American and European allies have imposed tough sanctions on the Russian economy in response to its unprovoked military war in Ukraine.
It started by the freezing of $630 billion of its foreign currency reserves. Some capital controls were imposed, restricting the movement of planned investments from one nation to another (into-outside Russia), including blocking citizens from depositing money into foreign accounts. Russia has also been shut out from the SWIFT payment system, which makes its isolation from the global financial system more severe.
The effects of these sanctions can be seen already. They have started crippling the Russian economy, whose currency is in a free-fall (Ruble fell over 30%). The stock market is crashing, the rate of inflation is rising, central bank interest rates increased from 9.5% to 20% (for taming inflation and increasing the cost of borrowing), and the government (external) debt-to-GDP ratio is rising.
In the weeks and months ahead, the impact of the massive sanctions on the Russian economy will alienate its financial system even more from the global monetary system. Let’s look at some of the numbers to get a sense of this.
One: On Russian Currency to US Dollar
In terms of currency, a crashing ruble is creating panic among Russian citizens, who are standing in long ATM queues. This can potentially cause a ‘run on some of its banks’ if depositors start pulling all their money out, wrecking Russia’s banking system. Inflation is already rising, which will make the purchasing power of the ruble decrease eventually, thus raising the cost of essentials. High inflation creates distrust towards the government, and this might change public opinion about Russian President Vladimir Putin very soon, driving more protests on the streets against the ruling autocrat.
Two: Soaring Inflation Rate
The rate of inflation has already reached around 9% in a short period of time. The central bank’s response to the increase in interest rates is aimed at reducing inflation, but more importantly, it increases the cost of borrowing from banks, making it even more difficult for households and firms to borrow money. The freezing of credit – and the higher cost of doing so – will only make business in and with Russia even more difficult.
Three: The Central Bank's Rate of Interest
We can see some of the effects of these trends while seeing the numbers on consumer-business confidence, which is precariously low. It shows that even for a military superpower like Russia, most of its people, including businesses, weren’t fully prepared to understand (or factor) the potential consequences of war at this time, especially for a COVID-wrecked economy, when businesses, firms, households, and governments (due to high fiscal expenditures) were already badly affected.
Four: Consumer Confidence Level Has Plummeted
As a result, Russia’s medium-to-long-term scenario could include persistently high inflation, a poorly valued currency triggering a low trust-faith contract in its banks, further driving high costs of borrowing. It will also dry up private investment levels, which, according to Bloomberg estimates, could affect more than 1.5% of the GDP, causing a deep-long recession (which seems inevitable now).
Five: What Will be the Global Impact?
Despite the volatility seen in the global stock market trends and the concerns regarding energy (oil) prices, the global impact of a crippling Russian (and Ukraine) economy is still likely to be limited. Russia’s current account to GDP is very low (as evident from the Figure below). It accounts for less than 2% of world exports and has a GDP of less than 1% of world stock market capitalisation. Ukraine’s share in these aggregates is even less, at 0.01% and 0.3%, respectively.
Six: Fiscal Expenditure and the Debt-to-GDP Ratio
Financing a war, no matter how strong a nation is militarily, stretches the fiscal limits of any nation. It also balloons up a government’s owed (debt) obligations to the rest of the world (from loans to government-bought debt in the form of bonds). When the value of the ruble falls (as it is now), the external value of all debt will rise, and so will the value of all interest payments.
In a post-COVID-19 scenario, when states’ capacities to spend more have been precariously weak, Russian capabilities will be tested, too. The spike seen in increased fiscal expenditure (over the last few months) paints a grim future. With a collapsing ruble, the real ‘cost’ of financing increased military operations in and across Ukraine could take a toll on Russian coffers.
Seven: What About India-Russia Economic Relations?
As per Indian figures, bilateral trade during April 2020-March 2021 amounted $8.1 billion (see Figure below). Indian exports amounted to $2.6 billion while imports from Russia amounted $5.48 billion. For the same period, as per Russian figures, bilateral trade amounted to $9.31 billion, with Indian exports amounting to $3.48 billion and imports amounting to $5.83 billion.
As argued before, Russia is one of India’s largest arms suppliers and a key strategic ally. Modi recently invited Putin to India, which was seen as a way of maintaining a close strategic alliance with Russia. This was despite proximate ties of India with the US.
