Russia’s economy will be cut in 2022, but so far, despite sanctions, the system is more stable than we would like to see – Elina Ribakova

3 June 2022

Despite on EU and USA sanctions against Russia, Russia’s monetary and financial systems have stabilized. The damage was mainly reflected in the trade effect of sanctions. At the same time, there are a number of actions that can be implemented and significantly weaken Russia’s economy during this year. The opinion was expressed by Elina Ribakova, Deputy Chief Economist at the Institute of International Finance, during a public lecture at the Kyiv School of Economics. The lecturer assessed the impact of the imposed sanctions, analyzed the “loopholes” found in Russia, and outlined the following priorities.

The financial sector sanctions are imposing the costs, but definitely much less of a cost than many of us expected. The reason is the Central Bank of Russia has provided very professional response. And therefore, the direct impact on the financial system was much less than we expected. These financial sector sanctions have turned into de facto trade sanctions. I think the European Commission or the US Treasury or many other sorts of the financial sectors wanted to keep financial sector sanctions separate and the trade measures separate. But reality took over. The corporate sector has decided to withdraw from Russia because of the compliance, risks. But also sort of toxicity of working with Russia.

– The principles from the beginning on the financial sector sanctions have been that the countries against the war decided to find where they have more leverage versus Russia. The point of pain. In 2014, it was very clear for Russian corporates, so they find the domestic financial system very small for their financing needs. In 2014, what was taken away from the Russian economy is the ability to borrow outside. So they all were forced to deliver. It had an impact on the economy. It had an impact on Russia’s ability to grow going forward.

– So what was Russia’s response to these financial sector sanctions? They said: we are going to build a fortress, to insulate and therefore isolate ourselves from you, to rely much less on the financial markets, and so we’re going to gear the whole of our macroeconomic policy thinking towards our geopolitical objectives. I think we’re going back to this economic sovereignty, statecraft, where we can no longer think that economics is just to one side and politics and foreign policy and everything is to that. No, it’s all together. They wanted to have the stock of reserves, prudent macroeconomic policies. And that’s why they let the technocrats do their job. In the early days, they knew that the fiscal contraction, the consolidation of the budget cannot be significant enough for domestic financial system to finance. So that’s why they needed foreigners and that’s why they opened office and market to the foreigners. They provided high real rates in order to attract them into the economy. Inflation targeting went alongside with it and in the meantime they did the size of the fiscal adjustment that is at par most of the balance of payments crises out there and the IMF programs. But they took money from the population and said: we need it for our geopolitical adventures plan and we’re going to put it in our reserves. So, common people in Russia from 2014 are already feeling the cost of this geopolitical adventure.

Part of it was move reserves away from the European Union, from the US, particularly from the US dollar to other jurisdictions. After 2014, they said: if we were to be disconnected from SWIFT, we will not be able to exchange information domestically, we need to set up our domestic system. And they set up their domestic system. It is sort of really picking up them after 2014, and it’s gradually increasing. The financial system didn’t come to a standstill for two reasons. Because they have the domestic alternative, and because we’re doing it bank by bank. 

– The Central Bank doubled the rate from nine and a half to 20, impose draconian capital controls, including exports, surrender proceeds requirement 80% of exports. Proceeds had to be surrendered to the market within three days. And then also effectively they froze foreign exchange deposits. We know that in the early days after the announcement of the sanctions, the Central Bank was forced to stop intervening on the market because of the sanctions on the Central Bank, but also because they lost the reserves. Half of it. But also, we know that the most of the domestic financial system experienced severe bank runs. That did happen. So if the response of the Central Bank of Russia would have been less prepared and less professional, there could have been a proper disintegration of the financial system because even the largest banks like Sberbank were running out of cash in the ATMs, in the branches. But the system is stabilizing.

Another huge reason is that we cannot forget that Russia is mostly export of oil and gas and other commodities. From January to April, Russia collected $96 billion in current account surplus. And this is contraction of imports, but it’s also astronomical prices for oil and gas. And even though there is a small contraction and there is a discount of about $30 per barrel on the Russian oil, they’re collecting very large amounts. So that also neutralizes some of the effect of the sanctions. As a result the Central Bank of Russia has brought the rate back to 11%. So I think that’s what the Central Bank on the loosening up requirement for capital outflows. They feel that the system is better, and they need to get ready for energy wars because this is the next stage of this game, the sanctions and the war.

