There is widespread agreement that Western sanctions on Russia are going to have a devastating effect on its economy. Forecasting the scale of the economic shock, which has been compared with 1998, 1991 or even 1918, appears almost impossible at the moment. However, we can set out in broad terms the nature of the challenge facing the government, and how it might respond.

The authorities have so far focused primarily on the risk of a balance of payments and currency crisis. In the last two major shocks, in 2008 and 2014, the central bank was able to do this by drawing on its large foreign currency reserves to keep credit flowing, reassure investors and hold up the currency. With the central bank itself sanctioned, its only option has been to impose strict capital and currency controls that have made the ruble almost non-convertible. These measures appear to have worked to the extent that no banks have collapsed and the rapid devaluation of the ruble has been halted for the moment. But the costs of capital controls are high: as well disrupting all kinds of economic transactions, it is likely to lead to a black market and types of economic crime that flourished during the collapse of the Soviet Union.

Unbelievably, these measures are the easy bit. The government also needs a strategy to manage an impending unemployment crisis. Whole sectors of the economy are at risk of disappearing because of falling demand, disruption to supply chains and the withdrawal of Western companies. In my view, it is in this context that the government’s announcement that it will nationalise Western businesses leaving Russia should be seen. It is not so much a punitive step as an emergency furlough, putting the firms into temporary state stewardship to avoid a sudden rise in unemployment.

So far, however, there is no sign of a broader labour strategy, although Izvestia reported on March 11 that the government would put around RUB500bn into employment support. The government does have well-established channels of communication with strategically important companies dating from 2014 or before, and these firms are presumably under strong pressure to avoid lay-offs. It is worth noting, though, that during the coronavirus (COVID-19) pandemic the authorities essentially abandoned efforts at economic shutdown and mass furlough to contain the virus.

To sustain itself in the longer term, the Russian government would also need to restructure its economy to rebuild disrupted supply chains. Whether it could do so in any meaningful timeframe while the war continues in Ukraine is debatable. The import substitution campaigns to date have had limited success and capital is very scarce. China potentially has a huge role to play as an alternative source of technology and other inputs, but Chinese companies are wary of dealing with companies sanctioned by the US. It's not at all clear how you maintain a modern economy without access to US computer operating systems, or Taiwanese semi-conductors.

Finally, the government will also have to respond to rising public discontent as living standards plunge. The strategy so far has been to eliminate the vestiges of independent media and push the propaganda machine into overdrive. The question is whether it can also mobilise people behind a new kind of war economy.

 

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This article originally appeared in FPRI's BMB Russia newsletter. Click here to learn more about BMB Russia and subscribe to the newsletter.