Contrary to Western expectations, Russia is on the way to regaining its form.

Since the Kremlin launched a “special military operation” in Ukraine last February, the United States and Europe have imposed a series of unprecedented sanctions on the Russian economy.

It has been 21 months since then, and key sectors of the Russian economy , from banking to auto manufacturing and aviation, have not only adapted to the “new reality,” but in some cases have fully recovered and are “thriving.”

Russia's gross domestic product (GDP) grew 5.5% year-on-year in the third quarter of 2023, beating market expectations of a 4.8% increase and outperforming the 4.9% growth in the second quarter of 2023, according to preliminary estimates by consultancy Trading Economics based on data released by the Russian Federal Statistics Service late on November 15.

This was Russia's fastest GDP growth since the second quarter of 2021, supported by higher benchmark prices for key Russian commodities and a recovery in supply chains following the West's exclusion from key financial markets and a year of low growth due to international sanctions, the New York-based consultancy said.

Bloomberg News said that 5.5% was Russia's fastest growth rate in more than a decade, excluding a spike when the country ended its Covid-19 lockdown. And this rate exceeded the expectations of all economists surveyed by Bloomberg.

The recovery is a vivid illustration of the limits of sanctions that US President Joe Biden has said are designed to cripple half of Russia’s economy and turn the ruble into “rubble” as punishment for Moscow’s invasion of Ukraine.

World - Contrary to the West's expectations, Russia is on the way to regaining its form. — Russian President Vladimir Putin and Chinese President Xi Jinping at the 3rd Belt and Road Forum in Beijing, October 17, 2023. Photo: Sputnik

As a necessary response to successive rounds of European Union (EU) sanctions and the decline of trade links between Moscow and the 27-nation bloc, Russian President Vladimir Putin has “turned east” by strengthening relations with major economies such as China and India.

The ruble (RUB) hit a record low shortly after the fighting in Ukraine began, but quickly recovered. Last month, the Russian government reimposed some currency controls after the ruble fell back to 100 RUB to the dollar, a move that made it the best-performing national currency among emerging market currencies over the past month.

What is certain, according to Bloomberg, is that although the country in the north of the Eurasian continent has so far escaped economic collapse, the Russian government is running out of resources to maintain state spending, while the wave of "migration" of foreign investors has not stopped and domestic businesses are finding it increasingly difficult to keep up with technological changes in the context of international isolation.

The most obvious example

The banking sector is one of the clearest examples of how the Russian economy has weathered the sanctions storm.

Russia’s largest commercial bank, state-owned Sberbank PJSC, which along with all major banks in the country has been blacklisted by the US and EU and removed from the international payment system SWIFT – is on track to make record profits in rubles this year.

“This year will most likely be the most successful year in our history,” said Sberbank CEO Herman Gref, who is sanctioned by the US, EU and UK.

World - Contrary to Western expectations, Russia is on the way to regaining its form (Figure 2). — The United States and its allies have imposed sanctions on Russian entities and individuals, including the country's largest commercial bank, Sberbank, over the Kremlin's military campaign in Ukraine. Photo: NY Times

Sberbank is no exception. The total profit of the Russian banking sector in the first nine months of 2023 exceeded the previous annual record set in 2021 – that is, before the outbreak of hostilities.

After “rocking low” in the first year of the war, Russia’s banking sector profits could reach more than 3 trillion rubles ($33 billion) in 2023, said Valery Piven, CEO of ACRA, Russia’s largest authorized credit rating agency.

The figure is three times higher than the Central Bank of Russia (CBR) initially expected this year, due to a credit boom and a weak ruble. The regulator said on November 15 that it would not extend a series of support measures for banks beyond the end of the year because the sector was sufficiently stable and profitable.

Next year is also expected to be “quite successful” for Russia's banking industry, ACRA said.

Challenges lie ahead

After two consecutive quarters of growth, the Russian economy has almost “recovered” and returned to pre-conflict levels, completely reversing the sanctions.