– We have evidence of Gazprom doing energy wars. We know they were in Ukraine. And so the next step, Poland, Bulgaria were disconnected. There are other signals that Gazprom is willing to step up their, quote unquote game and use energy wars against Europe as well. There is also the issue of having large effects in flows. Gazprom at some point announced that they wanted to be paid in rubles. But it does not give anything much. It was a signal to Europe that it is a fragmented power. “We give you some strange hoop to jump through”, and some countries are saying: “OK, we are going to jump”. And some countries are saying: “NO, we are going to walk around”. That signals to Russia and to the world that they cannot agree together, even on such a minor thing. They are fragmented power, and Russia has some leverage against them. 

The fact that the Europeans are talking about the 6th package, and there is some agreement on oil, is where the strength of Europe comes from. Working together, whether it has been on oil embargo, or on the gas cap, or tariff prices.

– Europe pays a disproportionate amount buying Russian commodities and gas. So Europe has a lot of leverage as well. The only issue here we should not forget is that for Russia, Europe is a big buyer of oil and gas, but for the budget, oil is much more important than gas. If you hit oil, you will be hitting a disproportionately higher share of the balance of payments, also hitting directly the budget and Russia’s ability to pay.

Europe relies disproportionately more on Russian gas. What is more painful for it is less costly for Russians. There the relationship is the opposite. In energy wars, it makes sense for Europe to use oil first, and it makes sense for Russia to use gas first.

It is not only the reliance on the Russian gas, but it is also the lack of physical infrastructure to be able to not only use the terminals (in the terminals, there is enough capacity to get gas) but distribute it domestically. The terminals are around the coastlines, but we have many countries that will not have gas just because there is not enough infrastructure. One of them is Germany. Germany is planning to build the terminals, two of them by the end of the year. That will have as much capacity as Spain and the UK, or even potentially more. That will change the equation dramatically. The earlier discussions of changing the pipeline between Spain and France showed that the pipeline of Spain does not have enough capacity, and building a new pipeline is a multiyear, multibillion project. The energy terminals might be a workaround for it, and that is an important solution for going forward. But again, it will take more time than even oil.

– At the moment, Russia provides a big chunk of oil to the EU. It also provides oil to China and India. So why don’t they ship more to China and India? China already has existing contracts with other providers. Also, China does not like to be reliant on one country too much for the contribution to their total energy supply. It brings us to the key topic – economic sovereignty. The Europeans put too much into one basket, while China wants to diversify. Even if India quadruples its imports of Russian oil, it is not going to make a big difference for Russia. And there are the same infrastructural problems with the delivery, and the refiners in India are not geared for the Russian oil either. It would be relatively difficult for them to switch to Russian oil.

There are plenty of other commodity wars that could have taken place. Ukraine was exporting 90% of its exports via ports, and top-4 ports accounting more than 80% of the traffic. All of them are being blocked, which makes it very challenging. There are also some areas where Russia could say that it does not cost them almost anything, and they can inflict some of the pain. The residual cost is mostly from the trade effect of the sanctions, not as much anymore from the financial sector sanctions. The action is on gas and oil. This is something the EU will be working on not for just the coming months. It will be for decades.

Elina Ribakova is a Deputy Chief Economist at the Institute of International Finance. Elina directs the IIF’s economic research on emerging markets.

Ms. Ribakova was previously a visiting fellow at Bruegel, where her research focused on financial markets, EMs, and central banks. Prior to Bruegel, she held senior level roles in economic research at a diverse set of financial institutions, most recently with Deutsche Bank in London as Head of EEMEA Research, as well as leadership positions at Amundi (Pioneer) Asset Management, Avantium Investment Management, and Citigroup. She has also taught graduate and undergraduate courses at the Stockholm School of Economics and given guest lectures at the London School of Economics, New Economic School in Moscow and Chicago Booth in London. Ms. Ribakova began her career as an economist at IMF headquarters in Washington D.C.