RosStat reported an even milder contraction in Russia's GDP in 2022 than the most optimistic forecasts from all the economists that follow Russia on February 20. In the six big crises Russia has suffered since the collapse of the Soviet Union, this crisis has been the least damaging.

Russia’s economy shrank by only 2.1% year on year, well below the 2.5%-3.5% contraction many professional economists were predicting. (chart) For example, the Central Bank of Russia (CBR) was expecting a 2.% contraction and the EBRD just improved its economic forecast for the year-end result for 2022 to a still painful -3.5% only a week ago, but left its outlook for this year at 3%. The EBRD’s previous prediction for 2022, given in September 2022, anticipated a 5% drop in Russian economic growth in 2022.

Economists in general have been left scrambling to work out what happened to the Russian economy in 2022, as it was battered by multiple major shocks. It is now emerging that Russian President Vladimir Putin’s Fiscal Fortress has proved to be even more robust than even the most optimistic forecasters expected.

The result also suggests that the contraction this year also be even milder than anticipated, despite the two new rounds of oil embargos and the oil price cap schemes that were introduced on December 5 and February 5, targeting crude and oil product exports respectively. While the EBRD kept its forecast for a 3% contraction in 2023, the IMF’s prediction that Russia’s economy would grow by 0.3% this year, considered to be a wildly optimistic outlier, now looks a lot more likely.

The 2.1% result is surprising on several levels. First, it is way below the 15% contraction most economists predicted a year ago at the start of the war, when the “massive package” of CBR sanctions and SWIFT sanctions were imposed only days after Russia’s invasion of Ukraine. Those both came out left field and were expected to be devastating.

It is also a full percentage point less than the 3.1% contraction in 2020 that was a result of the lockdown of the economy during the coronavirus pandemic. It was also much smaller than the falls in GDP during the financial crises of 1998 and 2009. Indeed, of the last five really big crises in Russia over the last three decades, as detailed by bne IntelliNews in a feature on the history of crises, the war-induced crisis is by far the most mild Russia has experienced.

The Ministry of Economic Development has begun developing scenario conditions for the forecast of Russia's socio-economic development until 2026. A number of indicators of the current forecast (prepared in September 2022) will be improved, according to sources inside the ministry. The revised document will be submitted to the government in April. According to Macro Advisory, the current forecasts include:

▪ The economy will contract by 0.8% in 2023 and grow by 2.6% in 2024

▪ Inflation at the end of this year is predicted at 5.5%, and the government expects it to return to the target of 4% in 2024

▪ Investments in fixed assets will decrease by 1% in 2023

▪ Real disposable income will increase by 1.6%

▪ The main factors for economic recovery will be consumer demand and high investment activity.

“When preparing the document, we will take into account the positive results of 2022 achieved through the implementation of the Plan of Priority Actions in the Conditions of Sanctions,” the Ministry of Economic Development said in February.

But unlike all the other big crises in 1991, 1998, 2009, 2014 and 2020, in each of those cases Russia remained an open market economy that still produced raw materials and was able to bounce back. In this crisis Russia has become a closed, non-market economy with sanctions on its major money earners, and the chances of it bouncing back are very low; even CBR Governor Elvia Nabiullina estimates that Russia’s long-term growth potential for the foreseeable future is a mere 1.5%. Russia will very likely stagnate for the next decade.

However, in a word of caution, the government has been restricting much of its economic reporting, which previously has been very good, and some analysts worry the picture is being distorted by the government on purpose. Large categories of data on things like trade and the bank sector performance have simply disappeared. 

“Who are the winners? Any factory that that is connected to the military or had to retool to supply the military. But I don’t believe in the second-quarter big investment figures. In the best of years there is never great investment and there is a lot of leakage, as a lot of “investment” is wasted. And there is a question of messaging, as the government needs to send a good message. And we might get a Chinesisation of reporting. In the past the reporting was good, but now RosStat is restricting what it reports, so it is not as clear,” says Elina Ribakova, deputy chief economists at Institute of International Finance (IIF), during a bne IntelliNews podcast on the impact of sanctions.

Find out more about the impact on sanctions on Russia’s economy. Watch bne IntelliNews’ podcast with an all-star cast of the leading commentors on Russia economy here.

