Russia’s Economic Freefall

The Russian economy is in a state of free fall, and it’s not a sudden event. It’s a slow, painful process, marked by the loss of its most important source of income, the departure of hundreds of thousands of top talent from the country, and the race to the bottom of the national currency. Russia is destroying the foundations of the state in order to finish off the victim it has attacked. The problem is that it is really determined in this act.

The moment the first Russian tanks drove onto Ukrainian soil, the natural response to the criminal invasion was to slash the source for its financing. The West began to shape sanctions to make the engine of the Russian economy inefficient enough to quickly obliterate it when faced with a robust Ukrainian Army backed by military and economic resources flowing from the West.

In the short term, however, the war itself has triggered a massive increase in hydrocarbon prices. According to some estimates, this sector alone accounts for as much as 60 percent of the Russian economy. As a result, Moscow, despite having just triggered a major armed conflict, recorded record peaks in revenue from raw material sales.

However, nothing lasts forever. Oil and gas prices have fallen by tens of percent, as if Russia’s other essential exports such as wheat. This has been compounded by the massive shift away from Russian fossil fuel Imports by the West, which until the war was Moscow’s most important export destination, and sanctions making it hard to sell Russian hydrocarbons.

A few months ago, Mikhail Krugitin predicted Russia would lose 57 percent of its fuel exports in 2023. And indeed, the erroneous decline in budget revenues from the sale of fossil fuels between January and April was 52 percent. Lack of revenue naturally leads to a deficit. In January, it reached a ceiling of 25 billion dollars or 60 percent of the plan assumed for the year. In the following months, it grew until it suddenly stopped at 45 billion at the end of April, reaching 117 percent of the deficit target for the year after its first four months.

Indeed, in May, the Russian finance ministry reported that the economy recorded a surplus, reducing the deficit to 42 billion dollars. Moreover, the ministry announced that the Russian economy will grow by 1.2 percent this year. Considering the country is in a proxy war with half of the Western World, this would be a skyrocketing success.

Yet one should remember that in Russia, macroeconomic indicators do not serve to be an objective measure for assessing the economy’s health but are another tool of the Kremlin’s power apparatus. Rosstat is famous for conductive creative statistics. As the Center for Eastern Studies reports, “Rosstat often changes the methodology it uses, the way it presents data, and the frequency of its publications, which in the long run makes it difficult or even impossible to compare the information it publishes. There were also frequent questions about the data updates that significantly changed previous readings, which Rosstat could not explain.”

A good example is the measure of poverty in Russia. According to official data, in 2022 the number of poor shrunk by 1.7 million people to an all-time low. And that’s because Rosstat came up with a new definition of poverty, recognizing as poor only those who live worse than their neighbors in the region. For example, according to this methodology, a resident of Tula earning 140 dollars per month is not considered poor at all. And it should be remembered that the cost of living in Russia is relatively high. Using previous data, The Insider calculated that the number of poor people has not shrunk by 1.7 million but has increased by 2.3 million. One in three Russians has money only for food, and one in 10 doesn’t even have money for that. In fact, up to 20 million people in Russia live below the poverty line, 40 percent more than in the Rosstat report. This shows only one thing: Russian statistics are modeled to achieve consistency with a meticulously prepared propaganda message.

The deficit trend could be read as follows: “We are feeling the impact of war, and it’s tough. That’s the high deficit from the beginning of the year. But we are coping with it. That’s deceleration of the deficit in the middle of the year.”

In practice, no one can determine the actual state of Russian finances, as the Russians themselves block access to data on hydrocarbon sales and budget expenditures, among other things. There is no logical reason why the Russian economy should suddenly recover and perform better than many countries that are not under sanctions and are not at war.

Like a mantra, one could repeat the problem of losing customers and half of the revenue from the sale of fuel products, which is not compensated by the redirection of exports to India and China. Both Delhi and Beijing buy raw materials at maximum discounted prices, and Moscow is forced to yield to them.

In addition to the fact of cutting off its most crucial income branch, hydrocarbons, several other arguments prove that the Russian economy is in a free fall. To name a few, after the Pregosin Rebellion, the Russian Ruble is plunging toward a record bottom. Excluding the momentary shock after the outbreak of the war, after which the ruble immediately collapsed and then strengthened thanks to the heavy Central interference, today the Russian currency is the weakest in its entire recent history of existence.

