Sanctions against Russia: what have been the effects so far?

Western sanctions have hindered Russia’s production of many goods and led to a widening budget deficit. While these measures alone cannot end the war, they do limit Russia’s ability to replace its destroyed military equipment and finance the campaign.

After Russia’s brutal invasion of Ukraine on 24 February 2022, the European Union (EU), the United States, the UK and many other countries introduced several rounds of far-reaching sanctions. While the threat of such measures was obviously not enough to deter Putin from launching the attack, sanctions have had a negative effect on Russia’s economy and capacity to wage its war in Ukraine.

Restrictions on exports to Russia have led to a drop – and in some cases, a collapse – in production in many industrial sectors. The price cap on seaborne oil imported from Russia – a sanction first introduced in December 2022 – has had a large negative effect on the country’s federal tax revenue. This is very significant, as up to 40% of Russia’s federal tax revenue came from the energy sector before the war. So, the Western economic counter-offensive appears to be working – but to what extent?

How have sanctions affected standards of living in Russia?

Immediately after the invasion, Russia came very close to a full-blown financial crisis. The external value of the rouble dropped by approximately 30% in just a few days, and Russians queued to withdraw money from their banks.

The Russian central bank responded by hiking its key interest rate to 20% and introducing restrictions on deposit withdrawals and capital movements. These measures were enough to quell the initial panic in the Russian financial markets. Higher energy prices and lower imports lifted the country’s current account surplus to a new record – $233 billion (10.4% of GDP) – which also supported the value of the rouble.

But the shock of the war and the subsequent sanctions packages have had a large negative economic effect in many areas. The initial exchange rate and inflation shock lowered ordinary Russians’ living standards. The volume of retail sales dropped 9.8% year-on-year in April 2022 and has not really recovered since (see Figure 1).

The sales of consumer durables (such as household appliances) have been hit especially hard. In February 2023, the year-on-year change in retail trade was still 7.8%. But in April, the year-on-year growth was already 7.4%, as the base period was already very depressed because of the sanctions. Sales of cars declined by 45% year-on-year in the first quarter of 2022. And in the first quarter of this year, sales of Chinese cars overtook those of Lada, Russia’s most popular locally produced car.

Finally, sanctions are preventing many Russians from travelling to EU countries, which have been very popular travel destinations in the past. Russian airlines have had to cut their flight routes significantly.

Figure 1: Volume of retail trade, year-on-year percentage change

Source: Rosstat and Macrobond

How have Western sanctions affected Russian manufacturing?

Sanctions also forbid the export of many goods to Russia. For example, sanctions have targeted high-tech goods and components as well as vehicles. This has the potential to hit Russia where it hurts.

During the past 30 years, many parts of the country’s economy have become closely integrated with the rest of the world. Russian manufacturing plants are dependent on the steady flow of parts and components from abroad.

The invasion changed all that. Many vital parts are now under export bans, financial sanctions have made trade much more difficult or impossible, and many foreign companies have left the Russian market altogether.

The effect of all this can be observed clearly in the car manufacturing sector. Virtually all global car manufacturers had established operations in Russia prior to the war, producing vehicles mainly for the domestic market.

But in the spring of 2022, production of cars collapsed by almost 90% from the pre-invasion levels and it has only partially recovered since. In the first quarter of 2023, car production is less than 25% of the pre-invasion level. All Western brands have exited the market: of the remaining 14 car brands in Russia, three are Russian and 11 are Chinese.

The experience of car manufacturing is not unique. Similar drops in production were experienced in electronics and machinery. For example, Russia produces far fewer railway cars, televisions, lifts and fibre optic cables than before. At the same time, imports of Chinese vehicles have ballooned.

But overall manufacturing output has declined relatively little. In January-February 2023, manufacturing was down just 1.7% year-on-year. Many sectors whose products are used in the war – for example, metallurgy, textiles and medical goods – have seen large increases in production. Russia has ample resources and capability to continue producing relatively simple manufactured goods, even in the face of harsh trade restrictions.

How has the oil price cap hit Russia’s state finances?

After the invasion, global energy prices spiked. Many European customers reduced their purchases of Russian crude oil and oil products voluntary. And in the summer of 2022, the flow of natural gas from Russia to EU countries stopped, as European energy companies refused to pay for their gas in roubles.

These actions reduced Russia’s export and tax revenue. And yet, much more consequential has been the G7 decision to cap the price of seaborne oil imports from Russia at $60 per barrel. This decision came into force only on 5 December 2022. At the same time, EU countries imposed an import ban on Russian seaborne crude oil. A similar ban on Russian oil products followed on 5 February 2023, although the contribution that crude oil to the Russian budget has always been much larger (compared with oil products).

In 2022, Russia’s federal budget deficit came to 2.3% of GDP. The deficit widened especially towards the end of the year, when the government had to spend much more on the war itself. In addition to this, lower oil prices and generally weaker economic activity led to a drop in tax revenue. Very rapid growth in government expenditure continued especially in January-February 2023. In the first quarter of 2023, nominal federal government expenditures increased 38% year-on-year – waging a war is costly.

On the other hand, the G7 oil price cap and the EU oil import ban have had a sizeable effect on Russia’s tax revenue. Overall, nominal tax revenue dropped by 15% in the first quarter. Receipts from the energy sector were hit particularly hard, declining by 43% from the first quarter of 2022.

Russia’s federal budget deficit reached 2,400 billion roubles in the first quarter of this year. This is more than half of the budgeted deficit for the whole year.

Traditionally, seasonal patterns of expenditures mean that the state deficit is at its largest in the final quarter of the year. Russia has now adjusted the formula used to determine how much taxes are paid by the oil companies to increase energy taxes from this point on. In addition, many state-owned companies have had to pay dividends in excess of their profits. So, the war and the resulting sanctions have had a negative effect on Russia’s state finances.

How is Russia financing this deficit?

Without significant changes to spending plans, Russia’s federal government budget deficit could easily reach 4-5% of GDP this year. As such, this does not need to be a disaster for the Putin regime. For example, liquid assets in Russia’s National Welfare Fund, where past excess oil revenues have been saved, were slightly over 4% of GDP in February 2023. And even though Russia is, for practical purposes, blocked from international financial markets, the state can still borrow from domestic banks.

Figure 2: Russia’s monthly federal government balance, billion roubles

Source: Russian Ministry of Finance

But the longer that the war and sanctions continue, the more difficult Russia’s fiscal position becomes. Waging a war requires huge sums of money, and in Russia’s 2022 budget a third of funds were allocated to the military and ‘internal security’. The original budget for 2023 expected nominal expenditures to decline, but this is now clearly very unrealistic – and sanctions are hitting Russia’s tax revenues.

Increasingly, this seems to be the main effect of Western policies on the Russian economy. In theory, this effect will accumulate over time. The fighting looks likely to grind on for months to come, but with each day spent on the battlefields, the chokehold of economic sanctions is set to get tighter.