Down but not out

“The contraction of 2.1% in 2022 was smaller than expected, indicating that the country's economy may have stabilised after the initial hit from sanctions in Q2,” Liam Peach, an emerging market economist with Capital Economics, said in a note. “This trend is supported by the expansion of the economy in Q4. However, the economy's momentum remains weak, and with headwinds to activity building, it may take until late this year for Russia to embark on a sustained recovery.”

The expenditure breakdown showed that the contraction was driven by a drop in inventories as well as household consumption, which declined by just 1.8%, according to Capital Economics.

“This is surprising given that the monthly retail sales data showed a fall of around 7% last year. Household spending weakened due to a sharp rise in inflation, a tightening in credit conditions, and a preference for higher savings in the face of greater uncertainty,” said Peach.

Inflation has also been doing well. In the first week of the war the CBR put though an emergency 100bp hike that immediately stopped a meltdown of the ruble that had gone into free fall. That in turn prevented a devaluation spike in inflation and unlike almost all the other countries in the region inflation began to fall steadily to the point where CBR Governor Nabiullina was able to quickly start cutting rates, switching her attention from fighting inflation to bolstering growth, although by September with the prime rate at 7.5% her easing of rates seems to have come to an end. (chart)

Unemployment also usually spikes during a crisis, as illustrated by bne IntelliNews’ despair index, but in 2022 it remained at close to its post-Soviet all-time low of 3.9%, partly constrained by the lack of labour after 300,000 men were conscripted during Russia’s partial mobilisation that started on September 21.

Russia’s PMI manufacturing index that surveys business activity also had fully recovered by the autumn and went back in the black with a strong finish to the year of 53 (any result above 50 is expansion), while industrial production in 2022 was resilient, declining by only 0.6% thanks to the war spending by the government.

Russia’s trade turnover has been hurt too, but the trade with “friendly countries” has softened the blow. Following the start of the war the government immediately passed a law allowing parallel imports – in effect legalising piracy and abandoning respect for intellectual property rights. Trade with the West collapsed, but trade with Turkey, China and the other countries of the Global South soared. This trade has been significantly undermining the effectiveness of sanctions.

“There has been rerouting of goods through other countries, both friendly and not, but it’s not clear. There is this import substitution. China has stepped in significantly to substitute goods that Russia used to get from West. Whether it's substitution or just rerouting from the West is not clear yet. There is some anecdotal evidence that chips and drones are getting through. Russia is getting access to what it needs. Maybe at higher prices or imperfectly, but it is an important part of undermining the sanctions,” say IIF's Ribakova, who adds that the financial sanctions have been more effective.

Russia’s shop shelves quickly refilled with all the goods that disappeared after Western multinationals brought down the shutters on their direct participation in the Russian economy in the first months of the war.

And its not just Russia’s friends outside the West that have been helping hold the economy together. After the initial reports that over 1,000 Western companies worth “40% of GDP”, according to Yale, were pulling out of the market it turns out that only 9% have left – and only 4% of German companies have gone. Russia remains too big a consumer market for many of the largest retailers to simply abandon it. Even those that have gone, many have sold to their local management in a deal that includes a buy-back option a few years down the road.

In the latest scandal, not only has French supermarket chain Auchan, that has a multibillion business in Russia, not left, but it has been caught supplying the Russian army in Ukraine.

A few sectors like mining, energy and construction have held up well because of the war but others that were heavily dependent on imports, like automitve, have been decimated. Russia normally manufactures about 100,000 cars per month, but at its low in July, Russia's carmakers produced a total of 3,400 cars in the entire country. (chart) However, by the end of the year as new parts began to arrive from China and Iran production had recovered somewhat, but remains 60% down on the previous year.

Construction has done particularly well as Putin insisted that the mortgage subsidy programme was extended that has supported development, especially in the residential sector, against the CBR’s advice, which is worried about a bubble forming. Mortgages is one of the ways the Kremlin is stimulating the economy, as they are one of the three big drivers of economic growth and have multiple beneficial knock-on effects on other sectors and to employment as well.

But other sectors have been caught between the gaps. 

“Pharmaceutical production has grown by 25% y/y, as it was one of the big winners from import substitution,” RBC’s economics editor, Ivan Tkachev said in a bne IntelliNews podcast on the impact of sanctions on Russia’s economy. “It is deceptive too, as the pharmaceutical sector was one of the most dependent on imports for equipment and inputs, so it has also suffered.”

