The Russian economy is facing its biggest recession since at least the 1990s, that is, since the collapse of the USSR. According to the forecast of the Central Bank of the Russian Federation - in 2022 the GDP will decline by over 6%, the IMF expects a decline of 8.5%, the EBRD of 10%, the World Bank of 11.2%. The Ministry of Economy expects a decline between 7% and 10%, primarily due to a decrease in private sector (business) investment, given the high uncertainty. A significant part of the economic data remains a secret in Russia: data on the budget, on foreign trade, on the losses of troops, which means that obtaining reliable information is complicated. The following conclusions can be drawn from the available data. The actual downturn will be greater than the official international forecasts.
Thus, the Russian industrial production contracted by 8% only from March to April 2022, the oil industry by 11% (even before the embargo), the production of coal, gas, coke, petroleum products by 10%, the manufacturing industry by 6%. In annual terms, all trade in April 2022 was 10% lower, consumption of non-food products by the population fell by 17%, wholesale trade was 12% lower, which indicates an increase in poverty. Official (thus biased) inflation is not lower than 18%, the official inflation forecast of the Central Bank for 2022 is 14-17%.
All economic sectors are slowing down
Sanctions on ferrous metallurgy led to production cuts of 20-40%. The transfer of exports to China is difficult, as China is interested in primary materials (iron ore and coking coal), and not finished products from Russia. The construction sector is slowing down. This leads to underemployment, downtime, lower wages and increased poverty. Pulp and paper mills are idle (for example, in the Republic of Karelia bordering Finland, and the Komi Republic, the Arkhangelsk region). There is a shortage of white paper. In the meantime, non-ferrous metallurgy did not fall under sanctions (nickel, copper, platinum, palladium, etc.) and benefits from high prices.
This year, the agricultural sector in Russia is relatively stable. The forecast for the next year is complicated yet, as Russia depends on imports of components and agricultural machinery, seeds of a number of crops, and critical supply chains have been disrupted.
In the public sector, salaries are indexed by 10%, which is important for maintaining the loyalty of the population (about 70% of GDP is the public sector), the status quo in the élites and the prevention of social discontent (through enforcement agencies). However, even in the public sector, there are partial staff reductions, the transfer of employees to part-time work, forced placement on leave. The business sector is obliged to raise the minimum wage by 10% in order to reduce the level of discontent of the population. The biggest blow has been dealt to business. The economy is trying to stabilize in a new equilibrium, looking for points of equilibrium between the models of Iran and North Korea.
At the same time, the budget for scientific research is decreasing, that is, Russia will not be able to make a technological breakthrough, and therefore an economic one, in the coming years. Back in December 2021, when GDP and total federal budget expenditures were planned to grow, it was already planned to reduce funding for civilian research. In 2020, domestic spending on R&D in Russia amounted to only 1.1% of GDP.
For comparison: in OECD countries this figure is on average 2.68% of GDP, including in the USA (3.45%), Germany (3.14%), Japan (3.28%), South Korea (4.82%), Israel (5.44%). In terms of the number of articles in the indexed Web of Science databases, Russia was recently on the 12th place, and before the war it slipped to the 14th place. Russia ranks 31st in the AD Scientific Index (assesses scientific productivity of individual scientists) – at the level of Mexico and Iran. A decrease in business investments in research and high inflation, which reduces the real cost of previously planned financing of science, will also have a negative effect on the development of technology and the Russian economy.
The real economic pain is yet to come
The maximum effect of the current sanctions will be achieved in the late summer - autumn of 2022. Russia's imports from key partners have almost halved since the sanctions were imposed. The gradual depletion of reserves, and the beginning shortage of components, the reduction of staff by socially responsible foreign companies that have left Russia (more than 1,000 transnational companies) will become more tangible, affecting sectors from agriculture and military to space to IT.
Russia's budget is in deficit despite high oil prices. Given inflation and the difficulties of borrowing abroad, the Central Bank will not be able to print money, as this will only exacerbate inflation.
Given that a number of companies have found ways to circumvent sanctions through other jurisdictions (for example, Armenia, Abkhazia, Serbia, Turkey, partially Kazakhstan, China and others), the blow to the Russian economy from sanctions is somewhat softened. If third countries can reach an agreement and eliminate the gaps that are still allowing parallel exports of scarce goods to Russia through other jurisdictions, this will increase the effectiveness of sanctions (for example, through secondary sanctions). There are geopolitical conditions for this: China's interest in weakening Russia, Serbia's interest in joining the EU, Turkey's more critical view, Kazakhstan's official disagreement to recognize the independence of parts of Ukraine, the development of energy exports by Azerbaijan and Kazakhstan bypassing Russia, etc. However, this does not seem an easy target to reach, as currently these countries are not imposing sanctions to Russia nor are considering to do so (at least in the near future).
The share of oil and gas revenues in the federal budget of Russia increased by almost 1/3, that is, to 2/3 of the federal budget. Following the reluctance of many socially responsible international companies to cooperate with Russia (the phenomenon of the "private embargo"), Russian oil is traded at a large discount. Also, the private embargo hits sectors that have not yet fallen under sanctions, for example, the export of heavy fuel oil to Europe has decreased. A number of refineries in Russia have been fully or partially idle. Despite this, now abnormally high energy prices and ongoing consumption of the Russian energy in Europe make it possible to maintain Russia's budget with a low deficit and receive super profits from oil and gas. An earlier European embargo would shorten the time frame for adaptation of Russia's political élites.
