Ukraine war: Russia's economy holding out against sanctions

In the dramatic days following Russia's invasion of Ukraine one year ago, the Russian economy was seriously rattled.

Western allies, led by the United States and European Union leveled severe sanctions against the country's financial system. The ruble fell to a record low against the US dollar, the Russian central bank doubled interest rates and the Moscow Stock Exchange was shut for several days.

In a statement, EU leaders described "massive and severe consequences" for Russia. Economists predicted a huge plunge in GDP. Weeks after the sanctions were brought in, the White House said in a statement: "Experts predict Russia's GDP will contract up to 15 percent this year, wiping out the last fifteen years of economic gains."

Nearly a year later, it hasn't happened. While the past 12 months have been very challenging for the Russian economy, it has performed far better than expected.

Getting a clear picture is ultimately impossible. The Kremlin made a lot of key economic data classified after it launched the war on Ukraine, and it remains so today. The underlying shape of the economy is uncertain. However, it's already obvious that the collapse many predicted has not materialized.

"I think we can say that the economy shrank a lot less than the 10 to 15% that people were talking about at the beginning of the war," Alexandra Vacroux, executive director of the Davis Center for Russian and Eurasian Studies at Harvard University, told DW.

She believes Russian GDP fell by between 3% and 4% over the past 12 months. That's broadly in line with estimates from the World Bank, the International Monetary Fund and the Organization for Economic Cooperation and Development.

Russia's official statistics agency this week said the economy had contracted by 2.1% in 2022, having predicted a contraction of 12%.

Panic in Moscow in the early months

Chris Weafer has worked in Russia for around 25 years as an investment adviser and strategist. He said there was a lot of genuine panic within Russia about the economy in the early months after the invasion. That was not only due to the sanctions but also because many companies were voluntarily leaving Russia.

"There was speculation that the loss of trade and logistic routes would hit manufacturing very hard and that one would have significant job losses. So around that time, I was definitely very pessimistic about the outlook for the economy in 2022," he told DW.

However, he said, by May the picture was "improving rapidly." "You could see that the worst-case predictions were not going to happen." 

Europe kept buying Russian energy for much of 2022

There are several reasons why the Russian economy has outperformed expectations. A major one is its hydrocarbons, namely oil and gas. The EU did not sanction Russian oil and gas imports in the early months of the invasion, as it was so dependent on them for its energy needs.

Europe continued to buy Russian oil and gas for much of 2022, while Moscow also found willing new energy trade partners in China, India and elsewhere. Earlier this month, the Russian Central Bank reported a record-high trade surplus of $227 billion (€211 billion) for 2022, largely driven by its colossal energy exports.

"Russia has been able to earn almost like windfall revenues from exporting those products at a very high level because traders in Europe not only continued to buy Russian products, but they started stockpiling them," said Weafer.

That 'windfall' meant the Russian government was able to greatly limit the impact of Western sanctions on its foreign reserves.

"It was able to use the money to provide subsidies for key industries, employment support, make sure it continued to fund not only the military but also social programs and to generally maintain economic and social stability in the country," said Weafer.

That, in turn, has helped keep unemployment low, reportedly at around 4%, although that figure is significantly distorted by the fact that many people have left the labor force, either because they were drafted into the armed forces or because they left the country in the aftermath of the invasion.

Another factor that has helped keep the Russian economy going is that a majority of Western companies continued to operate in the country once the initial clamor to exit the market faded.

Weafer said while companies such as McDonald's came under huge social media pressure to leave, most others rode out the storm. "Especially those that are important for the economy, such as big taxpayers or revenue generators or particularly big employers, they've been much, much slower to leave."

Old sanctions, new markets

Another reason for the robustness of Russia's economy relates to the sanctions themselves. Vacroux said sanctions have consistently failed to live up to expectations in countries such as Venezuela, Iran and Russia itself.

"The fact is that sanctions are most effective right before you levy them," she said. "When you have the threat and you say, if you do X, we're going to sanction Y, and at that point, the actor stops to think, like, is it really worth doing X? And maybe the sanctions have an effect. But once Russia does Y — invades Ukraine — then you really have no more leverage."

Then there is the fact that the Kremlin has been used to dealing with sanctions for almost a decade, since its annexation of Crimea in 2014.

The Russian Central Bank, well-versed in crisis management, took decisive action to shore up its financial system in February and March 2022. The interest rate hike helped prevent a run on banks as the country's inflation rate eased gradually.

Weafer said a decade of sanctions means the country's banks have been heavily stress tested, while Russia has also become relatively self-sufficient in key industries, particularly in food production.

Another major factor driving Russia's economic resilience is the strengthening of its trade ties with China and India. Trade between the countries has soared. Russia has also been able to increasingly benefit from so-called parallel imports, whereby Western products are now finding their way into Russia again via third-party countries like China, India and others across central Asia.

Vacroux said China is "the big winner," pointing out that while trade between the countries soared, so too has Moscow's dependence on Beijing.

"China doesn't really care about Russia," she said. "It's 3% of Chinese trade. But Russia now cares a lot about China. And the good thing about that for us is that when China says, 'You cannot use nuclear weapons in Ukraine. Right, don't do that,' Russia really has to listen."

2023: A different story?

Expectations for the Russian economy in 2023 vary. The IMF recently said it expected the country's economy to grow by 0.3% in 2023, although others have forecast a GDP drop of around 2%.

Europe has managed to largely divest itself of its dependence on Russian energy over the course of the last 12 months. However, so far there is little evidence to suggest that the bloc's price cap sanction on Russian oil — introduced in December — is working. According to research carried out by the British weekly The Economist, Russian crude oil sales remain high, driven by demand from China and India.

Weafer believes the new EU sanctions, which kicked in on February 5 and target diesel and other refined products, are a potentially key moment.

"There's an enormous question mark over how much money Russia will earn from exporting hydrocarbons and extractive industries this year," he said. "And it certainly will be significantly less than in 2022, that's for sure."

Edited by: Kristie Pladson