(CNN Business) — Six months following invading Ukraine, Russia is mired in a war of attrition that it did not anticipate, but is succeeding on another front: its oil-dependent economy is in one deep recessionbut it showed be much stronger than expected.
“I drive through Moscow and there are the same traffic jams as before,” says Andrey Nechaev, who was Russia’s economy minister in the early 1990s.
The willingness of China and India to buy cheap Russian oil has helped, but Nechaev and other analysts say Russia’s economy has begun to decline and is likely facing a prolonged period of stagnation as a result of Western sanctions.
On the surface not much has changed, save for a few empty shelves that once housed western brands that have fled the country by the hundreds. McDonalds is now called “Vkusno i tochka“, or “Tasty, and that’s it” and Starbucks cafes are now gradually reopening under the thinly disguised Stars Coffee brand.
The streets of Moscow are as busy as ever.
The exodus of Western companies and wave following wave of Western sanctions once morest Russia’s vital energy exports and financial system have had an impact, but not in the way that many expected.
Nechaev, who presided over some of Russia’s most turbulent economic times and helped lead its transition to a market economy, attributes some of this to the central bank.
The ruble fell to a record low once morest the US dollar earlier this year in the wake of the invasion when the West froze regarding half of Russia’s foreign exchange reserves, valued at $600 billion. But it has since recovered to its strongest level once morest the US dollar since 2018. (Remember President Joe Biden’s threat to cut it to “debris”?)
That’s largely the result of aggressive capital controls and rate hikes in the spring, many of which have now been reversed. Interest rates are now lower than they were before the war, and the central bank says inflation, which peaked at nearly 18% in April, is slowing and will be between 12% and 15% throughout year.
The central bank also revised up its GDP forecast for the year and now expects it to be cut by between 4% and 6%. In April, the forecast was for an 8% to 10% contraction. The International Monetary Fund is now also predicting a 6% contraction.
Moscow had been trying to build a “fortress economy” since annexing Crimea in 2014.
It helped that the Kremlin had eight years to prepare, buoyed by sanctions imposed by the West following Moscow annexed Crimea in 2014.
“The departure of Mastercard, Visa, hardly had an impact on internal payments because the central bank had its own alternative payment system,” says Nechaev.
Russia installed the Mir credit card and its own transaction processing system in 2017.
And there’s a reason Russian lovers of McDonald’s and Starbucks can still get their fix of fast food, says Chris Weafer, founding partner of Macro Advisory Ltd, a consultancy that advises multinational companies in Russia and Eurasia.
Since 2014, many Western brands in Russia have bowed to government pressure and localized some or all of their supply chains. So when these companies left, it was relatively easy for Russian buyers to buy them and continue to operate simply by changing the wrapper and packaging.
“Same people, same products, same supply,” says Weafer.
However, it is not a completely watertight strategy.
Rebranded McDonald’s stores reported a shortage of French fries in mid-July, when Russia’s potato crop fell short and foreign suppliers failed to fill the gap due to sanctions.
Can Russia’s energy boom continue?
The continuity of fast food is one thing. Russia’s long-term stability rests on its energy sector, which remains by far the largest source of government revenue.
To say that high energy prices have isolated Russia so far would be an understatement.
The International Energy Agency says Russia’s revenue from oil and gas sales to Europe doubled between March and July this year, compared to the average of recent years. That is despite declining volumes. IEA data shows that gas deliveries to Europe fell by regarding 75% in the last 12 months.
Oil is something else. The IEA’s March prediction that 3 million barrels a day of Russian oil would exit the market from April due to sanctions, or the threat of them, has not materialized. Exports have held up, although analysts at Rystad Energy note a slight drop over the summer.
The main factor has been Russia’s ability to find new markets in Asia.
According to Houyoun Falakshali of commodity consultancy Kpler, most of Russia’s seaborne oil exports have gone to Asia since the start of the war. In July, the turnout was 56%, compared to just 37% in July 2021.
Russian oil exports by sea to Asia have soared this year.
Between January and July this year, China increased its seaborne imports of deeply discounted Russian Ural crude by 40%, compared to the same period last year, according to data from Kpler. That is despite China’s initial efforts to avoid the appearance of taking sides in Russia’s war once morest Ukraine. India’s seaborne imports from Russia increased by more than 1,700% during the same period, according to Kpler. Russia has also increased gas exports to China through a Siberian pipeline.
What happens when the European embargo on 90% of Russian oil takes effect in December will be critical. An estimated 2 million barrels a day of Russian oil will be in limbo, and while some of that is likely to go to Asia, experts doubt demand will be high enough to absorb it all.
Falakshali says that China cannot buy much more Russian oil than it already does, due to a domestic slowdown in demand and because it simply does not need much more of the specific type of oil that Russia exports.
Price will also play a key role in determining whether Russia can afford to continue discounting to secure new markets.
“A 30% discount from $120 a barrel is one thing,” says Nechaev. “A $70 discount is another matter.”
“To simmer”
While global inflation is helping Russia’s energy sector, it is hurting its people. Like the rest of Europe, Russians are already suffering from a cost-of-living crisis, made worse by the war in Ukraine.
Nechaev, who helped guide Russia through a much more dramatic economic collapse in the 1990s, is worried.
“In terms of standard of living, if you measure it by real income, we have gone back regarding 10 years,” he says.
The Russian government spends to try to combat this. In May, he announced that he would raise pensions and the minimum wage by 10%.
A system has been put in place whereby employees of companies that have “suspended their activities” can temporarily transfer to another employer without breaking their employment contract. And it is spending 17 billion rubles ($280 million) buying bonds from Russian airlines, crippled by airspace bans and sanctions that prevent foreign manufacturers from servicing and supplying parts.
It is technological sanctions, such as those affecting the airline industry, that may have the most profound impact on Russia’s long-term economic prospects. In June, US Commerce Secretary Gina Raimondo said that global semi-conductor exports to Russia had collapsed by 90% since the war began. That cripples the production of everything from cars to computers and, experts say, will set the country even further behind in the global tech race.
“The impact of sanctions will be slower than fast,” says Weafer. “Russia now potentially glimpses a long period of stagnation.”
Nechaev is even more definitive. “Right now, the economic decline has started,” he says.