- Hubert Walas
Fragile economy.
150 days of war are behind us. Russia's war with Ukraine, the largest military conflict in Europe since World War II, is just as it was 80 years ago, a struggle for the world we will live in for decades to come. Will the West, pressured by domestic problems, accept a world in which authoritarian regimes conquer smaller states or will it stand firm against the local thug? In practice, this dilemma was one of the main reasons why the invasion happened in the first place. The war in Chechnya, the invasion of Georgia, the annexation of Crimea, and the creation of puppet republics - Russia was forgiven all of these by the West. What's more, it rewarded the Kremlin with more hydrocarbon supply deals (thus making itself dependent on them), by locating its own businesses in Russia, or by strengthening the Russian army with the export of Western technologies. Since the reaction to Moscow's criminal actions was so soft, should we be surprised that a full-scale war eventually ensued? This time the reaction is different, and the effects on the Russian economy are fundamental. Nevertheless, the Russians are playing all-in, having learned that each time, sooner or later, the West forgave Moscow and returned to talks. Will the same be the case now?
The Russians are aiming to annihilate Ukrainian subjectivity. Missile attacks on public places such as hospitals, schools, and universities serve exactly this purpose. It's a hedge for the Kremlin in case the goals of total war, and full annexation of Ukraine don't pan out. It makes it so that Ukraine’s most significant capital, i.e. it’s educated youth, will have to seek knowledge in the West and Western capital will be reluctant to invest in a devastated and unstable land. By destroying the infrastructural fabric of the country, Russia is preemptively destroying any potential future competition in the case that some kind of truce is reached. It will be years before a devastated Ukraine, even in peacetime, can manage to reach an adequate level of development. The scheme is quite simple: Russia attacks a civilian target inside Ukraine, people are killed, and the Kremlin concludes that there was a Ukrainian command center, weapons, or ammunition on the site. And so it goes, on and on. Recently, there were missile attacks on Vinnytsia, Mykolaiv, Dnipro, Kharkiv, or Odesa.
In Odesa, the target of the attack was the local seaport. Of course, the time and place of the attack were no coincidence. The day before, an agreement was announced in Istanbul on the supply of Ukrainian grain from Ukrainian ports to world markets. The deal was concluded in the presence of Ukrainian, Russian and Turkish representatives, as well as the UN with Secretary-General Antonio Guterres calling the talks a "critical step forward." Roughly 12 hours later, rockets struck Odessa. The Russian explanation was predictable: the target was a Ukrainian warship and Harpoon missiles. In addition to the effort to annihilate Ukrainian statehood, the Kremlin also continues to torpedo the solution to the world food problem and there are strong indications that these attempts will continue. Meanwhile, the Ukrainian president has stated that Kyiv has $10 billion worth of grain which it can sell now. In the meantime, attempts are being made to export it bypassing Russia - a 130-ship traffic jam has formed at the mouth of the Danube River in Romania at the Bystre and Sulina canals. This situation shows well that there is no reason to believe that any attempts at a ceasefire or even a truce will be respected by the Kremlin. It is in Moscow's interest to permanently destabilize Ukraine and thus destabilize the European continent which will have a profound effect on all European Union countries. The only remedy for this problem is to deprive Russia of the possibility of making such an impact. And this is both so little and yet so much. But this can be achieved by equipping Ukraine with the appropriate preventive measures which, first and foremost, are military technology that is unattainable for Russia as well as increasingly strong economic pressure. And it is to this subject, that we’ll now devote a closer look.
Many consider the Western sanctions imposed on Russia to be ineffective amid the continuation of the Kremlin's bold and arrogant rhetoric which is reinforced by the narrative of Russian policymakers that it is the West, and in particular Europe, not Russia, that suffers from the economic restrictions imposed. There is no doubt that Russia gains from Europe's dependence on its hydrocarbons which it sells to Western governments in the face of the coming winter at record prices. But it's only part of the picture that Moscow is portraying as its tremendous success. A recent report by the Yale School of Management which presents the state of the Russian economy in a broader context, in fact shows that the Russian economy is in dire straits.
The report's authors stress that Western perception is deeply affected by reports released by the Russians which are primarily propaganda. Statistics are selectively chosen to fit the overall narrative. In contrast, the Yale team took unconventional data sources: high-frequency consumer data, reports from Russia's main trading partners and the deep analysis of shipping data.
And these show that 60% of the Russian government's income comes from the sale of energy resources. This is a dreadful dependency and a major weakness in the Russian economy. For example, in terms of natural gas, which steals the headlines of many European dailies, Russia is far more dependent on Europe than Europe is on Russia. 83% of its exports go to Europe, which is already diversifying in droves. Moscow sells just 2% of its gas to China. All this is taking a toll on the Russian budget because, in addition, the Kremlin, playing all-in, is cutting supplies to Europe and thus receiving less revenue. So much so that in June, U.S. gas supplies to Europe were greater than Russian supplies. There is a lot of hype about recalibrating Russian exports to Asia, but Asian gas pipelines have only a fraction of the capacity of the European pipeline network. In the long run, Russia faces losing the lion's share of its profits in the face of European energy diversification and it is already putting 60% of its national revenue on the line by threatening Europe with a cut in supply. As it turns out, Russian roulette did not just come from anywhere.
