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Price of War: the account for the aggressor

A previous publication assessed how much money Russia could have to wage war against Ukraine and how European governments, avoiding decisive action to limit oil and gas supplies from Russia, are forcing Europeans to pay double the price of Russia’s military aggression against Ukraine.

What is the economic price of war against Ukraine for the Russians?

The Institute of National Economic Forecasting of the Russian Academy of Sciences (INP RAS) has announced a forecast for the state of Russia’s economy in 2022, the results of which indicate a clear impact of sanctions on Russia’s macroeconomic indicators.

Experts emphasize that the tightening of trade restrictions by Western countries will hit the Russian economy hard, and the reorientation of flows to Eastern countries will not be rapid: in 2021, countries that have already imposed sanctions on Russia accounted for 56% of Russian exports of goods and services and 50% – imports. While exports and imports to the EAEU countries, China and a limited number of so-called “friendly countries” accounted for 29% and 37% of total exports and imports respectively.

According to experts of the Russian Academy of Sciences, the main macroeconomic indicators in 2022 may be the following:

  • $ 130 billion in export cuts;
  • $ 185 billion in import cuts;
  • 95 rubles per dollar – the average rate;
  • income from business activities will fall by 14.2%;
  • salaries outside the budget sector will decrease by 7.5% (in the budget sector they will remain unchanged);
  • property income will decrease by 12.5%;
  • the number of unemployed will increase by 6.7 million people, including 2.4 million due to reduced exports and 4.3 million due to reduced production due to the rupture of production chains;
  • by 11.3% – a fall in GDP in the baseline scenario, of which about 3.5% will lead to a reduction in imports.

To date, this is the most detailed forecast available and can be called a weighted average in the palette of forecasts published by representatives of the economic bloc of power and experts. In particular, we have the following range of estimates of the fall in GDP during the week from government officials and economists:

One of the determining factors influencing the pace of development of the Russian economy is the level of inflation. According to the results of the year, the Central Bank of the Russian Federation expects inflation in the range of 18-23%. According to Rosstat, now the annual inflation rate has reached 17.6% – the highest since 2002. Experts from the Center for Macroeconomic Analysis and Short-Term Forecasting expect up to 20% year on year in April. According to E. Nabiullina on April 29, the main factor of high inflationary pressure is the fall in supply caused by rising costs of companies to change logistics, import-substitution, development of technological processes and adjust business models.

What does all this mean for the average citizen of Russia?

1. Falling incomes. That is, on average, revenues of the budget, businesses and citizens will be reduced by 10-11% – including salaries and social benefits.

Recently, Russian Finance Minister Anton Siluanov confirmed that there will be no budget surplus set for 2022 (1.1% of GDP), the excess of expenditures over federal budget revenues in 2022 will be at least 1.6 trillion rubles, ie with a deficit of about 1% of GDP. The main reason for the deficit is the government’s “anti-crisis package”, which is estimated at 4 trillion. rubles and he is the main cause of the budget deficit. Russia’s continued war on Ukraine and the imposition of new sanctions by Ukraine’s partners are expected to increase these costs. As the Russian Ministry of Finance has announced that it does not plan to raise funds on the federal bond market, the main source of additional expenditures to finance the deficit will be the budget.

According to Alexander Sperkach, a senior lecturer at the University of Finance under the Russian government, the deficit of 1.6 trillion rubles is a very optimistic scenario in the context of the war. The expert is convinced that the costs of its extension and the costs of the Russian-occupied territory of Ukraine are unlikely to be compensated even if the current surplus from energy exports is maintained. Russian economist Sergei Khrapach notes that in 2022-2023, the growing budget deficit will primarily lead to a significant reduction in social spending. The price of the Kremlin’s aggression will be felt by every citizen of the Russian Federation, having paid for it by falling living standards and prosperity.

