On March 27, President Joe Biden claimed that U.S. sanctions had reduced Russia’s currency to “rubble.” Yet in the past few weeks, the currency has rebounded, while the country shows no outward signs of crisis. So what impact are sanctions having?
Plenty of questions remain in the short term. But the long-term consequences of the sanctions are clear and severe. Russian industry now faces difficulties in acquiring crucial tools and components. The future of entire sectors of the Russian economy, from aviation to autos, is in doubt. Russia’s already weak tech sector is now cut off from accessing advanced software and microelectronics. The Russian government has successfully managed the immediate financial shock of the sanctions. But its playbook will be of little relevance in addressing the industrial and technological restrictions that will ultimately have a compounding and devastating impact over time.
A Banner Beginning
If it weren’t for the war and the sanctions that followed, 2022 would have been a banner year for Russia’s economy. Before President Vladimir Putin ordered his troops to attack on Feb. 24, Russia continued to recover from the scars of the pandemic, which (thanks to a policy that prioritized fewer restrictions and more deaths) was less economically costly than in many neighboring countries. Moreover, the price of Russia’s key export goods — oil and natural gas — increased substantially in late 2021 and the first part of this year. Higher energy prices were partly caused by Russian policy: first the Kremlin’s decision to limit gas exports to Europe last fall, then pre-war tensions that drove prices even higher.
Yet rather than benefiting from a year of rapid growth, Russia is in the early stages of a deep slump. The reason is the sanctions, official and voluntary, which are limiting Russia’s ability to import goods, increasing the cost of financing, driving firms toward default, and constricting consumption and investment.
Though Russia has been under different types of Western sanctions for many years, the measures imposed over the past few months are vastly more restrictive. Only a handful of countries with significantly smaller economies, like Venezuela, North Korea, and Iran, have suffered similar limits in recent years. In terms of their immediate economic impact, the most important set of sanctions were U.S., E.U., U.K., and Japanese restrictions on Russia’s central bank, which limit its ability to access reserves held abroad. In a single stroke, over $300 billion of Russia’s cash holdings were immobilized. More recently, these countries also sanctioned over $100 billion in gold held by Russian central banks.
Russia’s central bank reserves, over $600 billion at the start of the war, were the centerpiece of a longstanding strategy to build a fortress balance sheet that would insulate Russia’s economy from any geopolitical shocks. The idea was simple: A vast stock of reserves would give Russia an insurance policy in case of financial sanctions. Russia would have the option, the theory went, of using these reserves to intervene in currency markets to prop up the ruble, to backstop its banking system to prevent financial panic, or to fill holes in its government budget in case it swung into deficit. If Russia had been allowed to use these reserves, the strategy would have worked reasonably well.
Sanctions Get Serious
The problem, which Russian policy makers (and most observers) failed to comprehend, is that savings only matter if you are allowed to spend them. There are only a small number of places where you can realistically save several hundred billion dollars, a number that is larger than the size of most countries’ economy. China has restrictive capital controls and highly regulated financial markets, which makes saving there difficult. So it was only realistically plausible for Russia to park its currency reserves in a G7 economy, which left this money dangerously exposed.
However, even Russia’s gold reserves, mostly stored in vaults in Russia, were at risk of sanctions, because they still have to be spent to be useful. Before the war, Russia bought around half of its imported goods from the West, Japan, or South Korea. Almost all of Russia’s external financing occurred in Western capital markets. So being restricted from spending money in the West wasn’t too dissimilar from being restricted from spending money, period.
The central bank sanctions have made it difficult for Russia to respond to the many other measures that have been imposed. Most of Russia’s biggest banks face U.S., E.U., and/or U.K. sanctions, preventing them from carrying out many types of transactions abroad. To stabilize the banking system and the currency, Russia has had to substantially increase interest rates, which will slow the economy and make it more expensive to borrow money. Simultaneously, Russia has imposed strict capital controls, further deterring investment. In addition to these financial sanctions, the West imposed strict technology export controls, limiting Russia’s ability to acquire advanced technologies, especially semiconductors, which are only produced by the United States and its friends in Europe and Asia, notably Taiwan and South Korea.
In addition to legal restrictions, foreign firms have fled the Russian market, some of them voluntarily. Consumer brands like McDonald’s have closed up shop across the country, at least for now. BP, which had been a major investor in Russian energy for several decades, announced it was divesting from its stake in Rosneft, Russia’s biggest oil producer. Some companies are pulling out because the coming recession makes the Russian market unattractive. Others fear domestic political blowback for being seen to support Putin’s war. Others still worry that, even if their business is currently legal, the prospect of escalating sanctions does not justify the risk. Even some commodity traders — firms with a strong stomach for doing business in risky geographies — have said they are phasing out their business in Russia.
Paying the Price
What is the cost of these measures? Though projections vary, respected independent forecasters estimate that Russia’s GDP — the value of goods and services that the country produces each year — will fall by around 10 percent this year. According to this forecast, consumption — the goods and services Russians buy — will be down 14 percent; investment — companies’ building of new facilities and purchasing of new equipment — will decline by 20 percent; and imports of foreign products will fall by a staggering 50 percent compared to last year. The only relatively positive news for Russia is that exports, primarily of commodities like oil, gas, coal, and metals, are projected to decline by only 2 percent. This means that with massive export revenues and far lower imports, Russia faces no immediate risk of a balance of payments crisis.
