- Hubert Walas
Russian Economy. Report.
The loss of the most important source of income. The departure of hundreds of thousands of top talent from the country. The race to the bottom of the national currency. Russia is destroying the foundations of the state in order to finish off the victim it has attacked. The problem is that it is really determined in this act. Let's look at the shape of the Russian state in the context of the imperialist war it is waging. Why is the Russian economy in free fall, and why this fact alone is not enough to quickly push the Kremlin's forces out of Ukraine?
Without money, you can't wage war. This is a self-evident fact. Therefore, the moment the first Russian tanks drove onto Ukrainian soil in Western cabinets, the natural response to the criminal invasion was to slash the source for its financing. In other words, the West began to shape sanctions to make the engine of the Russian economy inefficient enough to quickly obliterate it when faced with a robust Ukrainian army backed by military and economic resources flowing from the West.
In the short term, however, the war itself has triggered a massive increase in hydrocarbon prices. According to some estimates, including all connections, this sector alone accounts for as much as 60% of the Russian economy.
This is how we described the situation in our recent material on the state of the Russian economy:
"As a result, Moscow, despite having just triggered a major military conflict, was recording record peaks in revenue from raw material sales. If the war had ended in the presumed 3 days, or even 3 months, or even half a year, Moscow would have emerged from it not only having achieved remarkable strategic success, but also unscathed economically, as the entire war expenditure would have been covered by the budget surplus from raw material sales. "
However, nothing lasts forever. Oil and gas prices have fallen by tens of per cent, as have Russia's other essential exports, such as wheat. This has been compounded by the massive shift away from Russian fossil fuel imports by the West - which until the war, was Moscow's most important export destination - and sanctions making it hard to sell Russian hydrocarbons.
A few months ago, Mikhail Krutikhin predicted Russia would lose 57% of its fuel exports in 2023. And indeed, the year-on-year decline in budget revenues from the sale of fossil fuels, between January and April, was 52%.
Lack of revenue naturally leads to a deficit. As we reported - in January, it reached a ceiling of $25 billion, or 60% of the plan assumed for the year. In the following months, it grew until it suddenly stopped at $45bln at the end of April, reaching 117% of the deficit target for the year after its first four months. Indeed, in May, the Russian Finance Ministry reported that the economy recorded a … surplus, reducing the deficit to $42bln. Moreover, the ministry announced that the Russian economy will grow...by 1.2% this year. Considering the country is in a proxy war with half of the Western world, this would be a skyrocketing success.
Yet one should remember that in Russia, macroeconomic indicators do not serve to be an objective measure for assessing the economy's health but are another tool of the Kremlin's power apparatus. Rosstat is famous for conducting creative statistics. As the Centre for Eastern Studies reports, "Rosstat often changes the methodology it uses, the way it presents data, and the frequency of its publications, which in the long run makes it difficult or even impossible to compare the information it publishes. There were also frequent questions about data updates that significantly changed previous readings, which Rossstat could not explain."
A good example is the measure of poverty in Russia. According to official data, in 2022, the number of poor shrank by 1.7 million people to an all-time low. And that's because Rosstat came up with a new definition of poverty, recognising as poor only those who live worse than their neighbours in the region.
For example, according to this methodology, a resident of Tula earning $140 per month is not considered poor at all. And it should be remembered that the cost of living in Russia is relatively high.
Using previous data, The Insider calculated that the number of poor people has not shrunk by 1.7 million but has increased by 2.3 million. One in three Russians has money only for food, and one in ten doesn't even have money for that. In fact, up to 20 million people in Russia live below the poverty line, 40% more than in the Rosstat report.
This shows only one thing - Russian statistics are modelled to achieve consistency with a meticulously prepared propaganda message. The deficit trend could be read as follows: "We're feeling the impact of war, and it's tough [thats the high deficit from the beginning of the year], but we're coping with it [thats deceleration of the deficit in the middle of the year]."
In practice, no one can determine the actual state of Russian finances, as the Russians themselves block access to data on hydrocarbon sales and budget expenditures, among other things. There is no logical reason why the Russian economy should suddenly recover and perform better than many countries that are not under sanctions and are not at war. Like a mantra, one could repeat the problem of losing customers and half of the revenue from the sale of fuel products, which is not compensated by the redirection of exports to India and China. Both Delhi and Beijing opportunistically buy raw materials at maximum discounted prices, and Moscow is forced to yield to them.
In addition to the fact of cutting off its most crucial income branch - hydrocarbons- several other arguments prove that the Russian economy is in free fall.
