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Russia's war-time economy shows surprising resilience

23 Feb 2024 9:24|Bartosz Sawicki

Two years after Russia's full-scale invasion of Ukraine, the aggressor's economy has not collapsed in a way that would force Vladimir Putin to end the war. Collapse was avoided by maintaining high revenues from raw material sales and a gigantic increase in budgetary spending. On the contrary, the economy's shift to a war footing has pushed it to the brink of overheating, with a key component being a labour shortage following the mobilisation and fleeing of the country's highly skilled workforce.

Shortly after the outbreak of the war and the wave of international sanctions, market forecasts suggested that Russia's GDP would shrink by around 10% in 2022. In the first year of the invasion, however, the economy contracted by a modest 1.2%. In 2023, Russia's GDP growth rate was 3.6%. This year, the growth rate could be close to 2%. The economy's shift to a military track means a sharp increase in government spending.

The weight of financing the tripling of military spending compared to 2021 would not have been possible without revenues from the sale of energy resources. Their flow in the first months of the war was at a record high, thanks to the sharp rise in gas and oil prices on world markets. This created the space to unleash the financial war machine. Last year, revenues amounted to 8.8 trillion roubles, which was still higher than the average for the decade before the war.

Imposed sanctions and the normalisation of commodity prices last year meant that budget revenues from the sale of commodities were down in the record year of 2022. However, the drop was not large enough to prevent increased spending on the army and security services, accounting for as much as 40% of the current budget.

The latest estimates put current oil exports at around 4.7 million barrels per day. Russia is cutting back slightly, not because of international sanctions but as part of the voluntary cuts under the OPEC+ agreement. A network of shell companies registered in Dubai and Hong Kong, among others, has taken care of finding new customers (above all in China and India) for the attractively priced crude oil. In the case of the latter, supplies from Russia rapidly became the first source of oil supply and accounted for more than a third of total imports last year.

The problem is not only the volume of oil and gas reaching world markets but, above all, the low effectiveness of the instruments designed to limit the price at which they can be sold. Russia is increasingly successful in circumventing the price cap of USD 60 per barrel of Urals imposed in December 2022. The discount at which it sells oil against the leading Brent type was effectively narrowed in the latter part of 2023.

Effective enforcement of sanctions will not end the war overnight but could lead to the failure to meet an insanely ambitious target for budget revenues and mounting problems financing Putin's war machine in the midst of an overheating, ever more internally unstable economy.

23 Feb 2024 9:24|Bartosz Sawicki

This commentary is not a recommendation within the meaning of Regulation of the Minister of Finance of 19 October 2005. It has been prepared for information purposes only and should not serve as a basis for making any investment decisions. Neither the author nor the publisher can be held liable for investment decisions made on the basis of information contained in this commentary. Copying or duplicating this report without acknowledgement of the source is prohibited.

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