Sanctions are the West’s key weapon in the fight against Putin, but there are signs that Russia’s economy and financial system is weathering the storm better than expected. The rouble has already bounced back and Russia has been able to continue to service its debts, with only minor hiccups. A closer look however reveals that sanctions are biting hard – and that Russia is losing the economic as well as military war.
Take the rouble’s resurgence, which is not what it seems. The ability of Russia’s currency to bounce back reflects the fact that Russian imports have fallen by more than the country’s exports, as local consumers and businesses have cut spending. This means there is less demand to sell roubles to buy foreign currencies.
The central bank has also propped up the rouble, but the measures it has used to do so are unlikely to endure for long. Conventional intervention in the markets – involving selling some of the country’s large reserves of international assets to buy roubles – has helped. So too has the insistence by the authorities that foreign businesses still buying commodities from Russia should pay in roubles, thus ensuring that there is least some international demand for the currency.
Russia’s central bank’s offer to buy gold for roubles has also sparked the rouble’s revival; it has encouraged some (not very well-founded) speculation that it would also be willing to sell gold for roubles, creating a de facto ‘Gold Standard’, and therefore support the currency in this way.
But while these measures have created an illusion of currency strength for now, that’s really all it is: a balance of payments surplus caused by a slump in domestic demand is a hollow victory.
What about interest rates, which have been cut from a peak of 20 per cent in March to 14 per cent? Again, this doesn’t give a full picture: interest rates are still higher than they were at the start of the year (8.5 per cent) and inflation has surged. Sanctions have caused a sharp tightening in financial conditions, which is also reflected in equity prices: the main Russian stock market indices have still lost between a quarter and a third of their value since February.
There’s worse news to come for Russians: the Russian central bank expects inflation to average between 18 per cent and 23 per cent this year, with the economy shrinking by between 8 per cent and 10 per cent.
This grim data is backed up by business surveys. S&P Global and IHS Markit produce monthly purchasing managers’ indices for all the major economies. The composite PMI output index for Russia recovered slightly to 44.4 in April, from 37.7 in March, but any reading this far below 50 still signals a sharp contraction in activity. Employment is falling sharply too.
Admittedly, the Russian economy is not collapsing, as some might like. But it would be a mistake to see Russia’s economic resilience as a sign that things are rosy. Russia is a vast country which is relatively self-sufficient in many essentials, including food and energy. Even in areas where Russia is more reliant on Western companies, notably professional services, these are often provided by separate legal entities operating within the country. This means that predictions that sanctions would quickly tank Russia’s economy always looked to be overblown.
There are also limits to the effectiveness of Western sanctions on Russia’s energy exports. Countries like the US and the UK are not particularly dependent on Russian oil and gas, but it is unrealistic to expect others, notably Germany and Italy, to turn off the taps overnight.
Indeed, anything less than comprehensive sanctions could simply play into Putin’s hands, by driving up the prices of the oil and gas that Russia is still able to sell – including to countries like China and India.
It’s also worth remembering that the war in Ukraine is not the fault of the vast majority of ordinary Russian people, all 144 million of them, young and old. It is not obvious that Putin cares about them anyway. The Russian economy has underperformed for many years, partly as a result of international divestment after the annexation of Crimea in 2014.
There seems to be a widespread presumption among some in the West that it would be ‘morally wrong’ to continue doing any business in Russia. But it is easy to think of exceptions. Would we really be willing to stop supplying medicines, for example? Targeting the rich and powerful, including the oligarchs and key figures in the apparatus of the state, makes far more sense, including from an ethical perspective.
Another point to remember is that economic and financial sanctions are not the only tool to counter Putin’s aggression. Perhaps the most effective thing the West can do is to ensure that Putin loses the war in Ukraine. This appears to be happening. Most of the credit obviously belongs to the heroic resistance of the Ukrainians themselves. But the increasing supply of military kit and intelligence is clearly helping too.
Softer power is coming into play as well. Cultural and sporting boycotts are having a substantial impact well beyond any simple economic calculations. Making Russia a pariah state is undermining morale and draining talent from the country. (Ps. this was written before Ukraine’s triumph in Eurovision!)
In short, there is more that could – and probably should – be done to tighten the screws on Putin’s regime, including further financial sanctions and a more rapid diversification away from Russian energy and other commodities. But my gut feeling is that the West has probably got the balance about right, at least for now.
The combination of military support for Ukraine, existing sanctions, and the exercise of soft power are working as well as could reasonably be expected. We also need to bear in mind the potential for further collateral damage to innocent parties, both in the West – and in Russia herself – if sanctions are ramped up too much.
Russia’s resilience in the face of unprecedented sanctions isn’t a sign that these measures are failing. And nor should it be seen as an invitation to slap ordinary Russians – who probably oppose Putin’s war anyway – with measures that will make their lives even more difficult.
This article was first published by the Spectator on 15 May 2022