To name a few - after the Prigozhin rebellion, the Russian ruble is plunging toward a record bottom. Excluding the momentary shock after the outbreak of the war, after which the ruble immediately collapsed and then strengthened thanks to heavy central interference - today, the Russian currency is the weakest in its entire recent history of existence.
A massive brain drain is underway. According to The Moscow Times, 1.3 million young, often the best-trained people left Russia last year. This fact, backed up by forced or not, conscription is leading to a collapse of the labour market. There are two vacancies for every worker. According to Goldman Sachs, this is currently the biggest pain in the Russian economy. For this reason, some believe that the Kremlin cannot carry out further mobilisation.
Another major export branch - arms, has also slumped. Sweden-based think tank SIPRI estimates that Russian arms exports have fallen from $50 billion in 2021 to $11 billion in 2022.
Going further - we have mentioned more than once that the Russian economy is a model example of a fragile economy. The entire operating model was based on one product - hydrocarbons - and one customer - the West. Suddenly, when this house of cards collapses, the Kremlin, in desperation, enters a second relationship that is extremely risky from its point of view. This is another cliché, but it needs reminding - Russia is gradually becoming totally dependent on China. Both on exports and imports from the Middle Kingdom. Exports to China have grown by 100% relative to the pre-war period, to 26% of the total value of exports. However, while China is the most important partner for Russia, Russia is economically one of many for China. Moscow is at the mercy of Beijing. For the time being, the Chinese are interested in keeping Putin's regime alive But, given, let’s say, an economic slowdown or total collapse of the Chinese economy, which according to some, is also possible, could drag down the Russian economy, which has no alternatives.
The cost of the war compounds all this. At the outset, one must assume that no one knows how much it really costs - even if one had access to all the data, which no one does, these estimates would vary, along with the methodology adopted. Considering this caveat - such calculations exist. The most modest ones, such as those of The Economist, speak of a figure of $55 billion a year. Boris Grozovski of the Wilson Center estimates them closer to the $100 billion figure. By contrast, Sean Spoonts of Special Operations Forces Report thinks both to be grossly underestimated, assessing the daily cost of war spending at $900 million, which would put the figure at close to $330 billion annually.
Spoonts explains:
“In our mind, if Russia spends $1 million on a missile to build it and then fires it, they have expended $2 million: $1 million to build it and another million to replace it. If you had a $50,000 car that burned up in a fire, you are out the $50,000 plus whatever you spend to replace it because you need a car. I think most estimates only take into account the initial cost.”
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And while all this is true, in the context of Ukraine's defence of independence and recapture of territory, it is insufficient.
All the statistics and phenomena cited tell us that the trend in which the Russian economy is heading is unequivocally negative. Russia is retreating by decades of development, cannibalising its economy, and overeating the national wealth, including the savings of its citizens. It is destroying the country's future and reaping it for its children. All for the sake of maintaining the war machine. Today.
In a word, Moscow is consuming resources from the future to cover the costs generated now, and it is doing so primarily at the expense of its people.
The central government's actions aim to transfer capital from the people to the government. Part of this process includes the massive nationalisation of Western companies that have exited or are exiting Russia. As the Financial Times reported, these are being taken over for half-price, "Any sale must be at a discount of at least 50 per cent to market value, and 10 per cent of the proceeds are allocated to the Russian budget." An anonymous person involved in the procedure tells FT, "This is privatisation 2.0, just like in the good old days." - says the source, referring to the looting of Soviet property in the 1990s.
In this way, Putin wants to compensate the oligarchs for their losses in the West. At the same time, it means that no established company will invest in Russia for decades because its risk-rating Excel will shine red from top to bottom.
"It's like in Venezuela. They’re giving the best to their cronies . . . and then everything will go to shit." - says the Moscow businessman.
Moscow is cannibalising its economy at a breakneck pace on a macroeconomic scale. It is destroying its future. The problem is that the time horizon used in macroeconomics and war differs. In the former, we are talking about decades, years or, at best, quarters. On the battlefield, on the other hand, every hour, and day matters, while in a week, the situation can turn 180 degrees.
Another critical factor is, let’s call it - the disproportion of involvement. As a starting point, we can assume that Ukraine is 100% involved in the war - meaning all sectors of the state are subordinate to it, and the bulk of society is involved in one way or another. Looking at Russian actions resulting in internal self-destruction, one can assume that Moscow is at least 60% involved. By contrast, the West - which is the foundation of Ukraine's persistence in the war - is at best 5% involved, although more often than not, that share would be closer to 1% - looking, for example, at the costs incurred in relation to each country's GDP.
