Ukraine’s military gains could exacerbate Russia’s economic problems

Russian President Vladimir Putin attends a meeting of the heads of member states of the Shanghai Cooperation Organization (SCO) at a summit in Samarkand, Uzbekistan, on September 16, 2022.

Foreign Ministry of Uzbekistan | via Reuters

The Ukrainian counter-offensive, which saw large swaths of Russia’s occupied territory recapture, could exacerbate Russia’s economic woes as international sanctions continue to hammer its fortunes.

The Ukrainian army has had extraordinary success in recent weeks, recapturing Russian-occupied territory in the north-east and south of the country. Now, Kiev hopes to liberate Luhansk in the eastern Donbas region, a key area in which one of two self-styled pro-Russian “republics” is located.

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Holger Schmieding, Berenberg’s chief economist, said Ukraine’s recent military gains could hit the Russian economy hard.

“Even more than before, the Russian economy looks set to plunge into a recession that is gradually worsening,” Schmieding said in a statement last week.

“The rising costs of a war that is not going well [Russian President Vladimir] Putin, the costs of suppressing internal dissent and the slow but pernicious impact of sanctions are likely to collapse the Russian economy faster than the Soviet Union collapsed some 30 years ago. “

Ukrainian soldiers travel in an armored vehicle to Novostepanivka, Kharkiv region, on September 19, 2022.

Yasuyoshi Chiba | Afp | Getty Images

He pointed out that Russia’s main bargaining chip when it comes to international sanctions imposed by the West – its influence on the energy market, particularly in Europe – is also in decline.

“Although Putin closed the Nord Stream 1 pipeline on August 31, the EU continues to fill its gas storage facilities at a slightly slower but still satisfactory pace,” he noted, adding that Germany – particularly exposed to Russian supplies – may even approach its 95% stockpiling target before winter.

Energy problems

Europe’s rapid departure from Russian energy is particularly painful for the Kremlin: the energy sector accounts for about a third of Russia’s GDP, half of all tax revenues and 60% of exports, according to the Economist Intelligence Unit.

Energy revenues fell to their lowest level in over a year in August, before Moscow cut off gas flows to Europe in hopes of bolstering European leaders to have sanctions lifted. Since then, the Kremlin has been forced to sell oil to Asia at substantial discounts.

The decline in energy exports means that the country’s budget surplus has been heavily depleted.

“Russia knows it no longer has influence in its energy war against Europe. Within two to three years, the EU will have rid itself of its dependence on Russian gas,” Agathe Demarais, director of global forecasts for Russia, told CNBC. ‘EIU.

This is one of the main reasons why Russia has decided to stop gas flows to Europe now, he suggested, with the Kremlin aware that this threat could carry much less weight within a few years.

Collapse of GDP

The EIU expects Russian GDP to shrink by 6.2% this year and 4.1% next year, which according to Demarais is “huge, both by historical and international standards”.

“Russia did not experience a recession when it was first subjected to Western sanctions in 2014. Iran, which was completely cut off from Swift in 2012 (which has not yet happened to Russia), has suffered a recession of only about 4% in that year, “he said.

Statistics are scarce on the true state of the Russian economy, with the Kremlin holding its cards relatively close to its chest. However, Bloomberg reported earlier this month, citing an internal document, that Russian officials fear a far deeper and more persistent economic downturn than their public claims suggest.

Putin has repeatedly said his country’s economy is facing Western sanctions, while Russia’s First Deputy Prime Minister Andrei Belousov said last month that inflation will stand at around 12-13% in 2022, far below. of the darker projections offered by global economists at the beginning of the year.

Russian GDP contracted 4% in the second quarter of the year, according to state statistics service Rosstat, and Russia raised its economic forecast earlier this month, now projecting a 2.9% contraction in the year. 2022 and 0.9% in 2023, before returning to 2.6% growth in 2024.

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However, Demarais said that all the visible data “points to a slump in domestic consumption, double-digit inflation and a drop in investment”, with the withdrawal of 1,000 Western companies likely to have implications for “employment and investment as well. ‘access to innovation’.

“However, the real impact of the sanctions on Russia will mainly be felt in the long term. In particular, the sanctions will limit Russia’s ability to explore and develop new energy fields, especially in the Arctic region,” he said.

“Due to Western sanctions, financing the development of these fields will become almost impossible. Furthermore, US sanctions will make it impossible to export the required technology to Russia.”

“Here to stay” sanctions

European Commission President Ursula von der Leyen delivers the State of the European Union address to the European Parliament, in Strasbourg, France, on September 14, 2022.

Yves Herman | Reuters

“We have cut three quarters of the Russian banking sector out of international markets. Nearly a thousand international companies have left the country,” he said.

“Car production has fallen by three quarters from last year. Aeroflot is grounding the planes because there are no spare parts left. The Russian military is taking chips from dishwashers and refrigerators to repair their military hardware, because they have run out of semiconductors. Russian industry is in pieces. ”

He added that the Kremlin had “put the Russian economy on the path of oblivion” and promised that the sanctions were “here to stay”.

“This is the time for us to show determination, not pacification,” von der Leyen said.

As the Kremlin rushes to strengthen security ties, having been shunned by the West, a senior Russian official said on a visit to Beijing last week that Moscow sees deepening strategic ties with China as a key political goal. . Putin also met with Chinese President Xi Jinping in Uzbekistan last week when the two countries touted a “limitless” relationship.

However, several commentators have noted that as Russia’s bargaining power on the world stage wanes, China will hold most of the cards as the two superpowers attempt to cement further cooperation.

“In the long run, China will be the only economic alternative for Russia to turn to, but even this process will be complicated, as China will continue to be wary of becoming overly dependent on Russian commodities,” added Demarais of the EIU.

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