A massive brain drain is underway. According to The Moscow Times, 1.3 million young, often best-trained people left Russia last year. This fact, backed by forced or not conscription, is leading to a collapse of the labor market. There are two vacancies for every worker. According to Goldman Sachs, this is currently the biggest pain in the Russian economy. For this reason, some believe that the Kremlin cannot carry out further mobilization.

Another major export branch, arms, has also slumped. Sweden-based Think Tank CIPRI estimates that Russian arms exports have fallen from 50 billion dollars in 2021 to 11 billion in 2022.

Going further, the Russian economy is a modal example of a fragile economy. The entire operating model was based on one product, hydrocarbons, and one customer, the West. Suddenly, when this house of cards collapses, the Kremlin, in desperation, enters a second relationship that is extremely risky from its point of view.

This is another cliché but needs reminding: Russia is gradually becoming totally dependent on China, both on exports and imports from the Middle Kingdom. Exports to China have grown by 100 percent relative to the pre-war period, to 26 percent of the total volume of exports. However, while China is the most important partner for Russia, Russia is economically one of many for China. Moscow is at the mercy of Beijing. For the time being, the Chinese are interested in keeping Putin’s regime alive. But given, let’s say, an economic slowdown or total collapse of the Chinese economy, which, according to some, is also possible, could drag down the Russian economy, which has no alternatives.

The cost of the war compounds all this. At the outset, one must assume that no one knows how much it really costs. Even if one had access to all the data, which no one does, these estimates would vary along with their methodology adopted. Considering this caveat, such calculations exist. The most modest ones, such as those of The Economist, speak of a figure of 55 billion dollars a year. Boris Grozowski of the Wilson Center estimates them closer to a 100 billion dollars figure. By contrast, Sean Spoonts of Special Operation Forces Report thinks both to be grossly underestimated, assessing the daily cost of War spending at 900 million dollars, which would put the figure at close to 330 billion dollars annually.

Spoonts explains, “In our mind, if Russia spends one million dollars on a missile to build it and then fires it, they have expanded 2 million dollars. One million to build it and another million to replace it. If you had a 50,000 car that burned up in a fire, you are out the 50,000 plus whatever you spent to replace it because you need a car. I think most estimates only take into account the initial cost.”

And while all this is true, in the context of Ukraine’s defense of Independence and recapture of territory, it is insufficient. All the statistics and phenomena cited tell us that the trend in which the Russian economy is heading is unequivocally negative. Russia is retreating by decades of development, cannibalizing its economy, and overeating the national wealth, including the savings of its citizens. It is destroying the country’s future and reaping it for its children, all for the sake of maintaining the war machine today.

In a word, Moscow is consuming resources from the future to cover the costs generated now, and it is doing so primarily at the expense of its people. The central government’s actions aim to transfer capital from the people to the government. Part of this process includes the massive nationalization of Western companies that have exited or are exiting Russia right now. As the Financial Times reported, these are being taken over for half price. “Any sale must be at a discount of at least 50 percent to market value, and 10 percent of the proceeds are allocated to the Russian budget,” an anonymous person involved in the procedure tells FT. “This is privatization 2.0, just like in the good old days,” says the source, referring to the looting of Soviet property in the 1990s. In this way, Putin wants to compensate the oligarchs for their losses in the West. At the same time, it means that no established company will invest in Russia for decades because its risk rating Excel will shine red from top to bottom. “It’s like Venezuela. They are giving best to their cronies, and then everything will go to shit” says the Moscow businessman.

Moscow is cannibalizing its economy at a breakneck pace. On a macroeconomic scale, it is destroying its future. The problem is that the time horizon used in macroeconomics and War differs. In the former, we are talking about the decades, years, or at the best quotas. On the battlefield, on the other hand, every hour and the day matters, while in a week, the situation can turn 180 degrees.

Another critical factor is, let’s call it the disproportion of involvement. As a starting point, we can assume that Ukraine is 100 percent involved in the war, meaning all sectors of the state are subordinate to it, and the bulk of society is involved in one way or another. Looking at Russian actions resulting in internal self-destruction, one can assume that Moscow is at least 60 percent involved. By contrast, the West, which is the foundation of Ukraine’s persistence in the war, is at best five percent involved, although more often than not, that share would be closer to one percent. Looking, for example, at a cost incurred in relation to each country’s GDP.

Russia is clinging to its misjudgment about triggering a war that collapses its economy and prospects. Nevertheless, this high level of involvement allows Moscow to bear costs that Ukraine cannot bear due to its smaller economy and costs that the West apparently does not want to bear. Thus, all indications are that the current sanctions economic architecture is insufficient to stop Russia with strictly financial factors.

