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

The Russian economy contracted sharply in the second quarter. The country bore the brunt of the economic fallout from the war in Ukraine.

Russia’s statistics office said on Friday that the economy contracted by 4% year-on-year from April to June. This is the first quarterly gross domestic product report to fully capture the changes in the economy since the February invasion of Ukraine. This was a sharp reversal from the first quarter, when economic growth was his 3.5%.

Western sanctions, which cut Russia off from about half of its $600 billion emergency stockpile of foreign currency and gold reserves, impose severe restrictions on transactions with Russian banks, cut off access to American technology, and what Hundreds of major Western companies were urged to leave the country. .

But even as imports to Russia dried up, financial transactions were blocked, and the country was forced to default on its foreign debt, the Russian economy turned out to be more resilient than some economists had originally expected. The GDP decline reported on Friday was less severe. It was expected by some as global prices rose and the country’s coffers were flooded with energy revenues.

But analysts say the economic hit will be greater as Western countries increasingly turn away from Russia’s oil and gas, a key source of export revenue.

Laura Solanko, senior adviser to the Bank of Finland Institute for Transition Economics, said of the Russian economy, “We were expecting a significant decline this year. She said the economy would slip into a shallower recession than two years ago.

Russia, which boasted a $1.5 trillion economy before the war began, acted quickly to mitigate the effects of sanctions in the days following the invasion. The central bank has raised interest rates to her 20%, more than double her, severely restricted the flow of money out of the country, halted stock trading on the Moscow Stock Exchange, and eased restrictions on banks so that lending could slow down. I tried not to stay. The government also increased social spending to support households and lending to businesses hit by sanctions.

This measure has dampened some of the impact of the sanctions. And Russia’s finances benefited from higher oil prices as the ruble rebounded.

‘Russia endured the first sanctions shock’ “It’s been relatively resilient so far,” said Dmitry Dolgin, chief economist for Russia at Dutch bank ING. But he pointed out that unless Russia succeeds in diversifying its trade and finances, the economy will weaken in the long run.

According to the Bureau of Statistics, retail trade fell by about 10% and wholesale trade by 15%.

Michael S. Bernstam, a researcher at the Hoover Institution at Stanford University, said the data released on Friday were consistent with other reports from Russia. He, too, expects the economy to deteriorate later this year and again in 2023.

As the war drags on, many countries and companies will seek to permanently end their ties with Russia and its domestic companies. Companies struggle to obtain replacement parts for their Western-made machines, requiring software updates. Russian companies will have to reorganize their supply chains as imports plateau.

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

So far, countries such as India, China and Turkey have absorbed some of the lost trade from Europe and the US, but it is unclear how many new buyers will be found.

Russia’s dependence on natural gas is also declining. In the last week of June, the European Union’s total gas imports from Russia fell by 65% ​​year-on-year, according to a European Central Bank report. Some of these reductions have been forced on Europe as Russia cuts its gas supply. However, European countries are stepping up efforts to find alternative sources of supply, and are rapidly developing infrastructure for additional imports of liquefied natural gas, for example.

Reduced ability of central banks and governments to provide money at the expense of “depleting stocks of investment imports, enacting EU oil embargoes, mounting financial pressure on households and increasing dependence on the state” So the economy will suffer. Financial support is limited, writes ING’s Dolgin.

In the immediate aftermath of the Ukraine invasion, Russian inflation soared as households scrambled for goods they expected to run out of. According to Russia’s Central Bank, inflation in July was above 15%. But there are already signs that inflation is slowing, and as a result the central bank has cut interest rates to 8%, lower than before the war.

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

The bank expects the economy to contract by 4% to 6% this year, well below initial expectations in the immediate aftermath of the war. This 6% figure is also in line with the latest update from the International Monetary Fund.

The central bank said Friday that the economy will contract further next year and won’t return to growth until 2025. The bank expects inflation to be 12% to 15% by the end of the year.

Supply chain issues will be a challenge in the coming months as sanctions-constrained companies seek to alter their supply chains to replenish their stockpiles of finished and unprocessed goods.

“I don’t think the Russian economy is doing well at the moment,” Solanko said. But the idea that sanctions and the withdrawal of companies from Russia would quickly collapse the economy was never a reality. “The economy won’t go away,” she said.

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