Energy exports keep the Russian economy alive…
Some Russian banks, but not all, have fallen under blocking sanctions and cannot actually use the dollar in settlements. However, Gazprombank can still work with dollars, as it is involved in the export of Russian energy to Europe. This is the most important source of financing for the institutional system and the decisions of the élites, at least until December 31, 2022, when the oil embargo begins to fully operate. At the same time, the absence of a gas embargo and Europe's slow transition to LNG are also beneficial to the Russian élite, given the high prices. Russia has decided not to repatriate part of the foreign exchange earnings to maintain the low exchange rate of the rouble. This makes it possible to provide for the freezing of those assets that Russia does not repatriate within the framework of the next sanctions. Paradoxically, the scenario of a protracted war has become more profitable for the Russian leadership élite, as it gives hope that the European economy will not withstand inflation and European populists (for example, the Hungarian factor) will force to weaken sanctions against the current Russian government.
…but major structural problems persist
Managerial problems that hindered the development of the Russian economy earlier became the most visible and increase the effects of sanctions: the lack of an independent judiciary in Russia, corruption and unprofessionalism of the judiciary at all levels. Separately, there is the problem of bloat and inefficiency of the power apparatus, divided among the élites into spheres of influence, exerting pressure on business and citizens (the Investigative Committee, FSB, Police, Prosecutor's Office, Rosgvardiya), as well as of high corruption, turnover and negative selection of the least educated in law enforcement agencies, repressive legislation. For example, the terms for economic crimes often exceed the terms for murder, and the terms for speaking out against war may exceed the terms for premeditated murder. There are still problems of ignoring citizens' appeals and the collective irresponsibility of the authorities when adopting bills and protecting the interests of citizens and entrepreneurs. The fictitious nature of trade unions and of around 70% of human rights NGOs also hinders the consolidation of the population and the protection of their rights.
The problem of impoverishment of resource-rich regions due to the centralization of financial resources by the federal authorities, the problem of the lack of meritocracy, of social lifts and appointment to senior positions on the principle of the greatest trust or nepotism, and not on the principle of professionalism, the bloating of the administrative apparatus and of the sphere of state employees as a whole have become more obvious.
The problem of the distance of power remains, which prevents the receipt of reliable information by the country's leadership about problems on the ground, as well as in individual organizations (for example, a separate elevator for the minister, a separate floor for the director with a ban on entry for other employees, or a regime pass of employees to the director of the enterprise, or disguising the head's email in the electronic document management system, etc.). More than 80% of the instructions of the leadership, including within enforcement agencies, are actually not executed.
The possibility of removing governors by a decision from the center, the possibility of the emergence of governors to manage a region whose specifics they do not know due to lack of experience, including lack of professional work experience and experience of living in the region, leads to dysfunction of the verticalization of power in Russia, to the fact that much greater emphasis is placed on reporting successes to the top and on preparing presentations on “Quick Wins” to the leadership, rather than on economic transformation.
At the same time, the low level of federalization and autonomy of the regions actually contribute to the growth of poverty and instability in the regions that do not have the tools to ensure their economic development.
Mass shutdowns and suspensions of plants in Russia under various pretexts lead to a reduction in tax revenues, primarily from VAT, the main non-oil source of the federal budget and the main tax of the regions of Russia, which they do not retain. Such a system of tax transfer dependence of Russian regions on the center was introduced in the 1990s to prevent the disintegration of Russia, taking into account the desire of individual resource-rich republics to obtain greater autonomy. As a result, the level of subsidization of one of the most loyal regions, the Republic of Chechnya at the moment is 84% (rich in oil resources and an advantageous border position), and the level of subsidization of the Republic of Sakha - the most resource-rich subject of Russia, is one of the highest in Russia. The same with the Kamchatka Territory and the Republic of Buryatia (Lake Baikal). In fact, the richest regions previously had no right to dispose of their resources and now suffer from sanctions the most.
There is a closure and suspension of the work of factories in single-industry towns, primarily in the automotive industry (after the outbreak of the war, car production fell by 85%), which creates the prerequisites for social tension and democratization of political élites in certain regions. Currently, even resource-rich regions have no motivation to develop international relations, since VAT in its entirety and most other taxes are taken by the center, while the income tax actually also remains in Moscow. For example, Khanty-Mansiysk (the oil heart of Russia) keeps only 9% of the mineral extraction tax, the remaining 91% goes to Moscow, and Moscow itself, according to statistics, is one of the leaders in oil exports, although it does not produce oil (enterprises are registered in Moscow).
Declining demography: a long-lasting issue
The migration inflow to the capitals of the regions, the general decline in the population, the brain drain and the depopulation of small towns and rural areas are accelerating. In the regions, prerequisites have been created to strive for greater economic autonomy and independence from the center, especially in those regions where attempts were previously made to develop the economy in an innovative and international way (the Republic of Tatarstan, the Kaluga Region, the Khabarovsk Territory, etc.). In the Kemerovo region, due to the embargo against Russia, coal supplies to Europe (the main product of the region) will have completely disappeared by August. Given the congestion of the Trans-Siberian Railway, the possibilities of transport to the East, including to China, are also low. In each region, there are problems of a different nature. An important role is played by the ability of the central government to finance subsidized regions, benefiting from the low speed of imposed sanctions and from the ability to circumvent sanctions, from China's wait-and-see attitude, which reduces China's strategic gain in the region.
The further impact of sanctions will depend on the creation of conditions for their inevitability (for example, the absence of parallel imports), on their purposefulness (aiming at disabling the accomplishment of budgetary obligations of the federal authorities towards state employees and to the regions), taking into account the geographical, social, resource, historical and other features and development needs of various regions of Russia.
The effect of sanctions may become apparent at the single voting day on September 11, 2022, if it leads to a change in the ratio of political forces in the regions where the elections will take place, since the economy is the basis of politics. As T. Carlyle said economics is ‘the dismal science'.