2. Economic and technological backwardness.

The effects of the recession will be felt for a long time: it is not difficult to assume that if Russia’s GDP grows by an average of 1.5% per year in the coming years, Russia will need 7-8 years to return to pre-war development. Similar assessments are expressed by Russian experts. But this is considered purely mathematical and provided that Russia overcomes restrictions on economic recovery. According to Olena Ustyuzhanina, Doctor of Economics, Head of the Department of Macroeconomics and Modeling of Regional Systems of the Central Economic and Mathematical Institute of the Russian Academy of Sciences, there are three possible options for restoring Russia’s economy to pre-crisis levels under sanctions:

  1. adjustment of Russia’s imports through third countries – the result will be an increase in the cost of production itself due to the development of logistics and final goods;
    1. development of its own import-substituting technologies without the possibility of alternative imports – will require at least 5-7 years of intensive budget expenditures to stimulate the Russian producer;
    1. compromise option – easing sanctions and the gradual development of import substitution.

At the moment, the situation contributes to the consideration of the first option as the main one. Analysis of Russia’s economic activity on the international track shows that Russia is actively trying to negotiate with Asian countries, especially China, India, Turkey, and the EEU countries on:

  • establishment of new and intensification of existing logistics routes, primarily sea, in particular, the finding of new hubs instead of the EU ports currently unavailable to Russia;
  • expanding the presence of Russian products in the markets of these countries, in particular, the volumes of exports of products of the metallurgical, oil and gas, coal, machine-building and agricultural industries released as a result of the imposed sanctions;
  • creation of joint ventures and the use of other schemes to circumvent sanctions to obtain through these countries sub-sanctioned components and the sale of products of Russian (joint) production to “unfriendly” countries;
  • finding mechanisms to ensure the continuity of settlements on export-import transactions between the subjects of foreign economic activity of Russia and “friendly” countries (in particular, through the organisation of bilateral and multilateral clearing schemes and bypassing the use of SWIFT by involving foreign financial institutions in the CBR system).

It is too early to assess the effectiveness of these measures, as no significant progress has been made on them, apart from the declarative statements of the Russian leadership.

Instead, according to Rosstat, there was a marked decline in the manufacturing industry, especially in such industries as the production of motor vehicles (-55%), production of cars and trailers (-45.5%), railway locomotives and rolling stock (-25%), electrical equipment (-18%), rubber products (-13%). The financial sector, the chemical industry, high technology and the IT sector have had a significant negative impact on sanctions. That is, the militarism of the Russian leadership has struck a blow primarily in those areas that are drivers of the development of leading states and societies, as they provide a qualitative change in living conditions and living standards. The dynamics of development of these industries require continuous development and improvement, a highly skilled workforce, and international cooperation.

The lag in these areas is estimated not only by how many years it will take to reach the indicators of the beginning of 2022 in terms of production volumes and import substitution by analogues, but also by the progress lost during these years. Every year, the gap between Russia, which is limited by the exchange of modern technologies and scientific knowledge, and the leading states will increase exponentially.

Russian officials report high levels of import substitution, but what’s the point of replacing even 98% of production capacity if 2% of them are complex foreign-made microcontrollers, without which all production will stop? And which Russia, given the growing outflow of intellectual capital and the degradation of scientific and technological cooperation, is unlikely to be able to import in the medium term.

At the same time, the Russian government’s focus on the extractive industry, including oil and gas and mineral fertilizers, as the main driver of rapid economic recovery, will only increase the country’s “resource curse. ”

So what do the abstract, at first glance, economic indicators of the development of the state and certain industries of the Russian Federation say?

The fact that the Kremlin’s war against Ukraine will have to pay every citizen of Russia not only the current decline in living standards – but also their future.

A future in which progressive economic development is already being replaced by attempts to catch up with yesterday.

The future, instead of a vision begins to build on “alternative historical reconstruction” in the economy.

A future in which, in a few years, citizens will rejoice in the “new achievements” of what was the norm yesterday.

Find more about sanction strategy and sanction policy in a recent publication “Sanction strategy – weapon of an accumulative actio“.

Oleksii KHARCHENKO,

Expert for the Institute of Information Security for “Ukrainian line”

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