Ukraine's military gains could deepen Russia's economic woes

Ukraine’s military gains could deepen Russia’s economic woes

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

Ministry of Foreign Affairs of Uzbekistan | via Reuters

Ukraine’s counter-offensive, which has seen vast swathes of Russian-occupied territory recaptured, may be compounding Russia’s economic woes as international sanctions continue to weigh on its fortunes.

Ukraine’s military has had surprising success in recent weeks, retaking Russian-occupied territory in the northeast and south of the country. Now Kyiv hopes to liberate Luhansk in the eastern Donbas region, a key area where one of two self-proclaimed pro-Russian “republics” is located.

Holger Schmieding, Berenberg’s chief economist, said Ukraine’s recent military gains could seriously affect Russia’s economy.

“Even more than before, the Russian economy appears poised to descend into a gradually deepening recession,” Schmieding said in a note last week.

“The rising costs of a war that is not going well for [Russian President Vladimir] Putin, the costs of suppressing domestic dissent and the slow but pernicious impact of sanctions will likely bring down the Russian economy faster than the Soviet Union did some 30 years ago.”

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

Yasuyoshi Chiba | Afp | Getty Images

He stressed that Russia’s main bargaining chip when it came to international sanctions imposed by the West, its influence over the energy market, particularly in Europe, was also fading.

“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 even Germany, which was particularly exposed to the Russian supplies, it could even come close to its 95% storage target before winter.

power problems

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

Energy revenues fell to their lowest level in more than a year in August, and that was before Moscow cut off gas flows to Europe in the hope that European leaders would lift sanctions. Since then, the Kremlin has been forced to sell oil to Asia at deep discounts.

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

“Russia knows that it has no leverage left in its energy war against Europe. Within two or three years, the EU will have weaned itself off its dependence on Russian gas,” EIU director of global forecasting Agathe Demarais told CNBC.

This is a key reason why Russia has chosen to cut off gas flows to Europe now, he suggested, and the Kremlin is aware that this threat could carry much less weight in a few years.

GDP drop

The EIU projects a Russian GDP contraction of 6.2% this year and 4.1% next year, which Demarais said was “huge, both by historical and international standards.”

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

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

Putin has repeatedly claimed that his country’s economy is coping with Western sanctions, while Russia’s First Deputy Prime Minister Andrei Belousov said last month that inflation will be around 12-13% in 2022, far below below the most pessimistic projections offered by world economists earlier this year. year.

Russian GDP shrank 4% in the second quarter of the year, according to state statistics service Rosstat, and Russia raised its economic forecasts earlier this month, now projecting a 2.9% contraction in 2022 and 0. 9% in 2023, before falling back to 2.6%. growth in 2024.

However, Demarais argued that all visible data “points to a collapse in domestic consumption, double-digit inflation and the collapse of investment”, and that the withdrawal of 1,000 Western companies is also likely to have implications for “employment and access to the innovation”.

“However, the real impact of the sanctions on Russia will be felt mainly in the long term. In particular, the sanctions will restrict 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. In addition, US sanctions will make it impossible to export the required technology to Russia.”

Sanctions ‘here to stay’

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.

YvesHerman | Reuters

“We have cut off three-quarters of Russia’s banking sector from international markets. Almost a thousand international companies have left the country,” he said.

“Car production fell by three quarters compared to last year. Aeroflot is grounding planes because there are no more spare parts. The Russian military is taking chips out of dishwashers and refrigerators to repair its military hardware, because they ran out of semiconductors. Russia’s industry is in tatters.”

He added that the Kremlin had “put Russia’s economy on the road to oblivion” and promised that the sanctions “are here to stay.”

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

'Boundless' Russia-China partnership has limits, says professor

As the Kremlin strives 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 as the two countries touted a “boundless” relationship.

However, several commentators have pointed out that as Russia’s bargaining power on the world stage declines, China will hold most of the cards as the two superpowers try to cement greater cooperation.

“In the long run, China will be the only economic alternative Russia will turn to, but this process will also be complicated, as China will remain wary of becoming too dependent on Russian commodities,” EIU’s Demarais added.

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