The 3.5% expansion in Russia’s GDP in Q1 is consistent with a small contraction in q/q terms, and this will almost certainly be followed by a steep fall in output in Q2 as the effects of Western sanctions bite hard. For 2022 as a whole, we’ve pencilled in a 12% contraction in Russia’s economy, which would be the steepest downturn since the 1990s.

​​Russia’s current account surplus widened to $58.2bn in Q1 of 2022 from $22.5bn in the same period last year, a preliminary estimate showed. It was the largest current account surplus since available records began in 1994, as the goods and services account widened to $66.3bn from $25.8bn a year ago, with exports jumping 50% and imports rising at a slower 14%. On the other hand, the aggregated primary and secondary income accounts recorded a deficit of $8.1bn, widening from the $3.3bn gap the prior year, as payables increased by 55% and receivables rose at a softer 36%.

Certain parts of the economy were hit particularly hard as Western sanctions, strict capital controls and a sharp interest rate hike hit home – car sales plunged 72% m/m in March. On the whole, though, the economy proved more resilient than we (and others) had expected. Industrial production continued to rise on the back of higher mining output and panic buying meant that retail sales fell by only 0.3% m/m.

The most acute phase of the crisis now appears to have passed, but even so a sharper decline in economic output is almost certain in Q2. The plunge in imports in recent months is representative of a collapse in domestic demand. Meanwhile, oil production reportedly fell by 8% m/m in April.

The Bank of Russia’s consensus forecast for April projected that GDP would decline by 9.2% this year, with real wages falling by over 10%.

Russia’s economy has been doing much better than expected as the effect of sanctions has yet to make itself felt at street level yet, other than the rise in prices. The Institute of Economic Forecasting of the Russian Academy of Sciences (IEF) estimates that GDP rose by 4% year-on-year in the first quarter, by 3.1% year-on-year in March, and by 0.15% between February and March, seasonally adjusted.

In part, the rise in GDP in March is simply a product of the sharp decline in imports, which flatters the headline growth figure but doesn’t say much about the change in living standards and productive capacity. But Rosstat’s most recent production figures show manufacturing output declined by only 0.3% in March year-on-year, largely due to a catastrophic 45% drop in production in the automotive sector, which is heavily reliant on imported spare parts. The manufacture of other transport machinery, metal goods and electrical equipment also fell by over 10%, but many other manufacturing sectors recorded growth in annual terms.

Industry surveys show a sharp jump in business uncertainty, and rising concern about the availability of inputs due to sanctions. But as the HSE Development Institute concluded, “there is currently no clear sign of a recession in the manufacturing sector, with the exception of the shutdown of car production.”

The IEF points out that given GDP growth of 4% in the first quarter, a full-year decline in GDP of 8-10% would require a very sharp contraction in the second quarter of more than 14%, which is highly unlikely. The economy has largely stabilised after the initial shock and the labour market is also stable.

But it is not clear if this “partial stabilisation” is the result of temporary factors or reflects a more fundamental resilience of the economy. Some firms have benefitted from a temporary rise in demand from consumers seeking to get ahead of inflation and the expansion of military production. It is possible that many producers have not yet exhausted their inventories, and the full disruptive effect of the ban on equipment and technology imports has not yet started to show. If that is the case, the sharp drop in car production may be a harbinger of things to come in other sectors.

Initial trade data for April shows that Russia is being denied access to critical industrial goods. But so far, manufacturing surveys, while negative, do not suggest producers anticipate a supply shock of the scale of the auto sector.

The biggest long-term shock will come from Europe’s efforts to end all Russian energy imports that account for some 40% of Russia’s budget revenue. This will take several years to implement but Europe is committed to the strategy.

The International Energy Agency (IEA) reports that Russian crude oil output averaged around 10mn barrels a day in the first three months of this year. Russian oil output dropped last month to around 9.1mn barrels a day. When natural gas liquids are included, Russia’s overall oil output in April averaged about 10.3mn barrels a day, a decline of roughly 10%. Oil refining volumes reportedly declined sharply in March and April. Deputy prime minister Alexander Novak says that he expects oil production to rise significantly in May and that production levels should further increase in June. Other forecasts are more pessimistic, however. The base scenario in the latest forecast of Russia’s economic development ministry sees oil production contracting by 9% this year. The IEA estimates that Russian oil production could decline to a level of around a 7mn barrels a day by the end of this year.

It will cost the EU €195bn to become independent from Russian energy, reported Spiegel.de. The European Commission wants to set more ambitious goals for increasing the use of renewable energy sources and energy conservation. The strategy aims to quickly reduce dependence on fossil fuels from Russia through the transition to the energy sector. By 2030, 45% of the total energy in the EU should come from renewable sources instead of the previously planned 40%. According to the project, by 2028, the number of solar power systems should more than double to 300 gigawatts. By 2030, 10mn tons will be produced in the EU, and another 10mn tons will be imported. At the same time, by the end of the decade, it is proposed to reduce energy consumption by at least 13%, instead of the previously planned 9%.

Finland and Sweden have applied for NATO membership and Russia responded by cutting off Finland’s electricity and gas exports. Russia has also said it will beef up its military presence in the Western Military district. The Finnish and Swedish Foreign Ministers signed the applications on May 17, and now their admission depends on ratification by all 30 member states. However, Turkey opposes the measure and has put forward a number of conditions for its approval in a move widely seen as Turkish president Recep Tayyip Erdogan using the issue to win political capital from Europe. Turkey wants Sweden and Finland to recognize the Kurdistan Workers' Party (a rebel group in Turkey) as terrorists and a new shipment of F-16 aircraft to Turkey, as well as Turkish readmission to the F-35 fighter supply program (from which it was removed in 2019). Finnish President Sauli Niinistö said that he was "optimistic" that these issues could be "resolved through discussions.”

The war in Ukraine rumbled on in May and has become entirely focused on the Donbas region. At the time of writing the forces were equally balanced and the fighting intense. It remains impossible to call a winner as the arrival of Nato weapons to the front line have evened the fight but Russia is slowing bring more and more resources to bare on the fight while those available to Ukraine remain limited, despite the huge mismatch, to Ukraine’s advantage, in morale and men available to fight.