So what’s going to be done in such a situation? Apart from continuing and increasing military aid to Kiev, it is necessary to close the sanctions loopholes wisely. And referring to the cited mechanism with great involvement, the following are examples of recommendations.

Robin Brooks, the chief economist of The Institute of International Finance, has been calling for months to target Russian oil sea transport. Russia relies on the Greeks for up to 60 percent of its maritime oil transport. Moscow does not have a large enough fleet to do this on its own, while the pool of tankers on the World Market is limited. The West, in this particular case, the EU, has the means to stop Greek tycoons facilitating Russian oil and potentially minimize the likely losses to the Greeks. Brooks also calls on the G7 to lower the oil price cap from 60 to 50 dollars.

Another potential area of action is suggested by The Economist, reporting that only 100 billion dollars of Russian oligarchs’ assets are frozen abroad. That’s 25 percent of the total, estimated at 400 billion dollars, making most of it available for use.

Yet the most critical hole to be patched is the gap in control of high-tech exports to Russia, even though the Russian war industry relies on them, and the West knows it. Key components continue to reach Russia. Kamigawaif points out to Russia’s dependence on industrial machinery, most of which comes from Europe.

More concreting numbers is a report prepared by the Kiev School of Economics. One of its authors, Elena Ibakova, admits that Russia obtains as many vital components for its military industry as it did before the war. “We rely on the analysis of Russian weaponry captured on the battlefield. In total, 58 pieces of equipment, ranging from missiles and drones to armored vehicles and artillery, and find 1057 individual foreign components, with microchips and processors playing the dominant role,” says the report. And it continues, “By the end of last year, imports of what we defined as critical components had fully recovered and, in fact, risen above pre-sanctions levels for key items such as semiconductors.”

So how does this happen? Not surprisingly, China plays a key role in the process, but mainly because the West enables it. The country of origin for as much as 68 percent of crucial components is the United States. Second place, with 14 percent, holds South Korea. Japan follows it with seven percent, ahead of Germany with 6.8 percent, Switzerland with five percent, Taiwan with four percent, and the Netherlands with 2.7 percent. Only then comes China, with a share of 2.6 percent. In this case, the authors considered the company headquarters as the country of origin. For example, a product manufactured by Intel in China is treated as American. Of this 68 percent, only four percent of products physically manufactured in the states found their way into the machines analyzed by the KSE.

In summary, China plays a crucial role in fueling Russia’s war machine, but only because the West allows it. Of the 1057 components analyzed by the KSE, more than 92 percent originated from a western company. Yet most of these 92 percent were manufactured in East Asia, in China, Malaysia, Vietnam, South Korea, or Taiwan. Then they are exported to Russia, most likely from China, which, including Hong Kong, accounts for 71 percent of the vital component exports found in the research. The NATO country, Turkey, holds the second export spot, which says a lot about Ankara’s policies.

So what can be done in this situation? The report’s authors point to several areas that require the Sciences’ intervention. Among other things, they call for better information sharing to quickly detect attempts to evade sanctions. Cooperation with the major manufacturers, whose products find their way to Russia, would also be highly fruitful, as they know their structures best. These companies can be most effective in blocking attempts to sell their products to Russia, including through intermediaries. This would also help to target them in third countries. This is a complex but feasible task.

Everything is a function of time. The collapse of the Russian economy is ongoing, but it is not a sudden event. On the other hand, the quick triumph of the Ukrainians, which is at least declaratively in the interest of the West as a whole, requires steps with a much shorter time horizon. The Ukrainians simply do not have the time to wait for the complete collapse of the Russian Federation, which may happen, but possibly after the most critical moments from Kiev’s point of view.

Of course, there are events, let’s call them chaotic events, which can make Russia implode in almost hours. Though ultimately failed, the Pregosin Rebellion was an example of such a phenomenon. The probability of such events is increasing along with the impoverishment of Russian magnates, the proliferation of the Russian poor, and the continued exposure of the weakness of Russian structures. Still, it would be irresponsible to pin hopes on fundamentally random incidents.

The West is not a fully cohesive entity, but it has demonstrated quantities of cohesion that has given Ukraine great hope. Today, to bring this war to a just end, that is for Kiev to regain the territory it has lost, a further push is needed to patch up the sanctions bridges and plug the Russian Hydra.