Russia is clinging to its misjudgment about triggering a war that collapses its economy and prospects. Nevertheless, this high level of involvement allows Moscow to bear costs that Ukraine cannot bear due to its smaller economy and costs that the West apparently does not want to bear.
Thus, all indications are that the current sanctions-economic architecture is insufficient to stop Russia with strictly financial factors.
So what can be done in such a situation? Apart from continuing and increasing military aid to Kyiv, it is necessary to close the sanctions loopholes. Wisely and, referring to the cited mechanism - with great involvement. The following are examples of recommendations.
Robin Brooks, the chief economist at the Institute of International Finance, has been calling for months to target Russian oil sea transport. Russia relies on the Greeks for up to 60% of its maritime oil transport. Moscow does not have a large enough fleet to do this on its own, while the pool of tankers on the world market is limited. The West, in this particular case the EU, has the means to stop Greek tycoons facilitating Russian oil and potentially minimise the likely losses to the Greeks. Brooks also calls on the G7 to lower the oil price ceiling from $60 to $50.
Another potential area of action is suggested by The Economist, reporting that only $100bln of Russian oligarchs' assets are frozen abroad. That's 25% of the total, estimated at $400bln, making most of it available for use.
Yet, the most critical hole to be patched is the gap in control of high-tech exports to Russia. Even though the Russian war industry relies on them, and the West knows it, key components continue to reach Russia. Kamil Galeev points to Russia's dependence on industrial machinery, most of which comes from Europe.
More concrete in numbers is a report prepared by the KSE Institute. One of its authors, Elina Ribakova, admits that Russia obtains as many vital components for its military industry as it did before the war.
"We rely on the analysis of Russian weaponry captured on the battlefield – in total, 58 pieces of equipment, ranging from missiles and drones to armoured vehicles and artillery – and find 1,057 individual foreign components with microchips and processors playing the dominant role." - says the report, and continues, "By the end of last year, imports of what we define as “critical components” had fully recovered and, in fact, risen above presanctions levels for key items such as semiconductors."
So how does this happen? Not surprisingly, China plays a key role in the process, but mainly because the West enables it.
The country of origin for as much as 68% of crucial components is the United States. Second place, with 14%, holds South Korea. Japan follows it with 7%, ahead of Germany with 6.8%; Switzerland with 5%; Taiwan with 4%; the Netherlands with 2.7%. Only then comes China with a share of 2.6%. In this case, the authors consider the company headquarters as the country of origin. For example, a product manufactured by Intel in China is treated as American. Of this 68%, only 4% of products physically manufactured in the States found their way into the machines analysed by the KSE.
In summary, China plays a crucial role in fueling Russia's war machine, but only because the West allows it. Of the 1,057 components analysed by the KSE, more than 92% originated from a Western company. Yet most of these 92%, were manufactured in East Asia - in China, Malaysia, Vietnam, South Korea, or Taiwan. Then they are exported to Russia. Most likely from China, which, including Hong Kong, accounts for 71% of the vital component exports found in the research. The NATO country - Turkey - holds the second export spot, which says a lot about Ankara's policies.
So what can be done in this situation? The report's authors point to several areas where decisive action is needed. Among other things, they call for better information-sharing to quickly detect attempts to evade sanctions. Cooperation with the major manufacturers whose products find their way to Russia would also be highly fruitful. As they know their structures best, these companies can be most effective in blocking attempts to sell their products to Russia, including through intermediaries. This would also help to target them in third countries. This is a complex but feasible task.
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Everything is a function of time. The collapse of the Russian economy is ongoing, but it is not a sudden event. On the other hand, the quick triumph of the Ukrainians, which is, at least declaratively, in the interests of the West as a whole, requires steps with a much shorter time horizon. The Ukrainians simply do not have the time to wait for the complete collapse of the Russian Federation, which may happen, but possibly after the most critical moments from Kiev's point of view.
Of course, there are events, let's call them - chaotic events, which can make Russia implode in almost hours. Though ultimately failed, the Prigozhin rebellion was an example of such a phenomenon. The probability of such events is increasing, along with the impoverishment of Russian magnates, the proliferation of the Russian poor, and the continued exposure of the weaknesses of Russian structures. Still, it would be irresponsible to pin hopes on fundamentally random incidents.
The West is not a fully cohesive entity, but it has demonstrated the qualities of cohesion that have given Ukraine great hope. Today, to bring this war to a just end - that is, for Kyiv to regain the territory it has lost - a further push is needed to patch up the sanctions breaches and plug the Russian hydra.
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