Unraveling the Enigma of Sanctions: Unveiling their True Impact on the Russian Economy

Unraveling the Enigma of Sanctions: Unveiling their True Impact on the Russian Economy
© 2023 Steven Alber. All rights reserved.

The West has been aiding Ukraine in its conflict against Russia through military assistance and economic sanctions. The delivery of weapons and ammunition has increased in preparation for a new Ukrainian offensive. However, there are concerns about the effectiveness of Ukrainian air defenses and artillery against entrenched Russian defenses. Economic sanctions have been implemented through ten rounds since 2014, but the effectiveness of these sanctions on the Russian economy is debatable. The threat of sanctions was intended to deter Russia's aggressive actions, but it failed to do so. If Russia had succeeded in its intended short war, the message to Western policy-makers would have been that tough measures are ineffective.

The Western response to Russia's invasion of Ukraine has been severe, with over 12,000 sanctions put in place since the invasion, including restrictions on Russian gas and coal exports, a price cap on oil exports, and freezing $300 billion of Russian assets. The sanctions have been implemented by several countries, including the US, EU, UK, Switzerland, Canada, Australia, New Zealand, and Japan. The economic impact was expected to be substantial, with the ruble depreciating, the Moscow Stock Exchange closing, and the Russian economy forecast to contract up to 15% in 2022. Inflation in Russia is also spiking, and over 400 multinational companies have left Russia. The hope was that these sanctions would have an impact on Russia's fighting capacity, drain public support, and encourage compromise in peace negotiations.

Despite the severity of the Western sanctions against Russia, the actual impact has been limited. The Russian economy coped better than expected, with higher oil and gas prices increasing state revenues and enabling debts to be repaid. Non-Western countries felt no obligation to take notice of the sanctions, and Russian technocrats showed ingenuity in managing the economy efficiently. While some Russian banks lost access to SWIFT, others retained access for oil and gas payments, and trade is increasingly in Yuan. The impact of individual sanctions has also been limited, as individuals make do with alternative holiday destinations and transfer assets to friends and family. The effort to pressure the regime through the oligarchs probably reflected an exaggerated belief in their importance in Russian decision-making. Smuggling and new trading partners have replaced some of the old trading relationships, with parallel imports and increased exports from countries like Armenia and Serbia to Russia.

The failure of Western sanctions against Russia has been lamented by many, with the IMF upgrading its forecast for the Russian economy from a 2% fall to 0.3% growth this year and 2% growth in 2024. This reinforces the view that Putin can cope with a long war and sustain the economy even as it replenishes and reconstitutes its damaged armed forces. However, some analysts argue that Russia's economy is suffering more than is superficially apparent, with long-term prospects being bleak and shortages and budgetary pressures affecting military capabilities. The IMF's forecast is on the high end, with the World Bank forecasting a 0.2% contraction and the OECD forecasting a 2.5% contraction. The accuracy of Russian statistics has also been called into question, with some suggesting that they are a collection of lies and distortions intended to convince people at home and abroad that the economy is chugging along despite the war and that Western sanctions are ineffective.

Oil and Gas: The Paradox of Sanctions

The recent deficit in the Russian economy has been caused not only by the costs of war but also by the fall in oil and gas prices, which has led to tax revenues being almost halved. Despite past efforts to diversify the economy and encourage manufacturing, Russia remains highly dependent on energy exports, and the performance of the oil and gas sector is at the heart of every assessment about the state of the Russian economy.

The paradox of sanctions lies in the fact that both Russia and the West saw the energy sector as a way to coerce the other. Russia saw Europe's dependence on its gas as one of its vital levers in persuading the West to abandon Ukraine, while Europe was trying to coerce Russia by denying it revenues. Even though Germany abandoned the NordStream 2 gas pipeline project after the annexation of Crimea, the Kremlin saw how Germany remained keen to persevere with it. This led to anxiety in Berlin and elsewhere in Europe about where the logic of sanctions might lead.

Russia found a sweet spot in the market where cutting gas supplies pushed prices up to cause the maximum hurt to Europe while allowing it to maintain or even increase its revenues. As an act of coercion, this failed, and instead of persuading Europeans to rethink their support for Kyiv, it injected urgency into the search for energy saving measures and alternative sources of supply. Gas prices fell, and with them, Russian revenues.

With regard to oil, the jump in prices after the invasion was the result not so much of shortages as market panic. The West agreed on a scheme last year to prevent Russia from selling oil above a price of $60 per barrel. Europeans no longer buy Russian oil, and the bulk of its crude exports are now going to India and China. However, this does not mean that they have been successful in getting the prices they need. Even to willing buyers, Russia is still having to sell at just above $60.

