Nearly three years have passed since the imposition of numerous sanctions on the Russian economy following its invasion of Ukraine. Opinions on the effectiveness of these sanctions have become increasingly polarized. Some argue they are entirely ineffective, while others claim they have already doomed Russia's future. This divergence of opinion extends even to expert circles, with both sides presenting substantial arguments. Interestingly, diametrically opposed views on the impact of sanctions are voiced both within Russia and from the countries that imposed these measures. How Russia is living under sanctions, how it circumvents them, and what lessons a market economy can draw from this experience?
Reformatting the Economy
Sanctions have forced Russia to reformat its economy. Restrictions on the export and import of goods and services have significantly reduced trade, especially with Western countries. This directly impacts the revenues of the Russian budget and companies, both state-owned and private. However, the main lesson for the world is that sanctions are less effective if not supported by all key global market players. As long as countries like China and India continue to cooperate with Russia, necessary and even sanctioned goods will find their way into the Russian market.
Russia undoubtedly suffers economically by pivoting its economy towards the East, selling oil and gas to China and India at lower prices than to Europe. Nevertheless, these volumes, despite increased logistical and other costs, are sufficient to maintain bureaucratic salaries and fund military ventures. Thus, while sanctions are a severe economic burden, they have not crippled the Russian economy entirely.
Impact on the Russian Ruble
Sanctions often lead to a depreciation of the Russian ruble against other currencies, affecting inflation and the purchasing power of the population. However, the market can learn that the impact on currency can be unpredictable. Initially, sanctions did cause a sharp decline in the ruble. Nevertheless, skilled financial management by Russia's Ministry of Finance and Central Bank stabilized and even strengthened the ruble temporarily.
Yet, this financial success was short-lived. A too-strong ruble against key foreign currencies posed a threat to financial stability. High exchange rates help balance significant budgetary expenditures but reduce exporters' competitiveness. Throughout 2023 and into the current year, Russian financial authorities managed to stabilize the exchange rate at a level acceptable for both major exporters and the national budget. However, the ruble's non-convertibility and increased transactions in less convertible currencies like the Chinese yuan or Indian rupee led to inefficiencies in foreign economic activities. High-margin Russian commodity businesses can afford this for a relatively long time, but it remains an unsustainable long-term strategy.
Sanctions on the Financial Market
Sanctions on Russia's financial market have proven particularly effective. Russian companies and banks lose access to foreign capital, making investments and debt refinancing difficult. Direct sanctions complicate international payments, while secondary sanctions extend supply chains, making goods and services entering and leaving Russia more expensive. Every ruble spent on more costly exports or imports is a ruble not spent on the war effort, which is a significant impact of these financial restrictions.
Decline in Foreign Investments
Foreign investors avoid the Russian market due to sanctions, reducing overall investment in the economy. Russia's integration into the global financial and economic system was more profound than previously thought. Consequently, the drop in foreign investments has severely impacted sectors like IT, engineering, and aviation. Quick actions, such as repurchasing aircraft for Russian airlines and filling the domestic market with Chinese cars, have averted immediate industry collapse. However, in the long run, this creates existential problems. For example, the Russian aviation industry is currently unable to produce its aircraft without foreign technology, and the automotive market becomes highly dependent on Chinese manufacturers, who hold a strong negotiating position.
Technological Constraints and Long-term Prospects
Sanctions often include bans on technology and equipment exports to Russia, hindering development and modernization in key industries like oil and gas, defense, and IT. This technological embargo is a major long-term challenge for the Russian economy, which relies heavily on access to advanced technology, equipment, and scientific advancements from abroad.
Despite possessing significant technological potential, Russia requires numerous parts, components, equipment, and software from abroad to maintain and develop its industries. Technological cooperation with China and, to some extent, India, plays a crucial role in Russia's current strategy. Both countries may leverage their access to Russian technologies as a condition for continued cooperation. However, without access to global scientific markets and cutting-edge developments, Russian science and technology face inevitable degradation.
Diversification and Dependency on China
Sanctions have pushed Russia to seek new trading partners outside the Western sphere, leading to increased interactions with countries in Asia, Africa, and Latin America. However, the most significant relationship is with China. Sanctions drive Russia toward deeper economic cooperation with China, potentially altering the global economic balance. China becomes a key partner for Russian oil products, critical imports, and equipment supplies, further integrating financial systems through yuan transactions and Chinese payment services.
This relationship benefits China significantly, granting access to essential raw materials at favorable prices. China's dominant position in many sectors of the Russian market allows it to dictate terms, filling the Russian market with second-tier Chinese products previously confined to domestic sales. For the global economy, China's ability to support Russia without fearing secondary sanctions is significant, but China cannot fully support the Russian economy without jeopardizing its crucial American and European markets.
The long-term consequences are significant and damaging
The unexpected outcomes of sanctions on Russia highlight the importance of understanding the nature of the targeted economy. Sanctions were expected to either cripple a fully market-oriented economy by cutting off global access or destabilize a centrally planned economy as in the Soviet era. However, Russia's economy exhibits a hybrid model, with elements of both market and planned systems. The planned aspect allowed for rapid resource reallocation toward military objectives, while the market aspect enabled mitigating negative effects through parallel imports, shadow fleets, barter deals, and cryptocurrency payments. This duality has allowed Russia to navigate sanctions more effectively than anticipated.
The primary takeaway from sanctions against Russia is that their effects are not immediate. The initial impact is often less severe than expected, but the long-term consequences are significant and damaging. Inconsistent and fragmented sanctions further reduce their effectiveness. The impact varies by sector, with internationally integrated and high-tech industries suffering the most. Basic industries, essential for the Russian military machine, remain relatively unscathed, allowing the economy to function without immediate shocks.
China's role is crucial, creating a dependency reminiscent of Russia's relationship with Belarus. This increasing economic dependency strengthens China but does not fully subordinate Russia, mirroring Belarus's status. Understanding this nuanced relationship is essential for evaluating the effectiveness of sanctions and anticipating future developments in the global economic landscape.
