How have the forecasts on the effect of sanctions on Russia held up a year on?

Commentators were over-optimistic in believing that sanctions would immediately cause a large fall in economic activity in Russia and thereby halt the aggression against Ukraine. But despite the revised forecasts and outcomes, sanctions have had a significant impact on the Russian economy.

It is now over a year since Russia launched its invasion of Ukraine. Shortly after troops first crossed the border, Western nations imposed a range of sanctions on the Russian government, as well as on individuals and firms supporting the Putin regime.

With Russia continuing its offensive actions in Ukraine, commentators have started to question whether these economic sanctions have worked.

To answer this, it is reasonable to ask what ‘successful’ sanctions could achieve in such a situation.

First, the sanctions have not been successful in stopping Russian aggression – the Ukrainian military has done a better-than-expected job of that. Neither have the sanctions brought Russia to the negotiating table. While Putin and his remaining acolytes dream of restoring a ‘Greater Russia’ and there is no internal means, as yet, of removing him from power, achieving these criteria of success is far-fetched.

The primary aim of sanctions is to induce major disruption to the economy of the sanctioned country. So, the real question is whether sanctions on Russia have achieved that goal. The current consensus appears to be that, to date, sanctions have had, at most, a very limited impact on the Russian economy.

Critics point to the slight fall in Russian real GDP – despite predictions to the contrary a year ago, and the maintenance of oil and gas exports from Russia – as sanctions’ minimal effect. They argue that the short-run impact of sanctions is inevitably limited, and that they will only ‘work’ in the longer run by putting cumulative pressure on the Russian economy.

This raises the concern that the sanctioning nations may gradually lose the willpower to keep restrictions in place, particularly in the face of the resulting disruption to the world economy and supply chains, especially in the energy and agriculture markets.

But so far, the coalition of Western powers against Russia has remained relatively solid with major, and perhaps unexpected, success in reducing the dependence of Western Europe on Russian oil, although less so with gas supply.

One year on, it is useful to consider what predictions were made a year ago, including earlier commentaries published by the Economics Observatory. In this article, I consider the accuracy of early predictions and whether the current consensus – which indicates that the short-run impact of sanctions will be very limited while the longer-run effects may be more promising – is convincing.

In this, and a companion article, I argue that the Russian economy has been more seriously damaged in the short term than these critics suggest, but that over a longer period, some of these losses will be recovered through new trading patterns.

What did the forecasts predict would happen to the Russian economy?

The World Bank’s initial forecast of the impact of sanctions announced in March 2022 was that by the end of 2022, Russia’s GDP would be 11% lower, investment 17% lower, inflation would have risen to 22%, and exports and imports would have fallen by 31% and 35%, respectively.

In addition to this impact on the economy, there would be an adverse effect on Russia’s war effort, not least because a large share of Russian imports is relatively technology-intensive.

In similar vein, our colleagues at the National Institute of Economic and Social Research (NIESR) predicted a 12% reduction in Russia’s GDP in 2022 and an inflation rate of around 20% by the second quarter of 2022.

By the end of 2022, these numbers were being revised downwards. The World Bank was estimating a fall in GDP of only 4.5% for 2022 and inflation of 13.9%. The International Monetary Fund (IMF) estimated that the real GDP decline in 2022 had been 3.4%, subsequently revised to only 2.1% – again, a lower decrease than forecast in early 2022.

Although initial forecasts of Russia’s GDP decline proved over-dramatic, there are some important points to consider before declaring that sanctions have been ineffective.

How should we interpret the changing estimates of real GDP growth?

Rather than looking simply at current estimates of GDP growth, we should compare these estimates with what Russia’s GDP growth would have been in the absence of sanctions. This is the appropriate ‘counterfactual’ (as economists call it).

In late 2021, prior to the invasion of Ukraine, the World Bank had forecast that Russia’s real GDP growth in 2022 would be 4.3%. NIESR’s estimate for 2021 was similar. Given an actual fall ranging between 2.1% and 4.5% in 2021, the impact on growth constitutes an effective reduction in GDP from forecast of 7-10% – lower than the predicted reduction but still striking given the major fiscal offset implemented by the Russian central bank.

