Michael Metzel | Kremlin | Sputnik | via Reuters Russia’s economy shrank in the second quarter – the first full months since the country invaded Ukraine – and economists are divided over whether it can continue to withstand the onslaught of international sanctions in the long term. The Russian economy shrank by 4% year-on-year in the second quarter, although it was less steep than the 5% that analysts had expected. The Central Bank of Russia expects the recession to deepen in the coming quarters, reaching its lowest point in the first half of 2023. It comes as Moscow tries to revamp its economy in the face of a barrage of sanctions imposed by Western powers in response to the war, which have disrupted trade and ostracized Russia from the global financial system. “There have been signs of stabilization in many areas over the past month or two, but we don’t expect the recession to bottom out until the second quarter of 2023 and we think the economy will stagnate at best thereafter,” said Liam Peach, senior emerging market economist at Capital Economics. The immediate impact of the sanctions was mitigated by the CBR’s swift action to implement capital control measures and the sharp rise in interest rates. The measures have stabilized domestic markets and even seen the ruble become one of the world’s top-performing currencies so far this year. Subsequently, fiscal stimulus measures and significant interest rate cuts have also been put in place, softening the short-term impact of the sanctions. Late last month, the central bank shocked with a 150-basis-point cut in Russia’s key interest rate, to 8% and the fifth straight cut since it began an emergency hike from 9.5% to 20% in late February. “The recession could have been much deeper, but the central bank took immediate action to prevent a financial crisis from taking hold. It also appears that the resilience of Russia’s energy sector has reduced the impact of Western sanctions,” Peach added. But many economists see the long-term damage to Russia’s economy as far more serious, as a flight of business and talent gradually squeezes economic activity, along with a lack of access to critical technologies. Meanwhile, the sanctions have hit some sectors of the economy hard, with manufacturing output down 4% quarter-on-quarter and output in import-dependent sectors falling more than 10%. Consumer demand has also weakened sharply. Retail sales fell 11% quarter-on-quarter after March’s brutal inflation shock, while consumer confidence collapsed and monetary conditions tightened. “The third quarter is likely to be another weak quarter, albeit a smaller contraction than the second quarter. Declines in retail sales and manufacturing have moderated, inflation has eased and monetary conditions have eased,” Peach said. “Even so, the economy still faces serious headwinds, including limited access to Western technology and the impending ban on providing insurance for the shipping of Russian oil, which we believe will cause production to fall by 10% next year.” . Capital Economics does not expect Russian GDP to bottom out for another year or so.
Flopping, not drowning
August 24 will mark six months since the first global sanctions were imposed on Russia in response to its February 20 invasion of Ukraine. There are now over 11,000 international sanctions on the country. Although many economists are focusing on the longer-term structural threats to the Russian economy – which the government and central bank are trying to address – the more immediate collapse some are predicting has not come to fruition. “Despite the onslaught of sanctions and the predictions of many observers, Russia’s economy has not collapsed, and although it faces a 5-6% contraction this year, it is not in danger of collapsing or facing any form of economic or financial crisis,” said Chris Weafer , CEO of Moscow-based Macro-Advisory. “However, it faces 5 to 7 quarters of low single-digit declines and a long list of challenges that, if not effectively addressed, will keep growth near stagnation for many years.” In a research note on Friday, Weafer suggested that the Russian economy is “stumbling, not drowning.” Macro-Advisory estimates that the Russian state accounts for more than 60% of GDP, while small and medium enterprises make up less than 25%. This imbalance limits growth in normal times, but also isolates the economy in times of crisis, he added. “Government, companies and people are used to economic crises (this is the fifth since 1991) and the support structures, for employers and in the social sectors, are well developed,” Weafer said. Meanwhile, business confidence, after falling sharply in March and April, has returned to long-term averages for both manufacturing and services. Weafer also disagreed with recent assessments that the economy is on a long road to “oblivion”, arguing that a mass exodus of Western companies from Russia would not be as damaging to activity as widely assumed. “Most of those exiting are either small companies (such as in retail) or have sold to local buyers. Of the top 50 foreign-controlled companies, only three have closed completely,” he said. “Another three have sold to local buyers and 10 others have said they intend to sell to a local buyer. The others are staying put. We estimate the hit to GDP at less than 1% because operating assets will remain in the country.” That’s in stark contrast to the “catastrophic” hit projected by a Yale University study published last month that analyzed high-frequency consumer, trade and shipping data. The authors of the study argue that sanctions and the exit of more than 1,000 global companies are “crippling” the Russian economy. But Weafer is far from convinced. “There is great skepticism about Russia’s so-called resilience and ability and even willingness to invest in localization, especially given how little has been done in areas such as technology, engineering and specialized services over the past twenty years.” Weafer added. “But as previous crises have shown, Russia usually faces such problems when it has no other choice, and usually only then.”
