Russia’s brutal war in Ukraine has now continued for more than nine months. The EU, the US and many other countries have imposed extensive economic sanctions on Russia to restrict Russia’s financial and technological capabilities for warfare. The war and the sanctions have already affected the Russian economy. Russia has been largely isolated from the global economy and found new economic partners only to a limited extent. The war and sanctions are eroding Russia’s economic outlook for years to come.
Financial flows to Russia dry up
Russia’s financial sector has been slammed by war and sanctions. A large part of the country’s currency reserves are frozen, access to international financing is limited, and international payment transactions are difficult. In the initial days of the invasion, the Central Bank of Russia was obliged to resort to heavy restrictions on capital flows to support the ruble’s exchange rate and prevent a financial crisis (Mukhin and Itskhoki 2022). In June 2022, Russia’s government defaulted on external debt for the first time in decades, as the sanctions prevented payment to international creditors.
Russia’s foreign financing has traditionally come mainly from countries that are now sanctioning it (Simola 2022a). Available data suggest that Russia has been unable to locate significant new sources of foreign finance. Indeed, Russia’s net foreign direct investment inflows plunged into historically deep negative territory after the invasion of Ukraine (Figure 1). Hundreds of foreign companies have decided to leave Russia, although Russian officials have severely complicated the exit process. Loss of foreign direct investment has been identified as potentially one of the most devastating consequences of sanctions for the Russian economy (Mahlstein et al. 2022).
Figure 1 Net flow of inward FDI to Russia
Sources: Macrobond and Bank of Russia.
Russia’s technology sectors hit by loss of imports
The numerous restrictions imposed on exports to Russia focus on high-technology goods, intending to weaken the production capacity of Russia’s military industry. Russia has ceased publication of international trade statistics, but Russian imports are estimated to have contracted substantially due to the war and sanctions (Borin 2022, Simola 2022c). Imports of many technology products have fallen particularly sharply. An alternative indicator relying on mirror statistics – export data from key trading partners – suggests that Russian goods imports in September were down by 28% from pre-invasion levels (Figure 2). In previous years, this alternative indicator has tracked the evolution of Russian imports quite closely, with a correlation of 0.97.
Figure 2 Russia’s goods imports based on official data and proxy constructed from mirror statistics
Sources: Macrobond, Eurostat and BOFIT.
Despite years of trying to substitute imports with domestic production, Russia was highly dependent on imported high-technology goods and inputs before the war (Simola 2022b). Russia’s production structure remains, as it has for decades, dominated by mining and low-tech resource-intensive industries. With sanctions now limiting the availability of technology and financing, Russia’s prospects for import substitution of technological products have become even more limited.
It appears that so far non-sanctioning countries have not provided Russia with substitutes for most technology goods in any substantial volume. Indeed, Russia’s imports from many non-sanctioning countries have also contracted. While Russian imports from China and Turkey have exceeded pre-war levels in recent months, the share of technology products has remained unchanged. Technology imports from neighbouring countries such as Kazakhstan have grown substantially, but the absolute volume is quite modest (Simola 2022a).
Output of many goods in Russia’s medium- and high-technology industries has contracted sharply. For example, in October the production of trucks was down on-year by 40%, TV receivers by 44% and excavators by 69%. As Russian companies deplete their inventories of imported inputs and the need for maintenance of imported machinery continues, the sting of sanctions will gradually intensify. The small share of these industries in Russia’s total output, however, limits the effect on Russia’s total manufacturing production.
Some of Russia’s export-oriented sectors already suffer from sanctions
Sanctioning countries have also imposed restrictions and tariffs on imports from Russia. The sanctions cover many of Russia’s key export goods, including crude oil, refined petroleum products, coal, gold, timber, and various steel products. Many of these import restrictions have come with transition periods or other modifications, giving sanctioning countries and global markets time to adjust and soften the ensuing impacts (e.g. a price ceiling on Russian oil shipments instead of a total ban on related services). Although reducing the costs for other countries, this approach also dilutes the effects of such measures on the Russian economy.
Some of the import restrictions implemented earlier are already having a visible impact on Russian industry. For example, Russian wood and steel producers have been unable to find alternative export markets that offer profitable price levels (Simola 2022c). In these industries, output has declined sharply and companies have suffered heavy losses (Figure 3).
Figure 3 Seasonally adjusted change in monthly output of selected Russian export-oriented industries
Sources: Macrobond and Rosstat.
Russia’s oil industry has suffered much less. Rosstat, Russia’s statistical office, estimates that the oil and gas GDP remained unchanged in the second quarter of 2022, even as non-oil GDP contracted by over 5% year-on-year, or slightly more than in the second quarter of 2020, during the first wave of the COVID-19 pandemic. The restrictions on oil imports imposed by the largest buyer of Russian oil, the EU, have just entered into force in December 2022. Moreover, a spike in global oil prices has supported Russia’s oil industry (even if Russian oil has been sold at a discount) together with a reorientation of Russian oil to new export markets, most notably India and China (Simola 2022a).
