Severe economic sanctions were imposed on Russia in response to the invasion of Ukraine. How effective will they be? We have not seen any serious, data-driven evaluation yet.
Some expect the embargo to trigger a financial collapse in Russia in a short time, while others expect it to be a more long and slow drag on the economy.
We desired to bring some numbers to the table to know how long Russia could withstand the Western sanctions regime. We divide our evaluation into two parts: The first considers the flexibility of the Russian economy to access dollars and euros and generate domestic revenues to finance the war and other non-discretionary spending. The second step will examine whether the reserves accrued by the Russian central bank and the sovereign wealth fund might be sufficient to finance these expenditures.
International Income: The Trade Deficit
Ironically, the sanctions imposed on many Russian industrial banks, investments and exports mean that Russia must grow to be a barter economy to generate income in hard currencies.
Under normal circumstances, the country can acquire dollars and euros through foreign investment or through the export of products and services. The export embargo has made it nearly unattainable for Russia to generate export revenue, just as sanctions on Russian stocks and other assets have made it unattainable to boost capital by issuing stocks and bonds to foreign investors.
Virtually the one way for Russia to get dollars or euros is thru oil and gas exports and thru Gazprombank, one among the few major Russian financial institutions not yet excluded from the SWIFT system. Of course, Russia can direct its oil and gas exports to other countries and receive payments in other currencies, but it should have little influence in setting prices, and since such currencies usually are not freely convertible, dollars and euros will remain difficult to acquire and briefly supply.
This is significant because Russia needs dollars and euros to pay for vital imports of food, medicine and other civilian products. In 2021, Russia’s total exports of products and services amounted to $493.3 billion, in accordance with Bloomberg data. Of that, oil and gas accounted for $235.6 billion, while metals, coal and wheat accounted for a lot of the remaining $257.8 billion, most of which are actually under embargo.
We estimate that under sanctions, Russia will give you the option to export oil and gas, in addition to food products akin to wheat, fertilizers and possibly cotton and timber products. But with fewer imports from the West, internal Russian demand for these raw materials – especially wheat – will increase. Therefore, much of the product produced will likely have to be for domestic use and never sold abroad. Ultimately, Russian exports (excluding oil and gas) will likely fall to around $25 billion.
So if we ignore the present buyers’ strike and the potential of further sanctions on energy exports and assume that Russia finds a marketplace for its oil and gas, the country will record total exports value $260 billion this yr. That’s a decrease of around 48%.
According to Bloomberg, total Russian imports of products and services in 2021 amounted to $293.4 billion. Of this, around $10.6 billion went to food, $9.4 billion to clothing and shoes, and $9.7 billion to medicines and antibiotics. The lion’s share – $144.3 billion – went to machinery and equipment. If we exclude passenger cars, furniture and other non-essential goods from the import list, but keep machinery imports at current levels, Russia’s total imports will likely fall to $270 billion.
Thus, Russia faces a trade deficit of around $10 to $20 billion that should be financed. Of course, the more machinery imports are reduced attributable to sanctions, the more the deficit narrows and eventually turns right into a surplus, reducing the Russian government’s financing needs.
$488 billion in hard currency?
The trade deficit exacerbates the challenge for Russia. In addition to the quantity the country has to pay for essential products, the country also theoretically has to service its debts and finance the war. That might be expensive.
Accordingly, the Russian invasion of Ukraine cost $7 billion in the primary five days alone Center for Economic Recovery Analysis. This includes an estimated GDP lack of $2.7 billion from the estimated 6,000 Russian victims. Excluding the strain on human capital, that is $4.2 billion in lower than every week. Over a three-month period, material costs for the Russian military alone would amount to around $50 billion at the identical rate of spending.
Foreign debt is one other complicating factor. According to Bloomberg, the Russian Federation held $490 billion in foreign debt in 2021. Of this, $67.7 billion was Russian government debt and $78.5 billion was bank debt. Total debt service on that $490 billion hovers around $100 billion per yr. Total debt service on Russian sovereign debt will amount to $7.3 billion in 2022 and rise to $10 billion in 2023.
Thus, within the remaining nine months of the yr, Russia could have to finance a trade deficit of $7.5 billion to $15 billion, $7.3 billion in foreign debt through government bonds alone, and in regards to the same amount through bank debt. Finally, depending on the length of the conflict, Russia needs $50 billion or more to finance its military operations, much of which is owed to domestic defense contractors paid in rubles.
To cover these costs, Russia must draw on the reserves of its central bank and its sovereign wealth fund, the National Wellbeing Fund. According to Bloomberg, at the top of 2021, the Russian central bank had $630 billion in international reserves, of which about $468 billion was in foreign currency and $132 billion in gold. 61.3% of foreign currency is held by the G7 central banks, the IMF and the Bank of International Settlements (BIS). The sanctions have frozen this 61.3%. Since the gold reserves are held domestically, the Russian central bank still has access to the $132 billion in addition to the remaining $181 billion in foreign exchange reserves. The National Welfare Fund has one other $174 billion in available reserves, while the Russian government has about $488 billion in available hard currency.
From then on, the purely financial calculation is elementary: Russia still has sufficient resources to finance the war and survive the sanctions for the subsequent few years.
Of course, that is just the headline. The economic sanctions will drastically reduce economic output and thus corporate and government revenue. Total government spending within the Russian Federation last yr amounted to $329 billion on the end-2021 exchange rate. The current embargo will reduce Russia’s GDP by around 9.5% annually, assuming oil and gas exports remain at 2021 levels. in accordance with evaluation by the Kiel Institute for the World Economy. That means tax revenues will fall by about $18 billion – which is not a great amount in comparison with available reserves. But if Russia cannot export its oil and gas, it should should make up for a further $120 billion in lost revenue.
The conclusion of all these calculations is easy: so long as Russia can proceed to export oil and gas, it may proceed to finance the lack of revenue attributable to the sanctions for a very long time. But the economic damage might be enormous: in the subsequent 12 months alone, GDP will fall by almost 10% and should not stop there.
However, if Russia loses its oil and gas revenues, it should run out of cash inside a yr or two.
If you enjoyed this post, do not forget to subscribe.
Photo credit: ©Getty Images/Bloomberg Creative
