The World Bank has released a forecast for the Russian economy in 2023, and the results are not pretty. According to World Bank calculations, Russia’s gross domestic product (GDP) will fall again by 3.3 percent in 2023, due to the full implementation of the EU oil embargo and falling natural gas exports from Moscow to Europe.
But Moscow is more optimistic than the World Bank. The government views its current plight as a period of adjustment to unique challenges rather than an outright disaster. That’s partly because it believes overall economic output will contract less drastically this year, at less than 1 percent (according to the Department for Economic Development).
So the question is: who is right? Is Moscow naive? Does it belie reality with its numbers? Or does Russia actually have a bigger safety net than the West thinks? The answer is important, because the Kremlin’s foreign policy decisions – particularly with regard to the Ukraine war – will depend heavily on how its economy is doing. Weak economic activity and social instability will require more financial leverage and government support as many sectors depend on government payments.
Survive despite adverse circumstances
According to the state statistics agency Rosstat, about 33 percent of the Russian population (excluding state employees) receive social benefits from the state. This creates a direct link between poor economic performance and potential instability. However, if the economy weathers sanctions and logistical difficulties reasonably well, the West will have to find new ways to weaken Russia. In time, he may even think about how to start negotiations and find compromises with regard to the war in Ukraine. Regardless of the actual economic situation, the Kremlin will therefore want to demonstrate to the West and its people that its economy can survive despite the adverse circumstances. His negotiating position in Ukraine depends on it.
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In fact, over the past six months, Moscow has begun to show that the Russian economy can do without America and Europe. The European sanctions and restrictions have affected the financial sector, the market for components and semi-finished products, logistics and the consumer goods market. Russia has adapted in a variety of creative ways, including diverting some of its oil and gas flows eastward and creating parallel imports that allow companies to stock their shelves and gain access to the components they need.
In addition, the departure of some foreign companies allowed domestic industries to develop in their place. The increasing use of national currencies in payment transactions meant that dependence on the US dollar for commercial transactions was reduced. Import substitution was particularly successful in the textile, service and food industries. Most importantly, prices for resources such as oil and gas remained high, allowing Moscow to absorb lower levels of overall exports.
Striving for technological sovereignty
Of course, the Russian economy has its problems. Sanctions and supply chains aside, the main problems are modest consumption, falling investment and increasing emigration. Since December, the Ministry of Digital Transformation has been meeting with representatives of professional associations and IT companies to discuss the return of IT specialists who left Russia. In addition, the Kremlin is not particularly happy with the budget situation.
Russia’s Finance Minister Anton Siluanov said the budget deficit in 2022 will be around 3.3 trillion rubles (about $50 billion), or 2.3 percent of GDP — excluding 2020 at the peak of the pandemic, that is highest budget deficit ever. The Treasury noted that spending increased about 25.6 percent compared to 2021, peaking in December at 22 percent of annual spending. The deficit was covered by government and National Welfare Fund borrowing, and by Gazprom, which temporarily paid higher taxes.
As successful as Russia has been in creating parallel imports in certain sectors, it has failed to find suitable substitutes in the complex, knowledge-intensive, and high-tech industries. Take the Moskvich, for example – a car that is rumored to be domestically produced. Although it is assembled in Russia, it is made with Chinese spare parts. Simply put, it was not possible for Russia to reliably produce and launch a car in less than a year.
So while Moscow aspires to technological sovereignty, in reality it is orienting itself more towards the Asian than towards the Western markets. Officials at the Moskvich plant said they want to assemble the cars from domestic parts by 2025 – which means it would have taken at least two to three years to figure out how to produce the necessary parts independently. That’s a long time.
Oil industry plays paramount role
Meanwhile, the state of the Russian budget depends primarily on three factors: the price of oil, the volume of hydrocarbon production and the ruble exchange rate in 2023. February – when the European oil embargo comes into force – will be a particularly revealing month in this respect. While it is possible that derogations will be introduced, hauliers have become increasingly cautious not to run afoul of the new legal requirements. And otherwise dependable target markets like China and India, which were keen on crude oil and gas, may no longer be as interested in certain other products as they are important refining centers themselves.
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Russia will of course benefit from selling the oil, but its profits will be lower as it is likely to be able to sell smaller quantities of it. The uncertainty surrounding the sale could also impact oil prices. There is no consensus on what the price of the Russian Ural mix will be in 2023. Western countries imposed a $60 per barrel price cap on Russian oil, after which the average price of Urals was $50.47 per barrel: significantly lower than in December 2021, when it was selling at $72.71 per barrel.
Russia itself is also likely to limit oil production: President Vladimir Putin’s ban on exports of Russian oil and oil products to certain foreign legal and physical entities directly or indirectly using the price coverage mechanism will come into force in February. This could push up the price of oil, but it could also curb sales. All of this calls into question Russia’s projected growth rates. The oil industry plays a paramount role in Russia’s GDP, and at least for now, it’s looking bad for production and supply.
Inflation is slowly declining
Against this background, both the World Bank and Moscow are right. The Kremlin’s economic forecasts are rosier than they should be, but there is reason to believe the economy can absorb more shocks than the World Bank estimates. The budget deficit is small compared to GDP; Russia has managed to accumulate cash earnings from oil exports, and there are enough funds in the National Prosperity Fund to cover deficits and possibly fund new social programs. Unemployment is low and many industries have started to gradually increase their pace of production. Inflation is slowly coming down. Russia is not out of the woods just yet, but the signals are enough to convince Moscow that it can weather the next few years while it adjusts to the new economic realities.
Time is perhaps the most important variable. The Kremlin will want to see positive results as soon as possible; he knows his prospects of negotiating an end to the Ukraine war depend on his ability to withstand Western pressure. And he knows that domestic political stability depends on his people being happy.
However, the World Bank and Moscow agree on one point: the Russian economy will shrink. There is practically no way around it. All the other uncertainties that come with it will force Russia to skimp and economize to avoid wasting limited resources, while at the same time presenting the image of greater economic success.
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