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Six months in, how are sanctions impacting Russia’s economy?

Fuel embargoes and private sector divestment are further isolating Russia.

Russian President Vladimir Putin in St. Petersburg, July 31.
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Ellen Ioanes covers breaking and general assignment news as the weekend reporter at Vox. She previously worked at Business Insider covering the military and global conflicts.

Six months into Russia’s war in Ukraine, severe economic sanctions initiated by the US and the EU seem to be having the twofold effect of stifling Russia’s economy and encouraging divestment by large corporations, with the US-based Citibank the latest to announce its formal withdrawal from the Russian market.

Citibank on Thursday issued a press release stating its intention to wind down its consumer and local commercial banking enterprises in Russia as part of a longer-term “global strategic refresh” first announced in April 2021. “We have explored multiple strategic options to sell these businesses over the past several months. It’s clear that the wind-down path makes the most sense given the many complicating factors in the environment,” CEO of Legacy Franchises Titi Cole said in the release. Although, as of July, the bank was still attempting to negotiate a sale of its local commercial and consumer banking sectors to local Russian companies, the Financial Times reported at the time. Sanctions complicated the sale to at least one potential buyer, Rosbank; owner Vladimir Potanin was recently sanctioned by the UK.

Citibank’s announcement, and the decision to wind down its operations rather than continue to pursue sales, is somewhat of an indicator that sanctions and bans are having their intended effect. “Months ago, the United States banned all new investment in Russia’s economy,” senior research scholar at Columbia University’s Center for Global Energy Policy Eddie Fishman told Vox via email. “So any US companies that remain in Russia are barely keeping the lights on.”

However, that doesn’t mean the Russian economy has collapsed; Russia’s central bank has been adjusting the country’s monetary policy to keep the ruble afloat, and it’s currently the strongest it’s been against the dollar since 2018, CNN reported Sunday. After a crash early in the war, when the US froze $600 billion in foreign currency reserves, the central bank took aggressive action, hiking interest rates to control inflation. That seems to have paid off, with inflation apparently leveling out after an April high of 18 percent.

Additionally, banks and businesses from other countries including China and Japan have helped to soften the blow somewhat, either by maintaining their business ties to Russia or committing to expanded investments there. China and India have both ramped-up fuel purchases, including coal despite sanctions on Russia’s fossil fuel industry as well.

Sanctions take some time to affect a major economy

Russia has also been working to mitigate the sanctions’ impact since the US originally imposed them in 2014 because of Russia’s invasion of Crimea. When major Western businesses like McDonald’s, Starbucks, Visa, and Mastercard left the country early on in the invasion, there were Russian companies there to mitigate the blow, Andrey Nechaev, Russia’s former economy minister, told CNN. “The exit of Mastercard, Visa, it barely had an impact on domestic payments because the central bank had its own alternative system of payments.” Fast food, too, is now becoming a homegrown enterprise, with McDonald’s franchises reopening under the name Vkusno i tochka — Tasty, and that’s it — and Starbucks is now going by Stars Coffee. Starting in 2014, the government pushed Western franchises to get their supplies locally; that policy has paid off, since imports are now difficult to come by.

Despite the preparations the Russian government made to help the economy weather the West’s aggressive sanctions regime, those controls aren’t sustainable forever. Furthermore, Russia still can’t import critical technological supplies, and its economy is heavily reliant on fuel exports and is currently benefiting from high prices due to inflation.

“Sanctions are having a dramatic impact on Russia’s economy,” Fishman said. “Even the most conservative estimates suggest Russia’s GDP will contract by 6 percent this year — a larger hit than the 1998 Russian financial crisis. Absent sanctions, Russia’s economy was poised for growth this year.” The country’s inability to import goods “has led to shortages of foreign components and rapidly declining industrial production. The result has been a wave of underemployment that will eventually translate into layoffs and declining living standards.”

Russia’s fuel industry ultimately has a limited lifespan, Thane Gustafson argues in his book Klimat: Russia in the Age of Climate Change. Russia’s economy is so deeply tied to fossil fuels that it has no significant alternative industry to make up for the money it rakes in from those revenues. In 2019, oil and gas exports accounted for 56 percent of Russian export income, totaling $237.8 billion. Those revenues contributed to 39 percent of the national budget, according to Gustafson. Without a strong oil and gas industry — high prices and a large customer base — Russia’s economy will, eventually, suffer due to the lack of diversification.

