25.10.22 Review

Geography of the Sanctions Crisis: reorientation to the East undermines the competitiveness of the Russian economy

According to the Regional Economy report prepared by the Central Bank of Russia's regional divisions, the current economic crisis has different profiles in Russia's macro-regions. Real incomes have fallen sharply in the European part of the country, and the retail trade has declined. Siberia and the Far East suffer more from reduced exports. The global problem is that the transport and logistics infrastructure cannot cope with the economy's shift to the East. Ports and terminals in the Far East lack capacity, and due to the large volume of unprocessed cargo, logistics companies limited applications for shipments to Western regions in October. Almost half of the country's population lives in its European part, and 5% live in the Far East. The colossal transport distance reduces export profitability and makes imports too expensive.

The economic crisis looks different in different regions of Russia, according to the Central Bank of Russia regional monitoring data. For example, inflation in the Central Federal District and Volga-Vyatka District in September was 14.2% in annual terms, and in Siberia — 14.6%, while in the Urals and Far Eastern districts, it was significantly lower — 12.5 and 12.7% correspondingly. In the advanced Central and North-western communities, the most crucial crisis factor is the retail trade decline — by 12 and 11%, correspondingly (in other macro-regions, this decrease was much more restrained). The general downward trend in real disposable incomes, leading to a reduction in demand, was more evident here (3.9% in the Central District against 2-2.9% in other macro-regions). At the end of September, attendance at the capital's shopping malls and restaurants dropped by more than 10% compared to the previous year.

At the same time, the Central and Volga-Vyatsky Districts industry showed slight growth in August (0.7-1.2%), while there was a slight decline in other macro-regions. Meanwhile, in the Northwestern District, the reduction in the industry was 3%, and in the Far Eastern District — 9%.

The North-West and the Far East are extremum regions of the current crisis. The Northwest has been growing in the last decade due to car assembly plants, the rapid development of transport and logistics infrastructure supporting European trade routes, and wood and woodworking exports oriented toward European markets. All these business directions are closed now.

At the same time, the Far East suffers from the declining profitability of the timber industry and growing domestic competition with North-Western companies. It is also becoming the country's central export-import hub but needs the relevant capacity. Russia's maritime imports to the Far East reached almost 70% in September (40% at the beginning of the year). As a result, the capacity of Far Eastern terminals and ports was overloaded, railway transportation prices increased by one and a half times, and the duration of cargo shipments was doubled, which led to increased demand for storage services and a significant rise in costs. Due to a large volume of unprocessed cargo in October, logistics companies have limited the acceptance of applications for cargo shipments by rail to the western regions. Shipments to the Far East were also partially suspended, and the waiting period reached one month.

In reality, what the official rhetoric calls the Russian economy reorientation to the East becomes a transport and logistics disaster. Timber is brought from European Russia to the Far East, which displaces Far Eastern loggers, and cars from Asia are brought from the Far East to European Russia. In August, imported used vehicles through the Vladivostok port increased more than one and a half times compared to last year, and the number of cars shipped to the Western regions tripled compared to February. By the end of September, some car dealers suspended accepting applications for purchasing second-hand vehicles due to logistics problems and the threat of new sanctions. As a result, prices for used foreign cars increased by 10% in September compared to the beginning of the year.

About 7 million people live in the Far Eastern District, while 70 million live in the Central, Northwestern, and Southern Districts, almost half of the country's population. They are the primary consumers of imports brought into Russia. However, the distance between Moscow and Vladivostok is 9,000 kilometers. Such transport leverage undermines the profitability of a large part of Russian exports and makes imports too expensive.

Companies in the country's south were actively taking new loans in September, including agricultural organizations — to finance seasonal fieldwork. According to a large regional bank in Kuban, the portfolio of concessional loans to the agricultural sector has grown by 1.5 times since the beginning of the year. However, in the coming months, banks expect lending activity in retail and corporate lending to become more restrained due to the tightening pricing environment (including the growth of uncertainty and insurance rates). The government has warned that employment will fall by the end of the year, so the banks know that new lenders face a growing risk of declining incomes and approve fewer applications. More and more companies in the southern macro-region experienced supply disruptions or cancellations in October. Production forecasts for the next three months deteriorated in the mining, agriculture, and construction sectors.

In the Siberian District in September and the first half of October, the demand for industrial products remained under the pressure of sanctions, and the volume of industrial production decreased. The search for new counterparties and export destinations continued in coal mining and metallurgy, Central Bank of Russia analysts write. In August-September, coal production kept decreasing due to the ban on coal exports to the EU and to several logistic restrictions. For example, according to the August results, coal production in Kuzbass decreased by 11% annually, while coal exports fell by 13%. Alternative supplies of coal to the Asian market can be arranged in some cases, but with a significant discount compared to the world prices. 

As we wrote earlier, business climate indicators based on the Central Bank of Russia surveys conducted in the first half of October have dramatically declined after several months of gradual stabilization. The sharpest deterioration occurred in the Central, Urals, Siberian, and Far Eastern districts.

CB business climate indicator by federal districts of the Russian Federation in annual terms, September-October 2022