Economy withstanding sanctions onslaught for now

Russia’s economy shrank in the second quarter — the first full three months since the country’s invasion of Ukraine — and economists are divided on whether the country can withstand the onslaught of international sanctions in the long run.

The Russian economy shrank by 4% year-on-year in the second quarter, although this was less than the 5% analysts had expected. The Central Bank of Russia expects the downturn to deepen in the coming quarters, reaching its lowest point in the first half of 2023.

It comes as Moscow scrambles to recalibrate its economy in the face of a barrage of sanctions imposed by Western powers in response to the war, which have disrupted trade and virtually banned Russia from the global financial system. .

“There have been signs of stabilization in many sectors in the past month or two, but we don’t expect the downturn to bottom out until the second quarter of 2023 and think the economy will stagnate at best after that,” said Liam Peach, senior emerging economist. markets in capital economy.

The immediate impact of sanctions was mitigated by swift action by the CBR to introduce capital control measures and sharply raise interest rates. The measures stabilized domestic markets and made the ruble one of the best-performing currencies in the world so far this year.

Subsequently, fiscal stimulus measures and sharp interest rate cuts have also had an effect, mitigating the short-term effects of sanctions. Late last month, the central bank shocked with a 150 basis point cut in the Russian key rate, bringing it to 8% and the fifth consecutive cut since it launched an emergency hike from 9.5% to 20% in late February.

“The downturn could have been much deeper, but the central bank immediately took action to prevent a financial crisis from breaking out. It also appears that the resilience of the Russian energy sector has softened the impact of Western sanctions,” Peach added. up.

However, many economists consider the long-term damage to the Russian economy much more serious, as a flight of business and talent gradually compresses economic activity, along with a lack of access to critical technologies.

Meanwhile, sanctions have hit some parts of the economy hard, with manufacturing output falling 4% on a quarterly basis and output in import-dependent sectors by more than 10%.

Consumer demand has also fallen sharply; retail sales fell 11% quarter on quarter after the brutal inflation shock in March, as consumer confidence collapsed and monetary conditions tightened.

“The third quarter is likely to be another weak quarter, albeit with a smaller contraction than the second quarter. Retail and manufacturing declines have eased, inflation has eased and monetary conditions have eased,” Peach said.

“Nevertheless, the economy continues to face severe headwinds, including limited access to Western technology and an imminent ban on insurance to ship Russian oil, which we believe will see production fall by 10% next year.”

Capital Economics does not expect Russia’s GDP to bottom out for another year or so.

thrash, don’t drown

August 24 will mark six months since the first global sanctions were imposed on Russia in response to the February 20 invasion of Ukraine. There are now more than 11,000 international sanctions against the country.

While many economists focus on the long-term structural threats to the Russian economy — which the government and central bank are trying to counter — the more immediate collapse predicted by some has not materialized.

“Despite the onslaught of sanctions and the predictions of many observers, the Russian economy has not imploded and, although it faces a 5-6% contraction this year, there is no danger of collapse or any kind of economic or financial crisis. .” crisis,” said Chris Weafer, CEO of Macro-Advisory in Moscow.

“However, it faces 5 to 7 quarters of a low-single digit decline and a long list of challenges that, if not addressed effectively, will keep growth near stagnation for years to come.”

In a Friday research note, Weafer suggested that the Russian economy is “floating, not drowning.”

Macro-Advisory estimates that the Russian state accounts for more than 60% of GDP, while small and medium-sized enterprises account for less than 25%. This imbalance limits growth in normal times but also isolates the economy in times of crisis, he added.

“Government, businesses and people are accustomed to economic crises (this is the fifth since 1991), and support structures, for employers and in the social field, are well developed,” Weafer said.

Meanwhile, business confidence, which fell sharply in March and April, has returned to its long-term average for both manufacturing and services.

Weafer also disagreed with recent assessments that the economy is on a long road to “obsolete,” arguing that the mass exodus of Western companies from Russia would not be as damaging to activity as widely believed.

“Most of those new businesses are either small businesses (such as retail) or have sold them to local buyers. Of the top 50 foreign-owned businesses, only three have closed completely,” he said.

“Three more have sold to local buyers and ten others have said they plan to sell to a local buyer. The others remain. We calculate the GDP blow at less than 1% as operating assets remain in the country. “

This is 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 study’s authors say sanctions and an exodus of more than 1,000 global companies are “crippling” Russia’s economy.

But Weaver is far from convinced. “There is a lot of skepticism about the so-called resilience and ability, even Russia’s willingness to invest in localization, especially given that little has been done in areas such as technology, engineering and specialized services over the past two decades,” he said. . Added weaver.

“But as previous crises have shown, Russia usually tackles such problems when there is no other choice, and usually only then.”