A long-debated sanctions bill in response to Russian meddling in U.S. elections was signed into the other week by President Donald Trump. The bill provides a framework for the extension of sanctions to various other sectors of Russia’s economy; but perhaps more importantly, it makes the lifting of existing sanctions a much more difficult proposition—nearly impossible, if the long-standing Jackson-Vanik amendment, which was signed into law in 1974 and only repealed when the Magnitsky Act was approved in 2012, is any indication. How painful are these now probably semi-permanent sanctions for Moscow? More hurtful than you might think.
There is a conventional wisdom that Russia’s ongoing recession, still lingering today since 2014, was mostly due to the collapse of international oil prices, and that Western sanctions have only played a minor, secondary role. This theory is as misguided as medieval cosmology. To wit, our eyes tell us that the Sun circles the earth, so it must be true. The same goes for Russia and oil prices: everybody knows that Russia is heavily dependent on oil, oil prices collapsed, and therefore it is self-evident that the main reason for all of Russia’s recent economic woes is low oil prices. The theory that Western sanctions were somehow “unimportant” is a sentiment that has been strongly amplified by a choir of Russian propaganda outlets, their numerous Western sympathizers, and all sorts of “useful idiots”—including a coterie of respected economists who focus on studying oil prices and their effects to the exclusion of all else.
The oil price theory doesn’t stand up to simple common-sense check of the figures. For one, Russia never cut its budget. It managed to keep spending at a constant level—around 15-16 trillion rubles per year, even slightly increasing spending during the 2014-2017 crisis (up from the 13.9 trillion rubles initially approved for 2014). This spending was in part financed from Russia’s Reserve Fund, a vehicle set up with cash windfalls from the period of high oil prices in the 2000s in order to guarantee Russians’ pensions in lean times. It was also paid for by a drastic shrinkage in imports. Despite falling revenues from global oil prices, there hasn’t been a single month since 2014 in which Russia has run anything but a healthy trade surplus.
Oil prices took a tumble both in 2008 and between 2014-2015, but the absolute scale of the collapse in prices was greater in 2008. Yes, Brent temporarily settled at a new low between December 2014 and March 2015, but by then, the worst for the Russian economy was over. But while the ruble took a hit in 2008, it was nothing like the gutting it has endured during the current crisis, losing more than half its value and remaining deeply depressed since. Some have argued that in 2008-2009, the ruble was supported by Russian Central Bank, which heavily spending its currency reserves. But once again, the figures don’t really bear this out. The Central Bank drew down nearly the same amount of its reserves during both oil collapses—$186 billion between July 2008 and April 2009 versus $154 billion between 2014-2015.
So there must clearly be something else going on besides oil, right? The answer is obvious: Western financial sanctions and the international credit blockade facing Russia since 2014 has taken its toll.
One factor is usually overlooked by analysts looking at Russia’s finances: Russian businesses accumulated significant foreign corporate debt between 2009-2014—a key to the modest Russian economic recovery after the 2008-2009 global financial crisis. Russian companies and banks kept borrowing like crazy: their total foreign debt nearly doubled in just 4 years, from $357 billion in July 2010 to the highest peak in July 2014—$660 billion. Much of this was short-term debt, rolled over regularly. When things were good well with the West, refinancing was never a problem.
Credible sources have told me that the possibility of refinancing problems emerging never occurred to Vladimir Putin and his inner circle when he decided to invade Crimea and Donbass. Heavy borrowers like Igor Sechin, the head of Rosneft, were apparently assuring Putin that Western banks had too much profit at stake to ever stop lending. And Western governments—according to this strand in Kremlin thinking—would never go against the interests of their key financial players.
But after the shooting down of Flight MH17 over the Donbas, of course Western governments did just that.
This resolve was a huge surprise to Putin, and the sanctions have caused a lot of pain. The measures not only led to credit drying up for the biggest players in the Russian corporate and banking sector that were directly included on the sanctions lists, but also for most others of Russian origin, just in case. As one major international banker told me at the time, “Who knows whom these Russians could invade tomorrow, and how the sanctions lists will be expanded; let’s just stay away from Russians for now.”
By the end of 2014, total Russian corporate foreign debt has shrunk by $112 billion. The ruble’s stunning plunge in December 2014 was directly tied to the demand for liquidity connected to end-of-year debt repayments. Total corporate foreign debt continued to shrink further, stabilizing roughly at its current levels of about $470 billion only by mid-2016—almost $200 billion in credit gone missing since mid-2014.
The credit blockade has also prevented Russia from borrowing its way to a recovery, as it did between 2010 and 2014. Its financial system is weak and can’t generate quality assets. The greater part of banks’ deposits are short-term. State reserves have been greatly depleted, and Putin appears to have banned their further looting for the purpose of aiding the corporate sector. There were hopes that China would flood Russia with credit, but China has proven to be neither interested nor capable of doing so. The Chinese financial system is four times smaller than that of the United States and three times smaller than that of the European Union. The Chinese have preferred to lend only to support domestic demand, and have only started lending abroad as part of their One Belt, One Road strategic initiative, which pointedly circumvents Russia. When loans have come through, most of the credits have been tied to direct Chinese participation in projects, or to the procurement of Chinese goods and services. And in any case, the scale has not been nearly big enough to make a difference.
The pressure on the ruble accompanying the credit crunch has led to a significant decline in the living standards of average Russians. The reason is simple: Russian standards depend on being able to import consumer goods. During Putin’s reign, Russia has been essentially redistributing petroleum revenue windfalls to raise standards of living. There was enough oil and gas money left over after Putin’s favored were done looting to keep the majority of the population feeling like things were improving. This complacency led to Russia failing to develop the capacity to manufacture quality consumer goods, something that would have required a favorable investment climate, less government interference in business affairs, an independent judiciary—everything that has been anathema to Putin and his increasingly authoritarian and kleptocratic state.
Putin tried to get “import substitution” going in response, most visibly by instituting counter-sanctions on Western food imports. But given the economic model he had nurtured during his reign, this was doomed to fail. Instead of a raft of domestic firms springing up to try to meet the demand of Russian consumers, the highly monopolistic environment and the brutal clientilism practiced by government institutions naturally led to nothing but rising prices for most people and extra profits for a handful of Kremlin-affiliated agro-businesses. With the ruble stabilizing in mid-2016, imports have started to grow again. Russians, fed up with “substitutes” and wanting to go back to better quality products, have started spending their declining wealth on imports nonetheless. According to official statistics, as of June 2017, imports of meat, poultry, milk and dairy products grew by 50-60 percent year on year, while domestic production growth was either in single digits for meat and poultry, or in decline for dairy.
Russian government officials continue to talk about the ruble being “overvalued”, and suggest that another drop may be ahead. Given the continuing importance of consumer imports, this means that domestic consumer purchasing power would once again take a hit. Structural reforms, which could in theory do a lot if they were implemented soundly and in good faith, are almost certainly not in the offing, given that they would involve de-monopolization of the state-owned economy and a massive exit of the government from so-called “vital strategic sectors”. Putin would obviously not allow this, even on his deathbed. And thus, Russia today finds itself stuck suffering the most severe and lasting decline in living standards since the collapse of the Soviet Union in early 1990s.
That all said, the collapse of oil prices is not unimportant—far from it. It remains the underlying factor that keeps Russia down and flailing. But low global oil prices alone would not have knocked Russia this far back, this hard. Western sanctions are playing an underappreciated role. And the fact that it looks like they are here to stay for the long run have put the Kremlin in quite a bind.