Russia’s economy shrinks sharply as war and sanctions take hold

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Russia’s economy contracted sharply in the second quarter as the country felt the brunt of the economic fallout from its war in Ukraine, in what experts see as the start of a year-long downturn.

The economy shrank 4% from April to June from a year earlier, the Russian statistics agency said on Friday. This is the first quarterly gross domestic product report to fully capture developments in the economy since the invasion of Ukraine in February. This was a sharp reversal from the first quarter, when the economy grew 3.5%.

Western sanctions, which deprived Russia of about half of its $600 billion emergency reserve of foreign currency and gold reserves, imposed severe restrictions on dealings with Russian banks and cut off the access to American technology, prompting hundreds of major Western companies to pull out of the country. .

But even as imports to Russia dried up and financial transactions stalled, forcing the country to default on its foreign debt, Russia’s economy proved more resilient than some economists had originally anticipated. and the fall in GDP reported on Friday was not as severe as some had expected in part because the country’s coffers were teeming with energy revenues as global prices rose.

Analysts, however, say the economic toll will rise as Western countries increasingly turn away from Russian oil and gas, key sources of export revenue.

“We thought it would be a deep dive this year and then even out,” Laura Solanko, senior adviser at the Bank of Finland’s Institute for Transition Economies, said of Russia’s economy. Instead, there has been a milder economic decline, but it will continue into next year, pushing the economy into a less deep recession for two years, she said.

Russia, a $1.5 trillion economy before the war began, moved quickly in the days after the invasion to lessen the impact of the sanctions. The central bank more than doubled the interest rate to 20%, severely restricted the flow of money out of the country, closed stock trading on the Moscow Stock Exchange and eased regulations on banks so that loans do not block. The government has also increased social spending to support households and loans to businesses affected by the sanctions.

These measures mitigated some of the impact of the sanctions. And when the ruble rebounded, Russia’s finances benefited from high oil prices.

“Russia withstood the initial shock of the sanctions” and “has been relatively resilient so far,” said Dmitry Dolgin, chief economist for Russia at Dutch bank ING. But, he noted, unless Russia manages to diversify its trade and finance, the economy will be weaker in the long run.

Retail trade fell by around 10%, the statistics agency said, while wholesale trade activity fell 15%.

Michael S. Bernstam, a research fellow at Stanford University’s Hoover Institution, said the data released Friday was consistent with other reports from Russia. He too expects the economy to deteriorate in the second half of this year and then again in 2023.

As the war drags on, many countries and companies will seek to permanently end their relationship with Russia and its national companies. Companies will struggle to get spare parts for Western-made machines, and software will need updates. Russian companies will have to reorganize their supply chains as imports come to a standstill.

The outlook for Russia’s energy industry, the heart of the country’s economy, is deteriorating. The United States and Britain have already banned imports of Russian oil, and the country’s oil production will fall further early next year when the full impact of a European Union ban on imports will come into effect. Russia is expected to find customers for around 2.3 million barrels of crude and petroleum products per day, or about 20% of its average production in 2022, according to the International Energy Agency.

So far, countries like India, China and Turkey have absorbed some of the lost trade from Europe and the United States, but it’s unclear how many new buyers can be found.

Dependence on Russian natural gas is also reduced. In the last week of June, the European Union’s total gas imports from Russia fell by 65% ​​compared to the previous year, according to a report by the European Central Bank. Some of these cuts were imposed on Europe because Russia cut gas supplies. But European countries have stepped up their efforts to find alternative sources and, for example, are rapidly developing infrastructure for additional imports of liquefied natural gas.

The economy will suffer as “the depletion of stocks of imported investment, the enforcement of the EU oil embargo, increased financial pressure on households and their greater dependence on the state “Will wreak havoc, while the ability of the central bank and government to provide funds and fiscal support is limited,” ING’s Mr Dolgin wrote.

Shortly after the invasion of Ukraine, inflation in Russia soared as households scrambled for goods they thought were becoming scarce. In July, inflation exceeded 15 percent, according to the Russian central bank. Already, however, there are signs that inflation is slowing and as a result the central bank has cut interest rates to 8%, lower than they were before the war.

Last month, the bank said business activity had not slowed as much as expected, but the economic environment “remains challenging and continues to significantly constrain economic activity.”

The bank expects the economy to contract by 4-6% this year, much less than it had originally expected just after the war began. This figure of 6% also corresponds to the last update from the International Monetary Fund.

The economy will experience a deeper contraction next year and not return to growth until 2025, the central bank said on Friday. The bank has forecast inflation to be 12-15% by the end of the year.

In the coming months, supply chain issues will present challenges as companies constrained by sanctions attempt to alter their supply chains to replenish their inventories of finished and raw goods.

“I don’t think the Russian economy is doing well right now,” Ms Solanko said. But the idea that sanctions and the departure of companies from Russia would cause a rapid collapse of the economy has never been realistic. “The savings just don’t go away,” she said.