War economy

Energy exports and extraordinary earnings thanks to soaring oil and gas prices obviously played a big role in propping up Russia’s economy. The economy finished 2022 with a current account surplus of an extraordinary $227bn – more than twice as much as 2021, which was itself an all-time high at $120bn. Russia’s economy earned more money than at any time since the fall of the Soviet Union in 2022, largely because of, not in spite of, sanctions.

In another quirk that leaves Russia with more money, the decision to freeze $300bn of the CBR’s money at the start of the war was considered to be a crushing blow to Putin’s fiscal fortress. The only problem is one year on, and EU officials can’t find most of it. Of the $258bn that the Bank of Russia held in Europe, according to its own reports, the European Union's legal service has only been able to identify €33.8bn ($36.4bn), which was impounded. The other $221.6bn is simply missing and presumably still under the control of Moscow.

Even if this money is found, it remains highly unlikely that the EU can grab it and give it to Ukraine. The money has been frozen, but technically it still belongs to Russia. Governments can only seize another government’s assets if they declare war on it – something that the West has made very clear it has no intention of doing, which leaves the frozen CBR money in limbo.

President Putin’s move to put the economy on a war footing also helped, as did industry’s scramble to retool to take account of the sudden disappearance of many essential inputs due to sanctions and self-sanctioning by suppliers. Companies chose to accelerate investments rather than delay them, and there was a mad rush to find new international partners. In one survey only 20% of companies said they were totally unable to replace banned technology imports from the West.

“Fixed investment expanded by 5.2% and government expenditure by 2.8%. Export and import data have been withheld, but RosStat reported that net trade accounted for 12.8% of GDP, up from 9.3% in 2021,” reports Peach.

However, there was a lot of pain too. On the production side, wholesale and retail trade collapsed by 12.3%, professional services fell by 5.1% and manufacturing declined 2.4%, reports Capital Economics.

“Beyond these sectors, output held up quite well. Construction expanded by 5%, mining by 0.4%, financial services by 2.8%, and most other services sectors by 2% or so. This shows how the hit from sanctions was in specific sectors, and much of Russia's economy was able to adapt,” says Peach, adding latest activity data point to a very small recovery in industry and retail trade at the end of last year.

Looking ahead, 2023 is likely to remain difficult as the outlook is beset with large unknowns. Russia's energy sector adapted remarkably fast to the imposition of self-sanctioning of oil and successfully redirected all the crude exports from Europe to India and China. The working assumption of most professional analysts is that it will repeat the same trick in 2023 so that the impact on budget revenues will be much milder than the collapse in oil and gas revenues seen in December and January, to prevent another large fall in GDP. While the IMF remains upbeat and expects some small growth, most of the other forecasters are more cautious. The CBR is keeping its options open, predicting GDP change in the range of -1% to +1%, up from its previously pessimistic range of -1% to -4%, while Capital Economics’ current working forecast is for a decline of around 2%, “which will be revised in due course,” says Peach.

“The biggest risk for Russia and Europe comes from the war in Ukraine,” says Isakov. “We are trying to understand what is going to happen in the next four, five six months and take it from there.”

Budget revenues collapse

But Russia has not come off unscathed from the sanctions. After putting 11 months of federal budget surpluses, revenues collapsed in December thanks to the first of the oil embargos. November’s budget would have been in deficit if it hadn’t been for a one-off payment of RUB416bn by Gazprom that kept it in the black, but nevertheless it was an impressive budget performance.

And then it all went wrong. Russia’s budget lost a whopping RUB3.9 trillion ($52bn) in a month in December – as much as the budget is expected to lose in the whole of 2023 – leaving the budget deeply in the red for the year with a 2.3% deficit.

January was no better, as the second round of oil products sanctions loomed. Usually the budget starts the year flat as most of the federal spending happens in December, but this year the government started with a RUB1.8 trillion deficit – half the total expected for the full year in 2023 – its worst result since the 1990s. (chart)

The ministry said the preliminary January deficit estimates included a spending spike of 59% on the year to RUB3.1 trillion that was compounded by a crash in revenue of 35% to RUB1.356 trillion, opening up a wide hole. Oil and gas revenue were the main culprits for the gap after they plunged by 46% in January y/y to RUB426bn mainly because of lower prices for the Urals oil blend and lower exports of natural gas.