Russia was helped by the April decision of the Organization of Petroleum Exporting Countries (OPEC), in which it participated, to lower output targets by 1.6 million barrels per day (bpd). For this decision to have its intended impact, all countries must stick to their lower outputs. The price must move appreciably higher to sustain the lower volumes so that they can earn more by selling less. After going above $66 per barrel just after the OPEC announcement, the price of Urals crude has dropped back to $63. At its peak last summer, it was over $93.

In conclusion, the paradox of sanctions is that while they may appear to be a way to coerce a country, they can also have unintended consequences that affect the global economy. In the case of Russia, the energy sector remains vital to its economy, and any actions taken by the West or OPEC can have a significant impact on its revenues. As we look to the future, it is clear that finding alternative sources of energy and reducing our dependence on oil and gas will be critical to ensuring global economic stability.

Putin's Russia faces an array of economic and demographic challenges that raise questions about its ability to maintain its current level of military activity in Ukraine. While Putin has been seen as seeking autarky as a desirable end state for Russia, for the moment, the situation is driving Russia to become increasingly dependent on China. The United States and its allies have imposed a range of sanctions on Russia, affecting its economy and ability to acquire essential equipment, including microchips, optics, and high-quality ball bearings. These sanctions have interfered with Russia's ability to replace thousands of items of destroyed or damaged equipment. Russia is following expedients, scavenging what is still left in the country, even in museums, and holding back on meeting export orders.

Around 1,000 companies have left Russia, depriving the country of future investment in oil and technology. Another serious issue, with both short-term consequences and dire implications for the long-term, is the declining population. Russia has long struggled with a declining birth rate and high mortality rate, and Covid-19 has exacerbated these problems. Many people have been killed or badly wounded in action, while others have fled the country. With the military still trying to find new recruits to replace its losses, there are reports of severe labor shortages elsewhere in the economy, especially in information technology. In this sector, 10% of workers left Russia last year, confident of being able to find employment elsewhere.

Furthermore, industrial production in Russia is shrinking by about 8% annually, while military orders have increased by over a third. This suggests that there is little investment in non-military sectors. The declining population, coupled with a lack of investment in non-military sectors, will have significant long-term implications for the country's economic and military stability.

The impact of sanctions on Russia is also a key question, as they can be difficult to end once they have been imposed, much like wars. It is unclear whether sanctions are a form of international virtue signalling, expressing a desire to have minimal relations with countries engaging in objectionable practices at home and abroad, or a means of persuading those countries to abandon some of these practices. If the goal is to change behavior, how much change is necessary before the sanctions can be lifted?

If efforts to stop the fighting do not progress beyond a cease-fire, there may be little reason to relax the sanctions, particularly if large portions of Ukrainian territory are still under Russian control. But what if Russia agrees to withdraw to the borders of February 23, 2022, with the Donbas enclaves and Crimea still held? Should this be rewarded with some easing of the sanctions? And even if Russia goes further, what about issues such as reparations and war crimes? And in the unlikely event that these can be resolved, can we still return to previous levels of business with Russia while Putin remains in power?

We have seen similar situations with the sanctions on Iraq imposed after the invasion and occupation of Kuwait in August 1990. Even after Kuwait was liberated, the sanctions were maintained to ensure that Saddam Hussein abandoned weapons of mass destruction, terrorism, and claims to Kuwaiti territory. There was also a suggestion that they would remain until Saddam was removed from power. Over time, the sanctions were criticized for their effects on the Iraqi people, particularly child mortality, and for how the regime used them to strengthen its position, blaming the West for the country's problems while controlling smuggling and rationing to cope. Their effectiveness gradually declined with increasing exceptions and evasions.

The sanctions imposed on Russia have been a topic of much discussion and debate in recent years. The complexity and range of these sanctions have created the possibility of a gradual unraveling, depending on Russia's behavior. It is unlikely that all measures will be lifted abruptly, and critical issues are bound to arise if serious negotiations for a long-term peace treaty ever take place.

It is possible that Russia has settled in for the indefinite future without regard for the inadequacy of its military efforts and the damage to its economy. However, it is important to support Ukraine's offensive and strengthen sanctions where possible. The future of sanctions will be a significant issue if Moscow begins to consider how to extricate itself from both the military and economic holes it has dug for itself.

In conclusion, the sanctions imposed on Russia are complex and multi-layered, and their future is uncertain. It is important to continue to monitor Russia's behavior and adjust sanctions accordingly. The possibility of a gradual unraveling of sanctions is more likely than an abrupt lifting of all measures. As critical issues arise, it is important to address them in a thoughtful and strategic manner. Ultimately, the future of sanctions will depend on Russia's actions and the success of negotiations for a long-term peace treaty.