Russia's economy defies sanctions but at what cost?

Western concern is raised by economic data concerning Russia. Two years of sanctions, and yet Moscow still finds the funds to continue the invasion. How is this possible? Has it become immune to sanctions and can now afford the war in Ukraine?

The paradox is that even if it can't afford it, it no longer matters to Putin. He will persist with the campaign, even if it incurs losses.

Despite the financial collapse predicted in the spring of 2022, Russia, though experiencing a recession, defended itself from the crisis and transitioned the economy to a war footing.

Russia's real GDP growth in 2023 was 3.6 percent, more than expected.

Analysts at Allianz Trade, a company specializing in receivables insurance and contracts, predict further growth of Russian GDP in 2024. They believe that the economy of the country, burdened with war in Ukraine and Western sanctions, will grow by 2.5 percent regardless.

In 2023, it was said that a problem for Russia would be soaring inflation. According to forecasts, it could reach even 25 percent.

Meanwhile, "The Economist" reports that prices in Russia in February 2024 rose by 0.6 percent month-on-month, compared to a 1.1 percent increase at the end of 2023. Year-on-year, however, inflation will maintain the level from November at 7.5 percent.

According to Prof. Artur Nowak-Far from the College of World Economy SGH, all these data, however, do not reflect the actual situation in Russia.

- The need to raise taxes, transition the economy to war tracks, conceal economic outcomes, and especially information on hydrocarbon extraction and trade, are proof that Russia cannot afford the war - assesses Nowak-Far.

The state operates at the limit of production and budgetary possibilities. Economic data may be misleading. GDP is inflated by sectors benefiting from war and conceals the degradation of other branches of the economy. Private entrepreneurs and society suffer alike. Similarly with inflation. Prices are controlled to maintain the illusion that the state functions normally. However, this will eventually run out, and the facade will fall - he explains.

Analysts at Allianz Trade similarly assess the situation, interpreting the positive GDP results as the effect of shifting to a wartime economy mode rather than as a sign of the resilience of the Russian economy.

"Stronger than expected GDP growth reflects the reallocation of resources to the war industry (not only military) and construction, masking the weak results of most other sectors" - according to their analysis. Foreign investments have dried up because investors avoid Russia.

- Considering the standard of living and the normal development possibilities of the country, Russia is losing in this war - convinces prof. Nowak-Far.

It's no secret that Russia largely bases its budget on hydrocarbons trade, especially oil and gas. That's why the West introduced sanctions aimed at reducing revenues from the oil and gas business. In addition to an embargo, it imposed price limits for trading the commodity with third countries (so-called price cap).

Sanctions were also applied to products and services that could technologically support Russia or allow their use for military purposes.

The effectiveness of sanctions is still debated. Skeptics point to the lack of tangible effects, while proponents emphasize their progressive character and destructive impact, highlighting individual problems emerging in various sectors over time.

- It's worth noting that losing the European market and facing Western sanctions have created a new cartel of buyers for raw materials from Russia. India and China have quite a strong negotiating position when bargaining over the price. This is one of the factors why Russian oil is priced £8-£12 lower compared to the Brent benchmark. These are tangible factors that reduce Russian revenues - indicates Filip Rudnik, an expert from the Centre for Eastern Studies.

Data indicates that Russia has managed to redirect a significant portion of its oil sales to China and India. The same goes for gas. Russia effectively increases LNG sales in Asian countries. In 2023, it sold fuel worth over £26 billion, completely replacing the lost revenues from the export of fuels and lubricants to the European Union – notes e-petrol.

Does this mean that despite the hits to Russian hydrocarbon giants - Gazprom or Novatek - Putin continues to earn from hydrocarbons?

- Russia has to sell its raw materials at a significant discount, sanctions limit its development possibilities. Smuggling and circumventing sanctions are like a drip feed, but that also means costs - explains prof. Nowak-Far.

He adds that Putin deliberately hides data.

The need to raise taxes, transition the economy to war tracks, conceal economic outcomes, and especially information about extraction and trade in hydrocarbons, are proof that Russia feels the pain of this war - assesses in a conversation with money.pl.

Western military equipment support allows Ukraine to strike important targets in Russia itself. As reported by money.pl, series of precise drone strikes on refineries and fuel depots are intended to paralyse the army's supply capabilities on the front but will also harm fuel export.

Ukrainians have already achieved significant successes with several hits on important refineries on Russian territory.

Ukrainian shelling has also reached energy plants and ports, like Ust-Luga, and even aircraft plants like the one in Taganrog, where, among others, early warning planes A-50U are serviced.

- These are strikes primarily on the incomes of specific companies. If the damages are lasting, this may lead to a fuel deficit or high domestic prices. It's a potential source of social unrest. Hence, among other decisions, is the ban on exporting gasoline. However, it's not that attacks by Ukrainian drones or sabotage significantly affect the flow of money from oil export - notes Filip Rudnik.

Besides, as reminds prof. Nowak-Far, Russia is a huge country that, if necessary, can relocate some of its industry - just as it did during World War II, when factories were moved to the Urals.

Experts believe Putin resorts to "creative accounting" in economics. This involves the need to seek additional funds from corporations, oligarchs, and entrepreneurs.

As Bloomberg reported, Russia is considering significant tax increases to collect up to £35 billion. "Considered are tax hikes on corporate profits and high-income individuals" - the agency informed.

- Putin talked about introducing a progressive tax scale (for a long time, Russia had a flat tax rate, now there are discussions about new thresholds). This suggests that after the elections, there will be an intensification of fiscal imposition.

'The victim' will mostly be the profitable business - from the petrochemical and oil-fuel sector - which still has access to hard foreign currency. Since 2022, Gazprom and oil producers have been subjected several times to additional 'special' taxes. I think this trend will continue - says Filip Rudnik from OSW.

An additional source of funds that Kremlin uses to patch holes is the so-called National Welfare Fund. But even this source is depleting rapidly.

According to information provided by the Russian Ministry of Finance at the end of 2023, out of £8.2 billion collected before the invasion, only £4 billion remain. Thus, over two years of war with Ukraine, Russia spent £3.2 billion from the Fund to support various branches of the economy weakening due to sanctions.

According to Prof. Nowak-Far, all this proves that the balance of this war is unfavorable for Russia, but "Putin can't afford" to stop it.

Vladimir Putin has no way out, as defeat would mean the end for him. Russia will continue this campaign as long as it has assured social amortization, as long as the Russians themselves are ready to bear excessively high costs - says the expert.

He emphasizes that this invasion does not pay off for Moscow, especially if, as a result, Ukraine is not conquered. - It's a strategic goal. The idea is for Ukraine to pay for this effort: with agricultural products, industrial production, and labour. This is a plan of colonization - emphasizes the SGH expert.