One reason for doing so could be to also avoid a closer Russia-China relationship, which now under the financial pressure of sanctions, may become more closely knit.
On defining the nature of Russia-India military relationship, Sameer Lalwani et al recently argued: “The breadth of Russian-origin platforms in the Indian military, which our analysis suggests composes 85 percent of major Indian weapons systems rather than the 60 percent figure often cited, have created a ‘lock-in’ effect, while the depth of relative support to India’s technology base and strategic systems have engendered a relatively high degree of indebtedness and trust in key strategic circles. Yet, the quantity and sensitivity of Russian contributions to the Indian arsenal, features that could reinforce and sustain the relationship much to the chagrin of US policy makers, have largely been underappreciated.”
In other words, both India and Russia share a path-dependent relationship from the pair’s historic Cold War ties. However, in the near future, it won’t be easy for India to continue doing its business with an economically damaged and sanction-hit Russian economy, and finding trade substitutes for relatively inelastic (or essential) Russian imports in areas of defence procurement and arms supplies may be extremely difficult.
Some might argue: didn’t Putin see all this coming? Given what he was planning to do, surely he would have known what sanctions can do to the Russian economy? Or did he ‘miscalculate’ and assume that the global financial response to his aggression in Ukraine would be the same as post the 2014 Crimea annexation (which was far weaker and less well-coordinated)? It’s difficult to say.
But this time seems different from the past. The global financial and monetary system, too, is quite different from the past.
Yes, the dollar is still the dominant foreign reserve currency, but it doesn’t have the same hegemonic role as it did a decade back or more. The Chinese government and Chinese money will surely play a more critical role in assisting Russia in its financial obligations, but we don’t know to what extent.
Eight: A Huge Vulnerability for Russia
The political economy implications of sanctions on Russia can be more catastrophic if the US and its European allies wish to make Russia suffer over the medium to long term. There might not be any pipeline deals. The Nord Stream pipeline plan is already in jeopardy. There won’t be much foreign direct investment in and out of Russia. After all, who would want to go ahead with a long-term financial commitment in a country whose leadership is autocratic and has shown a reckless contempt for its own rule of law?
More importantly, though, if America and its allies have a persistent will – and the political capital – to go directly after the vast overseas wealth of Russian oligarchs who have surrounded Putin and helped him stay in power, the suffering unleashed on Putin’s Russia could be far worse, and might even lead to his fall.
As Filip Novokmet, Thomas Piketty and Gabriel Zucman have pointed out, Russia has run huge trade surpluses every year since the early 1990s, which should have led to a large accumulation of overseas assets. Yet, official statistics show that Russia has only moderately more assets than liabilities abroad.
Paul Krugman, looking at this, said:
“How is this possible? The obvious explanation is that wealthy Russians have been skimming off large sums and parking them abroad. The sums involved are mind-boggling. Novokmet et al. estimate that in 2015, the hidden foreign wealth of rich Russians amounted to around 85 per cent of Russia’s GDP. To give you some perspective, this is as if a U.S. President’s cronies had managed to hide $20 trillion in overseas accounts. Another paper co-written by Zucman found that in Russia, ‘the vast majority of wealth at the top is held offshore’. As far as one can tell, the overseas exposure of Russia’s elite has no precedent in history – and it creates a huge vulnerability that the West can exploit.”
Can the West Afford to Go After Russian Oligarchs?
The question is whether democratic governments across the world can collectively align against Russia to do this in a deeply unequal wealth landscape. Many of their own influential people and businesspersons have their business and politics deeply entwined with Russian kleptocrats. This is true not only in the US but also in Britain and much of Europe.
If one goes after some Russian oligarchs and their wealth in offshore accounts, it is likely to yield adverse consequences for most oligarchs who have their wealth in these accounts as well, and their operations connected with Russians.
Whatever the future brings, it would test the political grit and economic capacity of both Putin’s Russia and the ‘will’ of the democratic world in standing against it.
(The author is Associate Professor of Economics, OP Jindal Global University. He is currently Visiting Professor, Department of Economics, Carleton University. He tweets @Deepanshu_1810. This is an opinion piece and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for the same.)