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Western sanctions catch up with Russia’s wartime economy

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Western sanctions catch up with Russia's wartime economy

When Russian President Vladimir Putin launched last month a new council for coordinating supplies for the Russian army, he seemed to recognize the scale of the economic problems facing the country, and his sense of urgency was palpable.

“We have to be faster in deciding questions connected to supplying the special military operation and countering restrictions on the economy which, without any exaggeration, are truly unprecedented,” he said.

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For months, Putin claimed that the “economic blitzkrieg” against Russia had failed, but Western sanctions imposed over the invasion of Ukraine are digging ever deeper into Russia’s economy, exacerbating equipment shortages for its army and hampering its ability to launch any new ground offensive or build new missiles, economists and Russian business executives said.

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Recent figures show the situation has worsened considerably since the summer when, buoyed by a steady stream of oil and gas revenue, the Russian economy seemed to stabilize. Figures released by the Finance Ministry last week show a key economic indicator – tax revenue from the non-oil and gas sector – fell 20 percent year in October compared with a year earlier, while the Russian state statistics agency Rosstat reported that retail sales fell 10 percent year on year in September, and cargo turnover fell 7 percent.

“All objective indicators show there is a very strong drop in economic activity,” said Vladimir Milov, a former Russian deputy energy minister who is now a leading opposition politician in exile. “The spiral is escalating, and there is no way out of this now.”

The Western ban on technology imports is affecting most sectors of the economy, while the Kremlin’s forced mobilization of more than 300,000 Russian conscripts to serve in Ukraine, combined with the departure of at least as many abroad fleeing the draft, has dealt a further blow, economists said. In addition, Putin’s own restrictions on gas supplies to Europe, followed by the unexplained explosion of the Nord Stream gas pipeline, has led to a sharp drop in gas production – down 20 percent in October compared with the previous year. Meanwhile, oil sales to Europe are plummeting ahead of the European Union embargo expected to be imposed Dec. 5.

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The Kremlin has trumpeted a lower-than-expected decline in GDP, forecast by the International Monetary Fund at only 3.5 percent this year, as demonstrating that the Russian economy can weather the raft of draconian sanctions.

But economists and business executives said the headline GDP figures did not reflect the real state of the Russian economy because the Russian government effectively ended the ruble’s convertibility since the sanctions were imposed. “GDP stopped having any meaning because firstly we don’t know what the real ruble rate is, and secondly if you produce a tank and send it to the front where it is immediately blown up, then it is still considered as value added,” said Milov, who wrote a report explaining the situation for the Wilfried Martens Centre for European Studies published this month.

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Deeper problems were also lurking in the Russian banking sector, where most accounting has been classified. The Russian Central Bank reported this week that a record $14.7 billion in hard currency was withdrawn from the Russian banking system in October, amid increasing anxiety over mobilization and the state of the economy.

Even so, a November report by the Central Bank warned that Russia’s GDP would face a sharper contraction of 7.1 percent in the fourth quarter of 2022, after falling 4.1 percent and 4 percent compared with last year in the previous two quarters. Last week, as the Russian economy officially entered into recession, Central Bank Chairwoman Elvira Nabiullina told lawmakers that next year the situation could get darker still. “We really need to look at the situation very soberly and with our eyes open. Things may get worse, we understand that,” she said.

Putin’s announcement in September of a partial troop mobilization dealt an enormous blow to business sentiment. “For many Russian companies the reality of the war sank in,” said Janis Kluge, senior associate at the German Institute for Security and International Affairs. “It became clear that this is going to continue for a long time. Now expectations are much worse than they were over the summer.”

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Putin’s creation of the coordination council, headed by Prime Minister Mikhail Mishustin, was a sign the Russian president is rattled by the increasing impact of sanctions, economists and analysts said. Putin “is concerned he needs to interfere to make sure supplies will be available,” said Sergei Guriev, provost at France’s Sciences Po. “He is concerned that sanctions have really hit the ability to produce goods.”

It also signals the Russian government is preparing a broader mobilization of the Russian economy to supply the army amid chronic shortages of basic goods such as food and uniforms. New laws will impose hefty fines on business executives who refuse to carry out orders for the Russian military, as well as potential prison sentences, clearing the way for entrepreneurs to be pressured into providing goods at knockdown prices. The creation of the council is “connected to big pressure on business and the need to enforce a tough diktat to make business do what it doesn’t want to do,” said Nikolai Petrov, senior research fellow for Russia and Eurasia at Chatham House in London.

One Moscow businessman with connections to the defense sector said a quiet mobilization of the Russian economy had already been long underway, with many entrepreneurs forced into producing supplies for the Russian army but fearing to speak out against orders at cut-price rates.

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“This became necessary right from the very beginning when the war began,” the businessman said, speaking on the condition of anonymity for fear of reprisal. “The main mass of business is silent. If you say you are making supplies or weapons for the Russian state then you could have problems abroad.”

Anecdotal evidence reported in the Russian press has pointed to enormous problems supplying Russia’s newly drafted conscripts with equipment. An in-depth October report in Russian daily Kommersant described huge shortages in ammunition and uniform supplies for conscripts, with manufacturers citing difficulties securing the necessary materials due to sanctions.

Other Russian business executives said Russia’s military debacle in Ukraine had exposed the huge inefficiencies and corruption in Russia’s military industrial complex. “There are huge questions over where all the trillions of rubles of the past decade have been spent,” said one former senior Russian banker with connections to the Russian state.

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If the new economic council fails to better coordinate the production of supplies and weaponry, it could impinge on Russia’s ability to launch new offensives in Ukraine, Petrov said. “The main problem ahead of the Kremlin is the question of when the army will be ready to begin new military action in Ukraine, and the preparation of arms and ammunition and so on will determine these plans.”

The outlook appears likely to worsen when the E.U. embargo on Russian oil sales comes into force Dec. 5, economists said. Combined with a price cap expected to be imposed on all sales of Russian oil outside the E.U., the measure could cost the Russian budget at least $120 million in lost revenue per day, Milov said, and already the Russian budget is expected to rack up a deficit by the end of this year.

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Video: In response to Russian President Vladimir Putin’s invasion of Ukraine, the West sanctioned some of his closest advisers.(REF:Luis Velarde/The Washington Post)

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