

Moreover, these declines amount to major reductions in business profit for Russian companies—an overall 21.3% decline year on year.

Compounding these economic problems are the ongoing challenges of Russia’s central bank, which TASS reports as having lost some $9.3 Billion over the past year, a 2700% increase from 2021.

Losses of the Bank of Russia surged by 27 times from 26.3 bln rubles ($339.9 mln) in 2021 to 721.7 bln rubles ($9.3 bln) in 2022, the regulator said in its annual report.

Assets of the Central Bank dropped from 52.4 trillion rubles ($677.5 bln) in 2021 to 47.2 trillion rubles ($610.4 bln) in the last year.

Ongoing losses by the Bank of Russia predate sanctions, but the dramatic surge in losses is almost certainly attributable to the sanctions regimes, and suggest the financial supports for the Russian economy are wobbly at best, and potentially breaking down completely.

Russian oligarch Oleg Derispaka, speaking at the Krasnoyarsk Economic Forum, certainly appears to lean towards the latter interpretation.

Russia will soon face a shortage of sources of financing for the economy, in order to cover it with foreign investment, clear rules of the game and predictability are needed, Oleg Deripaska said at the Krasnoyarsk Economic Forum.

"The rule of law and predictability are very important. If we change the rules of the game every year or quarter, no one will believe: neither Russian entrepreneurs nor foreign ones," the businessman said.

"It is necessary to stop these bondage, from the Stone Age," planting "of everyone in a row for no one knows what. If a person has committed an economic offense, compensated for it - let him go on working," Deripaska said.

"You don't have to choose. There will be no money next year. We will need foreign investors. And they will watch how Russian investors earn, what conditions they have. If we do not create them, do not ensure the attractiveness of our market, then we will Let's dream," he said.

Nor are Russia’s economic declines limited in their impacts to Russia. The decline in oil production especially has been matched with a decline in oil export volumes, with crude oil exports falling by 9% in February alone.

Russia’s crude oil exports declined by nearly 9% in February due mainly to port stoppages in Novorossiysk and lower flows to Europe.

A 9% drop in exports means that, while China and India have become Russia’s primary energy customers, they are not absorbing all of Russia’s pre-war oil production.

China and India absorbed 85% of Russia’s seaborne crude shipments for the month, on level with January.

Russian hydrocarbon exports have been in overall decline throughout 2022, and refined products exports have dropped significantly with the onset of the EU/G7 price caps for seaborne transport.

This decline in Russian oil export means less oil for the global market—at a time when global oil prices are declining, with Brent crude at a price level not seen since November of 2021.

While Russia’s economy alone is hardly sufficient to push the global economy into recession, the decline in oil price coupled with a decline in oil exports from a major oil exporter illustrates the degree to which the global economy is in recession.

Russia’s economic woes are not likely to improve in an economic environment where its principal exports—hydrocarbons—are in reduced demand. To sell one must have customers willing to buy, and while Russia has willing customers in China and India, that willingness does not include slurping up all of Russia’s pre-war oil output.

What Russia’s economic challenges do mean is that Russia likely lacks the resources to force a conclusion to the war in Ukraine. A shrinking manufacturing base leaves less capacity to support Russian forces in Ukraine with needed materiel and supplies. Even if Russia follows through with additional mobilizations of troops, the Russian economy is having difficulties just providing enough trucks and truck tires to move them and their needed equipment to the front lines, while declines in oil production invariably means less truck and tank fuel than would otherwise be available.

Such economically-driven logistical challenges can only constrain Russia’s capacity for future offensive operations in Ukraine. Numerical advantages in manpower do not compensate for what appears to be a growing inability of the Russian economy to support any additional troops.

Still, Russia’s economy is not in total collapse, and may not even spiral into total collapse. Russia’s economy is shrinking, but it is still productive enough that Russia is likely to still be able to sustain its forces in Ukraine for a while longer, even if offensive potentials are reduced for lack of adequate supply lines.

Perversely, while the sanctions regimes have clearly been impactful to Russia’s economy—and Rosstat’s own data demonstrates the magnitude of the impact—the practical consequence of that impact is to ensure that the attritional phase of the war in Ukraine will grind on, as Russia will need increasing amounts of time to accumulate the necessary supplies for mounting significant offensive operations. Unless and until Ukraine on its part succeeds in mounting its own offensives and transitioning from a war of attrition to a war of maneuver, the world can look forward to an ongoing meatgrinder of a conflict in eastern Ukraine for the foreseeable future.

Russia is already paying a heavy economic price for a year of war, and will continue to pay a heavy price. Yet Russia’s contracting economy—and corresponding declines in hydrocarbon production—means that, long term, at least a portion of that price will be paid by the larger global economy.

Proving once again that war is not merely Hell, it’s an expensive sort of Hell.