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Can the Russian Economy Survive Western Sanctions?


Western sanctions have been designed to try and cripple the Russian economy, causing the Russian government to run a siege economy - where heavy government regulation is imposed in which the trade of imports and outflow of capital is restricted. However, this is unlikely to change Putin’s mind on his onslaught in Ukraine.


It is predicted that the Russian economy will fall into a deep recession with soaring inflation. However, it is believed that the economy will not collapse so long as government policies are made rationally. A spokesperson for the Kremlin has said that there will be “serious pressures and a serious blow”. The question being asked in the West is how much of this pressure is Russia going to be willing to endure.


The West aims to achieve a similar result to the devastating costs of similar sanctions imposed on the Iranian economy in 2018. This was following President Trump’s decision to pull out of the Iran Nuclear Deal signed in 2015 by his predecessor, which at the time removed decade long sanctions. Trump’s set of sanctions included the complete banning of SWIFT from Iranian institutions, and aimed to isolate their economy from the world economy. The main aim was to create an embargo for their oil, which is the backbone of their economy.


Iran’s economy had to absorb great blows, leaving many households and producers suffering from the consequences. IMF figures suggest that gross domestic product per capita sank 15 per cent across 2018 and 2019 and that Iranians will not regain 2016 levels of living standards until at least a decade later. Inflation, which hit 48 per cent at the end of 2018, is forecast to remain well above 25 per cent.


However, the Iranian economy has survived, with markets still functioning to keep shelves full, and critical resources such as petrol not being in shortage. Higher class Iranians even enjoy luxury lifestyles in Tehran.


The survival of the Iranian economy in this ‘economic war’ could be seen as a result of Iran diversifying its trade partners. They traded their oil with friendly states and made a significant relationship with China, therefore maintaining some income into the country and being able to access hard currencies which they were able to use for imports and to protect their currency.


Diversification may be what needs to happen with Russia. Furthermore, sanctions on Russia aren’t as extensive as on Iran for now. For example, only some Russian banks have been removed from the SWIFT messaging system and there still isn’t a ban on oil or gas from the West as they are dependent on Russian energy sources, at least in the short run. A significant drop in oil or gas revenue to Russia may not even lead to a current account deficit.


Russia is still sure to feel the pain of these sanctions as the initial response continues. There will be a limit to growth and productivity. This will be due to the supply shocks from the Russian government limiting imports, to reduce leakages out of the economy, to less flow of capital into the country due to sanctions and the fact that the West is restricting loanable funds to Russia. Russian economic activity is expected to become more inward as it tries to use this siege economy to prevent an economic collapse.


The Russian economy has already suffered its currency plummeting by around 30% already as people fear that the current sanctions, with the aim of the West to isolate Russia, will reduce the demand for the ruble. The government has imposed restrictions to try and reduce the amount of transfers overseas in order to hold money in more hard currencies, like the dollar. Base interest rates have also more than doubled from 9.5% to 20% as the central bank aims to convince people to keep their money in Russian banks and even convince foreign savers to move their capital into Russian banks in attempts to shore up the ruble and prevent a bank run which would mean the collapse of the whole financial system.


The ruble has suffered even more due to the central bank’s helplessness to stabilise it due to sanctions imposed on it. Russia had grown a huge reserve worth $630 billion. A lot of this is held in currencies or assets in other currencies, with the intention to shore up the currency by selling these assets to buy back rubles. However, these assets have effectively been frozen from the Russian central bank making them useless. This follows an idea of Western leverage when it comes to dealing with finance, called the weaponization of finance.


The depreciation of the ruble will factor into inflation in Russia. Goldman Sachs has predicted a rise in inflation of 17% for the year and a contraction of real GDP.


Analysts believe that even with a lower price for oil, after about 6 - 9 months, the immediate impacts on the Russian economy may begin to be resolved. This is because the inflow of hard currency revenues from oil and gas will allow the central bank to shore up its exchange rates. A trade surplus, with a reliance on oil and gas revenues, is critical for the success of this siege economy.


Putin’s ministers have recognised that the public will have to endure pain as sanctions drive down living standards, but they are sending the message that they are determined to tough it out. Sanctions impacting households is likely to not impact Putin’s decision making in regards to the war as power is held at the top rather than with the people as it is an autocratic system. However, economic hardships along with resentment from the public if the war wages for a long period of time, may induce popular protests. These could eventually challenge Putin’s role in power.

 

Written by Florian Mihindukulasuriya Thiserage

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