The sanctions onslaught on year on were aimed at destroying the
economy. Twelve months ago, Western nations responded to Russia's
invasion of eastern Ukraine with an unprecedented ratcheting up of sanctions,
now totalling almost 13,000. Over the past twelve months, 10,900 sanctions
were applied, almost 9,000 targeting individuals. The aim was to create an
economic and financial crisis that would not only degrade the country's ability
to fund the so-called “Special Military Operation” but to create hardship at
home that would lead to political pressure against the Kremlin and, many
openly hoped, regime change.

None of the above had happened. Predictions of a rapid economic decline
and a budget crisis have proven to be greatly exaggerated. The Russian
economy did not suffer as sharp a contraction as markets initially expected last
year, with the Ministry of Finance assessing the damage at a comparatively
shallow 2.7% decline in GDP for 2022 and a 2.3% deficit – well below
expectations.

By comparison, Russia’s GDP suffered a near 8% contraction in 2009, 3.7% in
2015, and 3.1% in 2020.

The pain was offset Russia’s all-time record high net export earnings of
$580bn, an 18% increase over 2021 and 35% higher than the average
surpluses seen over the 2010s, of which two thirds was due to energy exports.

This year is confusing. Clearly Russia will not do as well as sanctions begin to
bite, but what is not known is by how much. The IMF predicted that Russia will
grow by Russia’s economy would grow by 0.3% but other analysts mostly
predict a contraction of a few percent. The Central Bank of Russia (CBR)
recently improved its outlook but is still keeping its options open with a -1% to
+1% range.

The year got off to a bad start for the budget too with a RUB1.76 trillion deficit
– more than half of what is expected for the whole year in just one month. The
fall was due to big one-off spending, plus a collapse of oil and gas revenues.
However, analysts bne IntelliNews talked to say the spending spike will be
contained to January and the oil and gas revenues will recover as the fall was
related to the increasingly meaningless price of the Urals brent, that is used to
calculate oil taxes, and Ministry of Finance (MinFin) has already dropped it as
a benchmark and is using Brent instead. For their part the oil companies are all
earning record profits. MinFin is sticking to its 2% deficit for the full year which
is entirely possible.

Adding to the confusion is the introduction of the ban on oil product exports on
February 5. But as bne IntelliNews has reported already seems clear that
Russia will be able to export most of what used to go to Europe to new
customers using its growing “ghost fleet” of tankers.

The economy was also held up by a surge in both public and private
investment as companies adjusted their production to take account of the new
sanction’s realities. As presumably a lot of this investment went into military
production it is not clear what effect this will have on both the amount of growth
and the quality of growth. The topic is being hotly debated and some are
arguing that the investment produces superficial growth, but is actually
hollowing out the economy as it does little to improve demand and
consumption.

Much of this investment was driven by companies and regional and federal
authorities accelerating the timelines for existing investment plans to cushion
the blow from sanctions and offering targeted relief for businesses in the form
of stays on taxation and direct financial support, effectively masking the
problem.

Some was also driven by import substitution and pressures facing import-
dependent firms to replace parts, goods, and services that were now more
difficult to access.

The base scenario is that the war will drag on all year. The two sides are
too far apart in their negotiating position and talks don’t seem possible.
Progress will be determined on the battlefield and for Ukraine everything
depends on securing more weapons and materiel from the West.

But here things are not looking good. Despite promising over 400 main battle
tanks (MBTs) only two have arrived and several countries have reneged on
their promises so a total of 380 are now pledged. That includes 31 from the US
but they recently said that their Abrams wont arrive for one and half or two
years. Likewise, the West very quickly quashed Kyiv’s calls for fighter jets. And
the lack of ammo is becoming a growing problem: here too there have been
calls for investment into bigger production, but little has been done.

There is no danger, under any plausible scenario, of an economic collapse or
financial crisis affecting Russia, according to Macro Advisory. The real impact
of the accumulation of 13,000 separate sanctions will be a steady erosion of
economic activity and efficiency. There will also be a steady decline in real
household incomes (e.g. a growth in part-time or reduced hours work) and in
the lifestyles that Russian people (especially those in the cities) have enjoyed
since 2000. The gap in technology with the rest of the world will widen and
become more damaging, but over several years rather than several months.
How far that degradation will go and what will be the impact on the country will
depend on volatile and unpredictable geopolitics.

Retail sales, a good proxy for consumption trends, has contracted sharply. The
volume of November retail sales was down by 8% y/y. High inflation has
eroded the purchasing power of Russian consumers, with consumer price

inflation running at 12% p.a. in November. Despite recession, the
unemployment rate has remained low and continued to hover around 4% in
November.