Another area in which Moscow is experiencing a deep slump is imports which make up 20% of the country's GDP. "Despite some lingering leakiness, Russian imports have largely collapsed, and the country faces stark challenges securing crucial inputs, parts, and technology from hesitant trade partners, leading to widespread supply shortages within its domestic economy," says the Yale report.
Looking at data from the Kremlin's main trading partners - and let’s recall that the Russians have no desire to share the economic success of their “special operation” and do not release their own reports - one can see that Russian imports collapsed by a whopping 50% in the first months after the invasion. Russian domestic production, despite the illusion of self-sufficiency, stagnated due to a shortage of basic components. Meanwhile, the sectors most dependent on international supply chains are experiencing 40-60% inflation. For example, car sales have fallen from an average of 100,000 units sold per month to 27,000 in June. And these are mostly primitive Russian automobiles while the sales of foreign cars have fallen by a massive 90%.
This is compounded by a massive hole caused by the mass exodus of foreign investment. The more than 1,000 foreign companies that suspended or terminated their operations in Russia had made up about 40% of the country's GDP or $600 billion dollars. In addition, these companies employed about one million people in Russia. The investment value of these companies accounts for the vast majority of total foreign investment in Russia since the collapse of the Soviet Union. And thus, in 3 months, Putin managed to destroy capital that had been built up for more than 30 years. Of course, this does not mean that Russia's GDP will shrink by 40% overnight. Some entities have been sold to Russians, some are in the process of leaving the market, and some are on hold. But the loss of know-how, specialists, or the inflows of new capital means that the most devastating effects will be felt within a few years, the Yale analysts predict.
All the best-educated young Russians were associated with these companies. That's why the Russian Federation is now experiencing the biggest brain drain in decades. It is impossible to estimate the scale of emigration Russia is facing accurately, say the report's authors, but most estimates point to a number of no less than 500,000. This pool includes 15,000 people who are among the richest Russians, accounting for 20% of the total rich people group. These Russians with significant wealth are seeking the stability, security, and freedom of Western markets, especially as Russia loses access to them. These people are taking their capital with them. The Russian Central Bank itself admits in its report that $70 billion flowed out of Russia in the first quarter of the year, a major underestimate according to Yale experts. And this is in spite of the stringent capital controls imposed by the Kremlin. Other capital transfers, which certainly took place, were therefore not captured by the Central Bank of Russia. A frequent destination for the fleeing Russian upper class is the Middle East and cities such as Dubai, which has caused real estate prices in the area to skyrocket. Real estate sales to Russians in Dubai had a year-on-year increase of up to 200%.
Going forward, the Kremlin's foreign exchange reserves, which were one of the Russians' main safeguards before the war, are shrinking at a remarkable rate. Before the war, they amounted to some $640 billion dollars. Of this, $300 billion was frozen by allied countries. Of the remaining $340 billion, the Kremlin has already used some $75 billion since the start of the war, which would mean they are falling at a rate of $180 billion a year. In two years, therefore, Russia will have drained all of its available reserves.
Later in the report, the authors punctuate the artificial bailout of the ruble exchange rate and conclude, “Putin is resorting to patently unsustainable, dramatic fiscal and monetary intervention to smooth over these structural economic weaknesses, which has already sent his government budget into deficit for the first time in years and drained his foreign reserves even with high energy prices – and Kremlin finances are in much, much more dire straits than conventionally understood."
The report's authors conclude that “looking ahead, there is no path out of economic oblivion for Russia as long as the allied countries remain unified in maintaining and increasing sanctions pressure against Russia. Defeatist headlines arguing that Russia’s economy has bounced back are simply not factual. The facts are that, by any metric and on any level, the Russian economy is reeling, and now is not the time to step on the brakes.”
It doesn't look like this will happen, as the European Union has agreed on the seventh round of sanctions against Russia, this time targeting gold exports, as well as new individuals and entities. For example, the assets of Russia's largest bank, Sberbank are set to be frozen.
The picture that the Yale report paints is quite clear. Each successive month is one step closer to the economic collapse of the Russian economy whose problems, contrary to general perception, are of unprecedented magnitude. Nevertheless, the Kremlin is playing all-in. Putting a good face on a bad game, it is betting everything on the victory with Ukraine. This strategy is not entirely without logic as Kyiv's economy, for obvious reasons, is in an even tougher position than Moscow’s. The difference is that Kyiv has behind it an economic powerhouse 40 times the size of the Russian Federation. If Ukraine receives constant economic and military support from the West, Russia will not win this war. Nevertheless, on the frontline, the situation remains difficult all the time, but there will be more on that in the next episode of the "Mapped" series that’s coming soon.
