02.02.23 Review

Horizontal Stabilisation: central bank analysts confirm that while Russia’s economy has adapted to sanctions, most industries will continue to stagnate

In its January review of ‘What current economic trends tell us about the future’, the Bank of Russia’s analysts contend that the Russian economy is in much better shape at the beginning of 2023 than many had predicted. In 2022, the economy was saved from going into freefall by the Bank of Russia’s anti-crisis measures, high oil and gas prices, businesses’ flexibility and the government’s generous cash injections. Despite acknowledging the negative impact of the newest wave of sanctions on Russian exports, experts believe their effect to be ‘of a limited nature.’ By the end of 2022, Russia’s production output had stabilised at third quarter levels. This means that due to the contrasting trends witnessed within different sectors, it is possible to characterise the economy’s dynamics as L-shaped. However, any further recovery will likely be hampered by weak demand and investment activity, increasing difficulties in servicing imported equipment, and structural distortions in the labour market.

The Russian economy entered 2023 in a much better state than expected, according to the authors of the latest issue of ‘What current trends tell us about the future’, which is published by the Bank of Russia’s Research and Forecasting Department. In their view, there are four reasons why this has been the case. 

First of all, the measures, which the central bank itself introduced at the beginning of the war, ‘stabilised the financial system,’ and, as a result, contributed to the rapid resumption of credit activity. When the key interest rate was at restrictive levels, businesses were supported by ‘various targeted programs of concessional loans.’

Second, rising prices for key Russian exports boosted the revenues of oil and gas companies, despite a reduction in the actual volume of deliveries. The central bank analysts define the impact of the latest wave of sanctions against Russian oil and oil products as ‘limited’, but warn that, as oil and gas prices actually decline, ‘this will have a negative impact on the profits of companies and the redistribution of these funds into the economy through taxes, dividends and other means.’

Third, companies that use imported components and materials in their products were initially able to adapt quickly to the effects of sanctions and even partially replace the goods that had disappeared as a result of import restrictions. The bank’s review presents data from a survey by the Gaidar Institute for Economic Policy, which indicates that the share of companies that rely solely on domestic components or materials for production increased from 9% in June to 16% by the end of the year. Other businesses were able to stay afloat due to the legalisation of parallel imports. In relative terms, parallel imports accounted for 10% of all imported goods and services, and this was sufficient to ensure the supply of critical products, without which production would grind to a halt.

Finally, ‘cash injections by the government partially compensated for losses in private and external demand.’ Towards the end of the year, the budget had taken on a noticeably bigger role when it came to stimulating the economy. 

The positive economic momentum gained in November–December 2022 was largely driven by export demand, as well as governmental demand, the review’s authors write. Satisfactory results within the agricultural sector was reflected in growth within the food industry (it should be noted that during a contraction or stagnation of demand, such growth can only be explained by import substitution). In the future, the economy may be supported if a recovery of demand takes place. At the same time, investment activity in the private sector remains suppressed, fueled by the fact that companies are experiencing an end-of-year decrease in profits, amid ‘continuing geopolitical tensions.’ 

Preliminary data from the fourth quarter indicates that production output has finally stabilised. This supports Re: Russia’s claim that the current crisis is L-shaped. If we were to look at different industries, we would see that this stabilisation can be explained by contrasting sectoral trends: mining and retail trade are in decline, while the manufacturing industries have provided some stability. This once again raises the question: what place does the defence industry now occupy on the country’s balance sheet? The Bank of Russia experts warn that ‘The production dynamics of intermediate and investment industries are increasingly being influenced by restrictions as a result of the  difficulties of servicing imported equipment, as well as staff shortages.’ 

The phrase ‘structural transformation of the economy’ initially appeared in the first military-themed issue of the bank’s ‘What current trends tell us about the future’ review, which was published in April. The future prospects of the economy, as outlined by the authors of the review, include further production growth in the manufacturing sector, while other industries will stagnate or even decline. They identify three factors that are to blame here: sanctions-driven technological constraints, weak external demand, and labour shortages amid record low unemployment.