After entering into force, the EU import restrictions on Russian oil are expected to lead to a decline in Russian export income and oil production. Simulation studies suggest that the costs of sanctions for Russia could become substantially higher with more countries joining in (Hertel et al. 2022, Langot et al. 2022, Simola 2022d, Wanner et al. 2022).
Erosion of Russia’s long-term growth potential
Even as Russia’s GDP forecasts for this year improved from last spring, the forecasts for 2023 deteriorated. Instead of a sudden fall, Russia faces a prolonged, painful recession. Recent forecasts anticipate a 7–8% drop in Russian GDP in 2022–2023, i.e. a decline similar to those seen in Russia’s major economic crises in 1998 and 2008. The difference is that the Russian economy bounced back rapidly after these earlier crises, whereas Russia’s current outlook is gloomy for years to come.
Russia’s potential growth already looked rather subdued before the war, with most estimates around 1.5% per year (Korhonen 2021). Russia’s long-term growth is restricted by unfavourable demographic trends, low investment rates, and low levels of productivity. The demographic structure is now further darkened by casualties, permanent injury, mobilisation, and emigration caused by war. Investment is hampered by high uncertainty and severely restricted access to foreign financing. Increasing state involvement, an emphasis on military industries, and a lack of access to Western technology weigh further on productivity.
The five-year forecasts of the IMF World Economic Outlook provide a rough illustration of Russia’s waning growth potential. Assuming that the fifth forecast year denotes approximate potential growth, the IMF forecasts show the magnitude of the effect of Russia’s military aggression and sanctions on its long-term growth since Russia’s illegal annexation of the Crimean peninsula in 2014. In the October 2013 World Economic Outlook, Russia’s potential growth was estimated at 3.5% a year (Figure 4). By October 2022, it had fallen to just 0.7% a year. Comparing the 2019 and 2021 forecasts suggests that the COVID-19 pandemic only accounted for about 0.25 percentage points of the forecast decline.
Figure 4 Russia’s long-term growth estimate has been cut substantially in the IMF World Economic Outlook forecasts
Source: IMF October WEO from respective years.
There is plenty of evidence that war and sanctions have affected the performance of the Russian economy. The harshest impacts are still largely limited to individual sectors specifically targeted by sanctions. Transition periods and other measures mitigate the harms of sanctions on sanctioning countries and global markets but simultaneously blunt their impact on the Russian economy. The direct effect of sanctions on the Russian population is limited, as they are primarily aimed at degrading Russia’s military capabilities. Nevertheless, all Russians will suffer for many years from a deteriorating standard of living from Russia’s ill-conceived war.
The literature suggests that a wider coalition of sanctioning countries could substantially increase the costs of sanctions for Russia. The impact of the sanctions is expected to increase gradually and darken Russia’s economic outlook for years to come. But while sanctions are an important tool to restrict Russia’s possibilities to continue the war, other measures are also needed.
Borin, A, F Conteduca, and M Mancini (2022), “The impact of the war on Russian imports: A counterfactual analysis”, VoxEU.org, 9 November.
Hertel, T, D van der Mensbrugghe, and M Chepeliev (2022), “Cutting Russia’s fossil fuel exports: Short-term pain for long-term gain”, VoxEU.org, 9 March.
Korhonen, I (2021), “Russia’s growth potential post-COVID-19”, BOFIT Policy Brief 9/2021.
Langot, F, F Malherbet, R Norbiato, and F Tripier (2022), “Strength in unity: The economic cost of trade restrictions on Russia”, VoxEU.org, 22 April.
Mahlstein, K, C McDaniel, S Schropp, and M Tsigas (2022), “Potential economic effects of sanctions on Russia: An Allied trade embargo”, VoxEU.org, 6 May.
Mukhin, D, and O Itskhoki (2022), “Sanctions and the exchange rate”, VoxEU.org, May 16.
Simola, H (2022a), “Can Russia reorient its trade and financial flows?”, BOFIT Policy Brief 7/2022.
Simola, H (2022b), “Made in Russia? Assessing Russia’s potential for import substitution”, BOFIT Policy Brief 3/2022.
Simola, H (2022c), “Russian foreign trade after four months of war in Ukraine”, BOFIT Policy Brief 5/2022.
Simola, H (2022d), “Trade sanctions and Russian production”, BOFIT Policy Brief 4/2022.
Wanner, J, J Hinz, K Kamin and S Chowdhry (2022), “Sanctions coalitions: Stronger together”, VoxEU.org, 30 October.