Russia: Recession May Continue into 2024

2 May 2023

Yes, I concede the Russian economy proved to be more resilient than I expected in 2022. Indeed, Russia’s GDP contracted only 2.1% last year compared to my projection that the imposition of sanctions would result in a slump of at least 7%. Of course, one must question the current reliability of Russia’s official economic releases. Indeed, the availability of key data has been curtailed since the outbreak of the Ukraine war. President Putin is keen to promote the view that international sanctions do not pose a serious risk to the Russian economic outlook.

However, the IMF’s recently released projection of an economic recovery during the next two years (with GDP expanding 0.7% and 1.3% in 2023/24 respectively) appears to be wishful thinking. To the contrary, I expect 2023 will be even more difficult than last year (chart above). And, if the war persists, the Russian recession could continue during the run-up to the Presidential election in March 2024. Indeed, the cumulative economic impact of the war may still approach my initial 7% projection. However, even if my forecast proves accurate, I do not expect these economic considerations will be decisive in the conduct of the war in the near term. Political and military realities will continue to play the leading role in the war’s outcome. However, a weaker-than-expected economy may cause volatility before polling day next year.

Russia: Secular Economic Headwinds

Let’s start with the basics. The long-term trend in Russian economic growth has slowed markedly during the past decade (Chart above). In part, of course, generally lower energy prices during the interval played a role. However, the Chart also reveals Russia now has the weakest growth potential amongst both advanced and emerging economies. This reflects unfavourable demographics, weak productivity, underinvestment in the non-oil sector, and the potentially catastrophic impact of climate change (see my earlier blog “Russia: Not Rushin’ to Buy” for more details).

Therefore, the IMF’s forecast of not only economic recovery, but above-trend GDP growth during the next two years is implausible. Indeed, the impact of international sanctions will intensify considerably this year compared to 2022.

External Challenges: New Friends Are Not Enough

Russia’s ability to increase energy exports to new partners — mostly China, India, and Turkey — has been a key reason for its unexpected economic resilience so far (Chart above). However, these sales relied heavily on discounted oil and gas prices (the Ural oil price has been 30% below the quote for Brent barrels). Even EU imports from Russia rose 25% last year (in nomial terms, in part reflecting higher oil prices).

Sanctions are likely to bite harder in 2023. The Chart above indicates that both American and EU exports to Russia are already declining sharply, depriving the country of needed technology and capital equipment. Even more importantly, the European Union has established ambitious goals to eliminate its reliance on Russian oil in H1 2023 and natural gas next year. Indeed, after peaking in Q1 2022, EU imports from Russia have declined 75% so far this year.

Russian energy exports to its new partners will not be enough to offset declining sales in Europe and elsewhere. Consequently, after peaking in Q2 2022, I expect Russia’s current account surplus to evaporate in the period ahead. Indeed, unlike the IMF, I believe the external balance could swing into deficit next year (Chart above). As a result, Russia’s holdings of foreign exchange reserves could come under additional pressure (next graph). To be sure, Russia’s stockpile of external reserves is large enough to absorb this shock in the near term. However, I would expect the Russian Ruble to depreciate another 10% or more.

Domestic Support Comes at a Cost

While the lack of data prevents a thorough assessment, Russia’s domestic economy also appears to have been somewhat more resilient than expected. To be sure, in order to maintain public backing for the war, President Putin has increased government spending. Capital spending is estimated to have risen 6% last year. Given the prevailing economic uncertainty (including the departure of numerous large foreign investors), such gains in business investment would not have been possible without government support. Likewise, President Putin is not completely immune to possible public dissent if the war is overly painful. Despite spending to support households, consumer spending is estimated to have declined 1% in 2022.

Sustaining public support, especially with an election in 2024, does not come cheaply. Militiary and civilian spending pressures will remain considerable. Meanwhile, energy taxes account for nearly 40% of government revenues, which will be under pressure if energy prices and exports decline as expected. If the war continues into 2024, the public sector deficit could balloon towards 10% of GDP in coming years. Again, Russia can withstand this shock in the near term as government debt is low. However, the costs of war will mount if the conflict continues.

Strategic Considerations

  • Russia’s economic recession will continue in 2023, and perhaps into 2024, as the impact of international sanctions intensify. The cumulative economic impact of the Ukraine war will approach 7% of GDP.
  • However, Russia’s external and public sector financial positions are strong enough to absorb this shock in the near term. The outcome of the war, therefore, will be determined by political and military considerations.
  • Nevertheless, the Presidential elections in March 2024 may provide war dissenters an opportunity to highlight their concerns. Economic and financial volatility is likely to increase.
  • The Russian ruble will depreciate 10% or more, and may approach RUB 100 by the election.
  • The European Union is successfully transitioning away from Russia energy sources. However, 2023 will be another tough year for the EU economy (see my blog “Ukraine Invasion: A Year On”).