Russian Finance Minister Anton Siluanov played the collapse down, blaming it on new accounting methods and the government’s decision to pre-pay some obligations to smooth out payments over the year. However, economists said that if the trends continued for the full year Russia would end 2023 with a deficit of not RUB3.3 trillion ($47bn) as per the plan, but something closer to RUB6 trillion to RUB9 trillion. That amount would eat up all of the National Welfare Fund (NWF), which held RUB6.6 trillion at the end of 2022, as well as all of the RUB3.5 trillion Ministry of Finance (MinFin) was intending to issue in Russian Finance Ministry’s OFZ treasury bills over the course of the year. (table)

Despite the dramatic collapse in revenues, this was still not a disaster for the Kremlin, as it has the resources to easily cover the shortfall and moreover, this is less than the RUB4.4 trillion deficit that Russia ran up during the coronacrisis in 2020.

More importantly, economists doubt that the oil and gas revenues will remain so low and expect them to recover in a few months after the market adjusts to the huge changes in the routes oil exports will have to find following the implementation of the two rounds of oil sanctions.

“The oil and gas revenues are down, as they are still using the Urals price. The revenues are linked to the Urals price but that has fallen, but the price is not clear any more, as now the prices are more of a surrey than a report of the real prices. Then we also had a lot of unseasonal spending in January, when usually there is not a lot of spending, which could have been military spending,” says Ribakova. “So I wouldn’t fully write off the budget with a RUB6 trillion, RUB9 trillion, for this year just because they are capable of removing all spending on babushki and investing it all into military spending.”

Oddly, the revenues fell sharply in December and January, but oil production did not. Russia was producing 11mn barrels a day (bpd) on the eve of the war and production has fallen in 2022, but Russia was still producing 9.8–9.9mn bpd of oil in January, unchanged from December, according to Deputy Prime Minister Alexander Novak. That is still far above the 6mn bpd that was predicted by the Yale report in last summer. For the full year, Russia produced as much oil in 2022 as it did in 2021. The following week the Kremlin announced it would cut production by 500,000 bpd, but it is not clear why. Some analysts have speculated that it has to, as it can sell everything it is making, while others say the Kremlin is simply hoping to drive prices up. The fact that shipborne exports soared in January suggests that the production cut has more to do with price than the lack of demand. On February 21 the government announced the production cut would be for the month of March only, further suggesting a lack of demand is not the problem. 

Despite the volatility on the energy markets MinFin maintains its forecast for the 2023 budget deficit at 2% of GDP, Siluanov said on February 17, in which case the liquid portion of the NWF plus the bond issues will easily be enough to cover the deficit.

“The most important thing is to look at the budget balance that we will have at the end of the year. Our plan is to have 2% of GDP at the end of the year, no one cancelled the plan, and we will adhere to these parameters,” he said during a televised interview.

The federal budget law stipulates that Russia’s budget deficit should amount to 2% of GDP in 2023, to 1.4% in 2024, and to 0.7% in 2025.

If, however, things do go catastrophically wrong, together the NWF and OFZ issues can still cover even the worst case RUB9 trillion deficit scenario – the most extreme forecast amongst economists – and that would set Russia up for yet another crisis in 2024. Few expect this to happen.

But MinFin is not taking any chances and has already started talks with Russia’s largest companies on ways to increase its tax take. The mineral extraction tax (MET) has already been increased and in January MinFin started talks with the Russian Union of Industrialists and Entrepreneurs (RSPP), a big business lobbying group, on voluntary contributions to raise an addition RUB200bn.

In another preparatory move the budget rule was changed in January. Previously excess oil and gas revenues above $42 per barrel of Urals oil were siphoned off into the NWF. At the same time, the oil price cap is specifically tied to the price of Urals blend barrels and that are determined by the Baltic oil exchange. But since the embargo the amount of oil that travels via the Primorsk-Rotterdam route has fallen dramatically and those prices are becoming increasingly meaningless. Russia has other blends and, for example, has boosted the amount of oil sent via its Black Sea ports by a quarter in the last year.