Nevertheless, a 10 percent decline in GDP is a serious slump. It would be the deepest recession that Russia has faced since emerging from the wreckage of the Soviet Union, even though the country’s financial crashes in 1998 and 2008 were nearly as painful. Yet as the examples of 1998 and 2008 show, a painful recession does not necessarily produce a political crisis. The 1998 financial crisis, in which the ruble crashed and inflation spiked, marked the beginning of the end of the presidency of Boris Yeltsin, though he limped on in power for another year before resigning. The 2008 economic crash, by contrast, had a far more limited political impact, because Russia’s leaders could reasonably argue that the crisis hadn’t been their fault and that they had dealt with it as skillfully as possible.
This time, Russia’s leaders have a different argument to explain the recession: that it is part of the West’s “economic war” against Russia. This is true, of course, even though the West’s economic war only started (in 2014) and escalated (this year) after Russian troops marched into Ukrainian territory. Yet most Russians attribute the “special military operation” in Ukraine to Western rather than Russian aggression. So, at least for now, the Kremlin looks likely to succeed in shifting blame on to foreigners.
It is not only Russian rhetoric that is following the government’s old playbook. Moscow’s economic policy response is also mirroring its reaction to previous crises. I’ve previously argued that “Putinomics” has been about shifting the cost of economic downturns onto the population. This was the practice in 2014, after the last set of sanctions, which corresponded with a painful crash in the oil price. Russia’s government sought to protect the government budget, preserving its freedom of maneuver, while letting living standards slump amid rapid inflation. Since 2013, Russians’ disposable incomes fell by around 8 percent to the start of this year. They will probably fall by an equivalent amount again this year. There are few governments with so dismal a record of providing for their population.
In response to the current sanctions, the Kremlin is again focused on stabilizing the financial system and the government’s budget, not on living standards. It has succeeded in bolstering the currency, for example, thanks to strict capital controls that make it nearly impossible to remove foreign exchange from the country. Russia’s biggest exporters, including oil and gas firms, are now required to convert 80 percent of their foreign exchange earnings to rubles, further supporting the currency. The banking system has suffered outflows and will provide less credit in the coming months, but it appears basically stable. The Russian economy is not on the brink of a financial crisis.
Three Further Challenges
Nevertheless, Russia’s economy faces three upcoming challenges, any one of which could disrupt the balance of economic policies that have managed to “stabilize” the economy by crushing Russians’ incomes. The first challenge is that not all of the sanctions have begun to bite. The West’s financial sanctions had an immediate impact in forcing Russia to impose capital controls, but the technological restrictions will be felt over time. Russia’s manufacturing sector is only just beginning to be impacted by the difficulty of acquiring Western components. Russia’s future energy production will be limited by an inability to buy Western equipment. Even Chinese firms like Huawei are limiting their activity in Russia given the export controls. Sectors like telecoms infrastructure will be nearly impossible for Russia to upgrade if the current export controls remain strictly enforced. Any sectors that rely on advanced technology, especially microelectronics, will face wrenching delays and will have to tolerate second-rate products. This will have a long-run impact on Russia’s ability to incorporate digital technologies, in both its civilian and defense sectors.
Second, Western sanctions could well be intensified. The Biden administration designed its sanctions so as not “to cause any disruption to the current flow of energy from Russia to the world,” as one administration official put it. The administration describes this reticence to hit energy exports as due to Europe’s dependence on Russian gas, though more plausible is that Biden’s political advisers are worried about high gasoline prices at home. The United States has thus shied away from Iran-style secondary sanctions, which would restrict Russian exports to third countries. If America adopted such measures, Russia’s export earnings would collapse and the Kremlin would face a much more serious and immediate crunch.
The third risk to the Kremlin’s economic strategy is the assumption that suppressing living standards is a stable political equilibrium. For the past decade, Russians have tolerated steady immiseration without any significant political protest. This time, the rate of decline in living standards will be more severe than previously — and it follows a decade of economic decline. Russia’s population has been forcibly depoliticized by a mix of relentless propaganda and escalating repression, so we should assume that the Kremlin can manage another few years of impoverishment without incident. Nevertheless, the risk of miscalculation in its political balancing act — whether at the level of elites, the Moscow middle class, or the industrial working class — is growing.
In the weeks before the attack on Ukraine, Russian leaders convinced themselves that they had “sanction-proofed” their economy. The sanction-proofing that has mattered, though, is not their efforts to build up financial reserves or prepare alternate payment mechanisms, but the Kremlin’s ability to coerce the Russian people to tolerate the ever-growing price tag of Russia’s foreign policy. Given the current and future disruptions, sanctions have imposed a cost of hundreds of billion dollars on Russia — meaning thousands of dollars per person. The key political question underlying all forecasts of Russia’s future economic policy is whether this is a price that the Russian elite and populace remain willing to pay.
Chris Miller is assistant professor at The Fletcher School and Jeane Kirkpatrick Visiting Fellow at the American Enterprise Institute. This article is a product of a workshop on “The Global Order after Russia’s Invasion of Ukraine,” hosted by the University of Pennsylvania’s Perry World House on April 14, 2022.