The fiscal stimulus that has helped drive this reversal will continue, thanks in part to Russia’s ability to divert oil supplies to other countries and sell crude above the $60-a-barrel ceiling imposed by the G7 and EU.

Energy sales have preserved a vital source of revenue for the Russian government, leaving the budget in better shape than officials had forecast despite the rising costs of the campaign in Ukraine.

Government spending will continue to stimulate the economy, according to a document from the Russian Ministry of Finance on the main budget policies for 2024-2026. And this “will not only help stabilize the situation, but also help to successfully and quickly adapt to new conditions.”

Russia's economy could reach pre-conflict levels as early as the fourth quarter of 2023, beating initial projections, according to Alex Iskov, an economist at Bloomberg Economics.

World - Contrary to Western expectations, Russia is on the way to regaining its form (Figure 3). — The NS Power tanker docked at a petroleum terminal in Vladivostok, Russia, December 2022. Photo: The Guardian

The drivers of this recovery are high energy prices, which provide Moscow with a stable source of oil and gas revenues, the Covid-19-era fiscal stimulus that the Russian government has implemented through increased military spending, and looser credit conditions that led to a 20% increase in retail and corporate loan portfolios compared to the same period last year, Mr. Iskov said.

But challenges lie ahead. Inflation has run well above the CBR’s 4 percent target due to supply constraints, public spending, credit growth and a tight labor market exacerbated by a surge in manpower into the military and defense industries.

“After the peak comes the trough,” Mr. Iskov said. With the CBR’s benchmark interest rate currently set at 15%, “credit is expected to shrink rapidly in the coming quarters, which will in turn dampen consumer demand and potentially lead to a weaker labor market,” the Bloomberg Economics expert said.

The Russian economy is likely to return to its potential growth rate of around 1% of GDP, which “would be a pretty good scenario in the current environment,” said Marcel Salikhov, president of the Moscow-based Institute for Energy and Finance.

Substitutability

Another factor in Russia's recent recovery, according to Stanislav Murashov, an economist at Raiffeisenbank in Moscow, may be Moscow's ability to find new sources of imports or, in some cases, replace them entirely.

“Russian business is trying to apply very non-standard solutions,” said Mr. Murashov. “We have not seen any serious deficits yet.”

The Russian car market is a testament to this. Seen as “dead” after a massive exodus of Western brands, car sales in Russia returned to pre-conflict levels in just over a year.

While volumes have recovered, the market structure has changed radically. China now accounts for about 80% of new car imports, and Chinese brands have captured more than half of the entire Russian car market in less than two years, according to analytics agency Autostat.

Russia’s Avtovaz controls another part of the market, reporting a 59% increase in production in the first seven months of this year and its best sales in a decade despite restrictions on the country’s supply of components. The US added Avtovaz to its sanctions list in September.

The price to pay

In the civil aviation sector, after being excluded from many international routes, Russian airlines have turned to developing new domestic routes in the country with the largest land area in the world. Official data shows that they have now achieved the target of 50% bypassing Moscow, set by President Putin in 2018. This achievement came ahead of the original plan of 2024.

The surge in domestic air travel, even as authorities shut down airports in tourist cities in southern Russia as part of the war with Ukraine, was largely due to government support, the Russian Transport Ministry said in response to a Bloomberg request for comment.

Despite sanctions, international air travel is “growing strongly,” with passenger traffic up nearly 30 percent in the first nine months of the year compared to the same period last year, the ministry said. Russia has air links with 37 countries and 59 foreign airlines provide services.

However, the industry remains heavily dependent on Boeing and Airbus aircraft and has been forced to find other ways to service and maintain its aircraft at home or abroad. Russian aviation giant Aeroflot this year sent its first jetliner to Iran for maintenance.

But even if some sectors have adapted to the restrictions, operating under sanctions still comes at a cost to the Russian economy, said Olga Belenkaya, an economist at Moscow-based financial services firm Finam.

“Russia has found workarounds for most of the sanctions, but is still suffering from rising logistics costs, limited access to equipment and technology, and the declining quality of technological solutions,” she said .

Minh Duc (According to Bloomberg, Trading Economics)

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