March 6, 2022
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Can Russia Withstand Western Sanctions?
Moscow is willing to accept short-term pain for long-term gain.
By: Ekaterina Zolotova
In response to Russia’s invasion of Ukraine, Western countries have introduced a series of measures to try to force the Russian economy into meltdown. Many Western governments have imposed strict sanctions on Russian banks, elites and exports, and major international companies have suspended their Russian operations. The European Union, Switzerland, Canada and others closed their airspace to Russian airlines. The Kremlin says its economy is strong enough to withstand the pressure. This may be true in the long term, but in the short, there's little question average Russian citizens will feel an impact.
Countries Banning Russia from Their Airspace
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Mitigating Factors
It’s already clear that the sanctions imposed on Moscow are having a much greater effect than previous anti-Russian sanctions. Since they were introduced, the value of the ruble has plummeted (from 81 rubles to the dollar on Feb. 23, the day before the operation was announced, to 106 rubles to the dollar on March 3), Moscow has imposed restrictions on foreign exchange, trading on the Russian stock market was closed for several days, and the share value of major Russian companies has crashed. The sanctions are also taking a toll on Russian banks, including the largest bank, Sber, which accounts for about 90 percent of transfers and about 70 percent of card payments in the country. VTB, Otkritie, Promsvyazbank, Sovcombank, Rossiya Bank, Novikombank and the state development bank VEB were all disconnected from the SWIFT banking system, which severely limits their ability to do business outside of Russia. The decision of the EU, U.S., Britain and Canada to freeze Russia’s central bank reserves will also have a big impact.
Russian Household's Investment in Currency
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Bad for Consumers
But it's unlikely that these will bring about the total collapse of the Russian economy. For one, the banks included in the sanctions list already operate mainly within Russia, where they receive most of their profits and where most of their clients are located. In addition, not all Russian banks were included in the SWIFT ban, meaning some transactions between Russian businesses and foreign clients can still go through as normal. Even the banks that were included can use one of several alternative systems available to them. Moreover, Russians’ historical distrust of the banking system will provide some cushion for the financial sector. More than 90 percent of the Russian population keeps at least some of their savings in cash – especially those who have savings in foreign currency – and roughly 40 percent of trading operations in the country are carried out in cash.
Thus the panic caused by the sanctions may be greater than the impact itself. For the financial sector, the blow will be mitigated by several factors. First, the West is reportedly considering excluding energy payments from the SWIFT ban. There are also no signs of a major sell-off of shares in Russian companies, including by non-residents – which makes sense since they’ve lost so much of their value over the past week. In fact, some Western institutional investors such as JPMorgan and Goldman Sachs are actually buying up bonds from firms like Gazprom and Russian Railways. Russia’s central bank has introduced several measures to soften the blow. For example, even before trading opened on the first business day after the initial sanctions were announced, it raised the key interest rate sharply – from 9.5 percent to 20 percent – to prevent the financial fallout from spreading. And the Ministry of Finance announced that exporting companies will be obligated to sell at least 80 percent of their foreign exchange earnings domestically, which will force them to buy rubles and create more demand for the currency.
But despite these efforts, the average Russian citizen will likely feel some pain from the sanctions. This wasn’t the case with the previous sanctions regime imposed in 2014 (and then renewed and expanded yearly) by the EU and U.S. after Russia annexed Crimea. (Though Russians did feel the impact of Moscow’s retaliatory ban on food imports from the EU, U.S., Canada, Japan and Australia.) Small and medium-sized businesses and large state-owned companies were able to find loopholes and continue to conduct business mostly as usual. In some cases, foreign goods were delivered to third countries before arriving in Russia to skirt the sanctions. Average Russians continued to travel and pay for purchases abroad with cards from state-owned banks, and shops remained fully stocked with foreign products – sometimes with quality substitutes from friendlier nations.
When it comes to the current crisis, the burden on average consumers will come not just from the sanctions themselves but also from major companies' withdrawal from the market. In the first days after the Russian campaign began, many companies announced that they would leave the Russian market or suspend their operations there, either because the sanctions and other restrictive measures made it too difficult to do business in Russia, or because they didn’t want to be seen as profiting from a country that invaded its neighbor. Some of the firms that announced at least partial suspensions of their Russian operations include Boeing and Airbus, Apple, Nike, H&M, and automakers Daimler, Volvo, Jaguar and Land Rover, Ford, BMW and Mercedes. Many other companies that supply products for processing are considering leaving.
These withdrawals will affect the range of products available to consumers as well as corporate profits and jobs. Until now, the range of foreign goods available to consumers in Russia had expanded every year. In 2021, Russia depended on imports for 40 percent of consumer goods and 53 percent of non-food products. Imports accounted for 32 percent of Russia’s milk powder and cream, 30 percent of cheese and 28 percent of beef. They also accounted for 39 percent of cars, 58 percent of machinery and equipment, 60 percent of medicines and medical devices, 82 percent of clothing, 87 percent of computers and electronics, 88 percent of shoes, and 95 percent of auto parts. Notably, more than 70 percent of microchips in Russia come from foreign suppliers, while domestic chips are used mainly in the military-industrial sector and space. All of this means consumer prices will likely rise both because of the lack of confidence in the market and the depreciation of the ruble. The extent will depend on how quickly Russian companies can find substitutes.
Russian Financial Liabilities, October 2021
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Short-Term Pain
Assuming more severe sanctions aren’t introduced, Russia’s economy will weather the storm in the long run. It still has plenty of money in its National Wealth Fund, low public debt and large gold reserves. It’s also counting on two additional factors to soften the blow. First, it believes its budget funds are protected because existing contracts to supply oil and natural gas remain intact. The high price of energy and depreciating ruble will make these contracts even more valuable to the Russian budget. Second, Moscow expects reduced competition from multinational firms will increase profits for small and medium-sized Russian businesses. Previous sanctions had a positive impact on domestic production and helped Russia achieve self-sufficiency in a number of goods. It’s relying on allied countries, particularly those in the Eurasian Economic Union, to supply products for which there is currently no quality domestic substitute. It’s also hoping to coax countries in Asia, Africa and Latin America to continue or expand trade, even in a different currency, and that more countries will join its System for Transfer of Financial Messages – its alternative to SWIFT – and its Mir payment system – similar to VISA or Mastercard.
The problem is that these contingencies will come to fruition only in the long term. In the short term, the people and the state are bound to suffer. Factory shutdowns, layoffs and closure of retail stores and businesses will require the government to spend more to support the population. Moreover, logistical problems, the anemic ruble, the weak position of Russian companies, and mere speculation will increase the cost of goods and contribute to rising inflation. Add to this a shortage of specialized workers, especially in the IT sector, as people search for employment in other countries with fewer restrictions due to sanctions.
Moscow is betting big on its long-term prospects at the expense of its short-term economic health. It’s also betting that the West won’t be willing to impose more severe punishments, such as refusing to buy Russian oil and gas or a total SWIFT ban. Time will tell if these bets pay off.
