Executive Summary 

1. External environment has become dramatically less supportive. The most important change to Russia’ macroeconomic situation over the past 12 months has been the sharp deterioration of its external balance. In 2023, total goods exports reached $423 billion, a decline of 29% vs. the previous year. This has contributed to much smaller trade ($118 billion, -63%) and current account ($50 billion, -79%) surpluses and is fundamentally eroding macroeconomic stability. As a result of sharply lower inflows of foreign currency, the ruble has lost ~40% of its value against euro and U.S. dollar since the fall of 2022. In turn, this has increased inflationary pressures and forced the CBR to hike interest rates by cumulative 850 bps as well as reintroduce capital controls. 

2. Signs of stepped-up energy sanctions enforcement having impact. Following a period during which the price cap’s shortcomings had become apparent and threatened the overall effectiveness of the energy sanctions regime, coalition authorities have stepped up enforcement measures, including by modifying the ineffective attestations system and by imposing sanctions on entities as well as vessels involved in price cap violations. These measures appear to have an effect already. The discount on Russian oil vs. Brent, which is the key mechanism through which export earnings are driven down, has started to widen again in recent months. Should similar steps be taken in the coming months, Russia’s external balance could approach a critically low level. 

3. Macro buffers under stress due to the war and sanctions. While the 2023 budget deficit reached only 1.9% of GDP and rising non-oil and gas revenues allowed authorities to spend 3 trillion rubles more than originally expected, financing is set to become more challenging. With external sources cut off due to sanctions, Russia has had to rely primarily on the National Welfare Fund. In fact, almost half of the fund’s liquid assets, including all hard currency, have been used up since the start of the full-scale invasion. Going forward, the Russian banking system will likely have to carry more of the burden by buying up domestic debt issuance. Sanctions have also significantly constrained access to foreign reserves and limited policy space for the central bank.

4. Robust economic recovery conceals underlying vulnerabilities. The Russian economy is benefitting from a large war-related fiscal stimulus, which will become even stronger this year. A dramatic increase in military spending could add around 2.5pp to GDP growth in 2024. Thus, it is not surprising that economic activity has essentially fully rebounded from the initial shock due to the war and sanctions. However, the underlying fundamentals of the economy are weak, and problems will eventually resurface.