The IMF is now forecasting a small increase in real Russian GDP in 2023, but has lowered its forecast of growth in 2024. Even with this small increase, the means by which this will be achieved raise doubts as to whether Russian consumers will benefit.

What about inflation and fiscal policy?

The forecasts of inflation and the fall in imports and exports were close to predictions, subject to greater buoyancy of the oil and gas market (discussed in more detail below).

Although GDP and even fixed capital formation have held up better than expected, these have required highly pro-active polices by the Russian government and central bank, with a major fiscal support package for companies and active monetary policies to maintain the value of the rouble and the balance sheets of Russian-based enterprises.

By early 2023, the costs of these measures, coupled with slowing oil revenues and accelerating defence expenditures, were showing up in a sharp jump in the fiscal deficit and the running-down of Russia’s accumulated reserves from previous oil and gas revenues. The latest estimates confirm this widening fiscal deficit.

The shift to a war economy

Perhaps the starkest example of the implications of the war and consequent sanctions concerns the drivers of Russia’s GDP in 2022.

According to the World Bank, in 2021, a primary driver of real GDP growth had been private consumption (+4.8%), whereas in 2022, private consumption was expected to decline by 4.5%. A combination of high inflation and a major diversion of economic activity towards public spending, notably on defence (which is expected to account for 30% of the public budget in 2023), shows how a combination of the continued war effort and sanctions are having a significant impact on living standards in Russia.

Oil and gas

It is generally agreed that what has kept the Russian economy afloat during 2022 is its exports of oil and gas.

An immediate impact of the invasion of Ukraine was a sharp rise in the price of energy in world markets, notably oil. Brent crude rose to a price of $120 per barrel by February 2022 – a rise of around 30% from the start of that year.

But it should be noted that crude oil prices had been rising for some time. At the end of 2021, crude oil at $90 per barrel was 80% higher than prices at the start of 2021 – a result of the cessation of a price war in the previous year between Russia and Saudi Arabia.

This re-establishment of the oil cartel was an important reason for rising oil prices, independently of Russia’s activities in Ukraine. As noted in a previous article, had Western governments been successful in persuading other members of the Organization of the Petroleum Exporting Countries (OPEC) to expand oil production in 2022, the collapse of the Russian economy would have been more dramatic.

In mid-2022, a twofold attack of sanctions on Russia’s exports of oil was agreed by Western nations, implemented in late 2022. First, an oil embargo by sea to European Union (EU) countries came into force, further affected by damage to the Nord Stream pipeline by unknown assailants.

Second, by the end of the year, the G7 nations agreed an oil price cap of $60 per barrel on Russian oil. At the same time, the EU targeted a reduction in gas exports from Russia by March 2023. In fact, as Figure 1 illustrates, oil prices had been declining from their 2022 peak through much of the second part of that year.

The chart also reflects how the posted price of Russian oil (‘Urals crude’) has fallen below the Brent oil price, reflecting the oil price cap agreed by Western nations. The complexities of the oil market, and how the Urals price may not reflect actual receipts by Russian oil traders, are discussed in more detail in the companion article to this one.

Oil price over time, by type/origin

Source: Reuters; Investing.com

According to the Centre for Research on Energy and Clean Air, Russia’s earnings from fossil fuel exports fell in December 2022 to the lowest level since the start of the invasion of Ukraine. The EU oil ban and price cap cost Russia an estimated €160 million per day, as the measures caused a 12% reduction in Russia’s crude oil exports and a 23% drop in selling prices, with a 32% drop in Russian crude oil revenues in December alone. Germany’s stoppage of pipeline oil imports reduced this by another 5% at the end of December.

While Russia is still making an estimated €640 million per day from exporting fossil fuels (down from a high of €1,000 million in March-May 2022), the EU’s ban on refined oil imports, the extension of the price cap to refined oil, and reductions in pipeline oil imports to Poland are estimated to have reduced this by an estimated €120 million per day as of February 2023.

Where can I find out more?

The Centre for Economic Policy Research (CEPR) has a series of reports on the effects of the invasion and subsequent sanctions, available here.
Assessing the impact of international sanctions on Russian oil exports: VoxEU column by Tania Babina, Benjamin Hilgenstock, Oleg Itskhoki, Maxim Mironov and Elina Ribakova.