The effects of sanctions against Russia have been less acute than expected so far, Central Bank chief Elvira Nabiullina said on June 17 at St Petersburg International Economic Forum (SPIEF) and she is right. While the sanctions are clearly very painful, the economy has stabalised and many of the indicators are starting to recover.
The latest Russian data for May suggest that activity, having declined sharply after Western sanctions were imposed in March, has started to stabilise. Some sectors of manufacturing have benefited from a shift towards domestic production. On balance, the fall in Russian GDP this quarter looks like it will be in the order of 10% q/q, not the 15% q/q analysts had previously expected.
Overall, the latest data for May suggest that Russian economic activity, which had declined sharply since March, has now largely stabilised and that output in some sectors has started to recover. Analysts don’t expect a strong recovery from here but, given that the retail and industrial sectors represent more than 40% of Russia’s economy, it now looks very likely that our forecast for a 15% q/q fall in Russian GDP in Q2 was too pessimistic. On balance, it looks like it may be no larger than 10% q/q.
The most noticeable is the exchange rate with the Russia strengthening from a nadir of RUB133 to the dollar in the first days of the war to RUB51 at the end of June – a level not seen since 2008 – and making the ruble the best performing currency in the world.
However, as Central Bank of Russia (CBR) capital controls remain in place, and notably foreign investors remain trapped in the bond and equity markets, the exchange rate is artificial. Should those controls be dropped than over $100bn could flee the country overnight leading to a collapse in the value of the ruble.
Indeed, as bne IntelliNews reported, Russia is suffering from a bad case of the Dutch Disease as massively profitable oil and gas exports have coupled with a collapse in imports, made worse by sanctions and self-sanctions, that have driven up the value of the ruble to well beyond its fair value of somewhere between RUB60 and RUB70 to the dollar.
More concrete progress was made in oil production which started to grow again in June, up to 10.7mbpd after dropping in the first months of the war due to sanctions. That is a major success as Russia finds ways to dodge the sanctions and self-sanctions, largely by massively expanding oil shipments by tanker to India, China and the rest of Asia. The West is attempting to stop this leakage and intends to sanction the use of tankers via their need to get insurance, but a G7 summit in Bavaria came to an end without any concrete proposals being tabled. Experts say blocking Russia exports this way will be very hard.
But Russia remains vulnerable to more energy sancitons and if oil and gas were cut off completely Russia could only cope for a few months before FX liquidity would disappear, inflation would surge, the ruble would collapse and a wave of defaults and bankruptcies would begin. Even if a price cap of $80 were imposed then the budget would likely go into deficit and Russia would be forced to burn through its remaining reserves, pushing Putin to end the war.
But as things are in general the sanctions regime has hit a brick wall as all the sanctions the West can impose on Russia that don’t hurt its own interests have been imposed, leaving only those sanctions that will hurt the West as much, or more, such as banning the import of Russian oil and gas. This is the fatal flaw in the sanction’s regime: the West is very unwilling to hurt its own economy for the sake of rescuing Ukraine.
However, long-term damage has been done to the Russian economy that will slow its develop and take a generation to undo. German Gref says that the economy will stagnate over the next decade if things stay as they are.
In the meantime, Russian President Vladimir Putin is working hard to build new relations for Russia with the nonaligned countries of the Global South. He attended the BRICS summit and is due to attend the G20 summit as well as the second Africa summit in November where he hopes to forge an alliance amongst the nonaligned countries in opposition to the West.
Russia defaulted on a $100mn bond at the end of June that the Kremlin says was a force majeure forced by the US sanctions. The Ministry of Finance actually transfer the payment, in dollars, but it was not sent on to bond holders by Euroclear causing a default. The default will have immediate effect as Russia’s budget is in surplus and it doesn’t need to use the international capital markets. But over the long-term the default will be a black mark and will drive up borrowing costs, even from friendly countries. The whole episode is now headed to court where it will take years to resolve.
But the high oil prices will carry the Kremlin over for the meantime. The positive balance of the current account of the balance of payments of the Russian Federation in January-April 2022 hit an all time record of $95.8bn, which is 3.5 times more than in the same period in 2021 ($27.5bn). And oil prices are expected to climb even higher this year, according to Capital Economics to around $135 by year end.
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