External environment has become dramatically less supportive for the Russian economy and critical buffers are coming under pressure, Kyiv School of Economics (KSE) said in its latest Russia Chartbook released on January 24.

The most important change to Russia’ macroeconomic situation over the past twelve months has been the sharp deterioration of its external balance. In 2023, total goods exports reached $423bn, a decline of 29% vs. the previous year, report KSE analysts Benjamin Hilgenstock, Yuliia Pavytska and Vira Ivanchuk.

This has contributed to much smaller trade turnover in 2023 ($118bn, -63%) and current account surpluses ($50bn, -79%) that is fundamentally eroding macroeconomic stability.

As a result of sharply lower inflows of foreign currency, the ruble has lost ~40% of its value against euro and US dollar since the autumn of 2022. In turn, this has increased inflationary pressures and forced the CBR to hike interest rates by cumulative 850 bps as well as reintroduce capital controls.

Signs of stepped-up energy sanctions enforcement having impact. Following a period during which the price cap’s shortcomings had become apparent and threatened the overall effectiveness of the energy sanctions regime, coalition authorities have stepped up enforcement measures, including by modifying the ineffective attestations system and by imposing sanctions on entities as well as vessels involved in price cap violations.

The data shows that widespread violations of the oil price sanctions continue. In October-December 2023, more than 98% of Russian seaborne crude oil exports were likely sold above $60/barrel. At the same time, close to one third of the total volume was shipped with the involvement of G7/EU service providers. This points to very low compliance with the price cap, likely via falsified pricing information (i.e., attestation fraud).

0124 Ukraine 98% of oil price sanctions ignored KSE

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0124 Ukraine share of EU tankers in Russian oil transport KSE

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0124 Russia oil price discount OOTT KSE

0124 Russia oil tax revenues federal budget OOTT KSE  

Russia’s reliance on G7/EU-owned and/or -insured vessels has fallen significantly in the case of crude oil. In H2 2023, their share stood at only 30%—a sharp drop from 51% in H1 2023 and 58% in H2 2022. Importantly, however, the shadow fleet’s expansion has slowed down/stalled—at least for the time being.

However, Western efforts to tighten the oil sanction implementation appear to be having an effect already. The discount on Russian oil vs. Brent, which is the key mechanism through which export earnings are driven down, has started to widen again in recent months. Should similar steps be taken in the coming months, Russia’s external balance could approach a critically low level.

Russia’s macro buffers are coming under stress due to the war and sanctions. While the 2023 budget deficit reached only 1.9% of GDP and rising non-oil and gas revenues allowed authorities to spend RUB3 trillion more than originally expected, financing is set to become more challenging in 2024.

With external sources cut off due to sanctions, Russia has had to rely primarily on the National Welfare Fund. In fact, almost half of the fund’s liquid assets, including all hard currency, have been used up since the start of the full-scale invasion.

Going forward, the Russian banking system will likely have to carry more of the burden by buying up domestic debt issuance. Sanctions have also significantly constrained access to foreign reserves and limited policy space for the central bank.

The robust economic recovery reported for 2023 of about 3.5% y/y growth conceals the underlying vulnerabilities, according to KSE. The Russian economy is benefitting from a large war-related fiscal stimulus, which will become even stronger this year. A dramatic increase in military spending could add around 2.5pp to GDP growth in 2024. Thus, it is not surprising that economic activity has essentially fully rebounded from the initial shock due to the war and sanctions. However, the underlying fundamentals of the economy are weak, and problems will eventually resurface.

 

The Kyiv School of Economics (KSE) is a bne IntelliNews media partner and a leading source of economic analysis and information on Ukraine. This content originally appeared on the KSE website.