Under the new budget rule, the Urals price has been abandoned completely and now the cut-off is predicated directly from the oil and gas revenues earned by budget from all oil exports to decide if money should be siphoned off into the NWF or to simply pumped straight into the budget.

Much will depend on how the oil and gas revenues story plays over the rest of the year.

Oil and gas revenues

There is a great deal of uncertainty over what will happen this year. The government’s revenues got off to a really bad start in January, but it remains to be seen if the oil price cap schemes can be made to work and if Russia can continue to reorientate its exports to Asia. And it is already becoming clear that the oil sanctions are very leaky.

Isakova said: “The updated current account forecasts are a bit confusing: the average oil price for 2023 was down by -$15 per barrel, but the exports of oil was almost unchanged at about RUB0.5 trillion for the year, but should have been down about 10%. One hypothesis for this is the Bank of Russia believes Urals benchmark price is flawed and understates export price.”

The Kremlin already has multiple schemes to dodge sanctions. The most obvious is that it has bought up old tankers and is operating a “ghost fleet” of anywhere between 150 and 600 tankers that are not subject to the oil price cap restrictions.

Greek shipping companies have also been helping by increasing the amount of Russian crude they ship, much to the ire of the EU, and with the reported deep discounts Russia is offering on its oil, far below the $60 cut-off, after which restrictions apply to shipping Russian oil, even these EU member-owned ships can legally transport Russian oil to anyone that wants to buy it.

At the same time, scams like ship-to-ship transfers, one of the easiest ways to dodge sanctions and disguise the origin of Russian oil, have exploded. They are most visible off the Spanish North African city of Ceuta and off the Greek coast near Kalamata. At least 30 cargoes have been transferred between ships in those two locations since the start of the year, according to Bloomberg based on a study of ship destination and cargo data. Twelve more Aframax tankers that loaded in the Baltic since late January also appear to be transferring their cargoes to other vessels at sea in the Mediterranean, the newswire reports.

And Russia’s friends in the Global South are coming to its rescue. India continues to import large amount of Russian crude, but as the oil products embargo loomed, African nations boosted the import of Russian oil products, including the all-important diesel exports, in January as the market races to remake itself in the face of the new realities. Turkey, Morocco and Senegal in West Africa all became big customers of Russian diesel. Turkey imported 213,000 bpd of Russian diesel in December, reaching its highest level since 2016, according to Vortexa Ltd. A similar trend was seen in Morocco, which has also noticeably stepped up imports of diesel from Russia.

Analysts at oil consultants Kpler speculated that African nations, many of which support Russia or at least remain neutral, will consume more Russian diesel or export it back to the EU. In the same game of musical chairs, the EU will also start sourcing diesel from further away, from the likes of the India, which is using Russian crude in its refineries to make “Indian” diesel.

Finally, it appears that Russia is playing games with the prices assigned to a barrel of its Urals blend of crude. The price of a barrel loaded onto a ship (the FOB, or “free on board” price) at Russia’s biggest Baltic port of Primorsk has fallen to below $50 compared with the $80-plus price of Brent in recent weeks. However, according to reports, Russia has begun to add services to buyers in India and elsewhere like insurance shipping and when these costs are included the end buyer of the oil can pay an addition $25 for a barrel of Urals. As the oil price cap scheme is tied to the FOB price, Russia can export oil unimpeded, but be paid around $75 at the end of the barrels journey – $15 more than the $60 price cap and only a $5 discount to the current price of Brent, slightly more than the traditional $2 discount Urals used to have against Brent before the war.

This assessment is supported by the fact that India reported that the discount between Urals and Brent paid for the Russian oil it was importing in November fell to nothing in November and remained zero in December. As it takes a month for oil to travel to India the effect of the oil price cap introduced that month will not be visible until January but the previous narrowing of the discount India was getting earlier in the year suggests the discounts won’t be large. (chart)

All of this means the outlook for Russia’s oil and gas revenues remains very uncertain. While few economists expect Russia to earn the same $227bn current account surplus as it did in 2022, oil and gas revenues are also unlikely to collapse either. Elina Ribakova, deputy chief economists at IIF, who has been studying the oil business for years, estimates the current account surplus will come in at around $100bn, less than half of this year but still close to all-time highs compared to the average of the last five years.