What’s more, the full brunt of fuel sanctions hasn’t yet come to bear; in December, the EU will ban 90 percent of all Russian oil imports, slashing Russia’s output by as much as 2.3 million barrels of crude oil products per day by February 2023, according to the International Energy Agency. It could be difficult to find new customers for those products, Bloomberg reports, as outflows to Asian markets have steadied in recent weeks.

What role does foreign divestment play?

Sanctions are only part of the strategy. Foreign divestment represents a blow to the Russian economy, though not as severe as curtailing oil and gas revenues and critical imports. Though many companies, including US and European corporations, are continuing to do business in Russia, over 1,000 corporations have expressed their intent to withdraw from the country to some degree, according to research from the Yale School of Management’s Chief Executive Leadership Institute.

“It could take months or even years for some companies to fully unwind their businesses [in Russia],” Fishman told Vox. “But that doesn’t mean they are funneling money into Russia.” Financial services companies, heavy machinery, airlines, oil companies, fast food, and retail companies based all over the world have suspended their operations in Russia, impacting people at a variety of income levels. Russian companies and the ultra-wealthy, for instance, can no longer get a Deutsche Bank loan, and ordinary people won’t be able to buy Nike shoes once the company fully exits Russia as it announced in June it would.

For consumer goods like Nike, the decision to divest is one that won’t substantially impact the bottom line; according to Reuters, less than 1 percent of the company’s revenue comes from Russia and Ukraine combined.

Since the collapse of the Soviet Union, Russia, for its part, has “remained suspicious of integration, resistant to openness, ambivalent toward foreign investment, and isolated from major scientific and technical currents,” Gustafson writes in Klimat. Those tendencies have only increased during President Vladimir Putin’s rule, according to Gustafson; any promise most foreign companies did see in the Russian market is now likely gone or short lived at best.

“The Russian economy is one of the riskiest destinations for foreign investment, and it will remain so at least until sanctions are removed,” Fishman said. On the contrary, capital flows have often gone the other way, Gustafson writes in Klimat. “Russia suffers in particular from the tendency of Russian companies and individuals to move their capital out of Russia,” with the ultra-rich often moving their wealth to off-shore havens. In fact, according to a 2018 study by Filip Novokmet, Thomas Piketty, and Gabriel Zucman, which Gustafson cites, “the wealth held offshore by rich Russians is about three times larger than official net foreign reserves, and is comparable in magnitude to total household financial assets held in Russia.”

Early on in the war, Putin banned Russian customers from sending money abroad, including foreign debt repayment, although those restrictions were eased somewhat in April. Though Russia is not providing data regarding capital inflow and outflow, Bloomberg reported in June that as many as 15,000 high-net-worth individuals — an estimated 15 percent of its millionaires and billionaires — could leave Russia for places like Israel and the United Arab Emirates because of the sanctions squeeze.

Where is Russia’s economy headed — and how does that affect Ukraine?

Sanction projects are, in theory, supposed to impose sufficiently and suitably painful conditions that push the sanctioned state to change its behavior. At six months in, Russia hasn’t felt the full extent of the economic pain that it will in the future should the US, UK, and EU be able to maintain the energy embargo in particular.

“The big question, though, is whether all this economic damage is advancing worthy policy goals,” Fishman said. “And it’s a hard question to answer, as we can never know the counterfactual.”

Russia, despite heavy losses on the battlefield, has maintained its presence on the southern front and intends to increase its total military force from 1.9 million to 2.04 million, Reuters reports. It’s not clear how exactly the military will accomplish that, given reports that many Russian men have tried to avoid military service. And the conflict has entered a grueling new stage — a war of attrition requiring sustained military force and morale. A Russian victory would depend on significant mobilization of industry and social support; it’s unclear how that would come to pass given the challenges sanctions have brought to the industrial sector and recent sanctions against defense companies and associated individuals.

“For the last two decades, Putin has used Russia’s access to the global economy to build up a military machine and pursue an imperialist foreign policy. Going forward, that will be much harder for Putin, as Russia’s economy has little hope of dynamism under these sanctions, which are likely to stay in place for a long time,” Fishman said. “Sanctions aren’t changing Putin’s desire to bully neighbors — but they are reducing his means to make good on his threats.”

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