For all the brave talk on Capitol Hill about “crushing” new sanctions against Russia, you’d think that someone might have done their homework about what actually makes the Russian economy tick, let alone whether any of the ideas circulating among U.S. policy experts are likely to change the Kremlin’s calculus.
The dirty secret is that the Russian economy has become well-insulated against sanctions. Thanks to Russia’s orthodox version of monetary policy, approved by the International Monetary Fund, and the recent rise in oil prices, Moscow’s foreign currency reserves have recovered since their post-2014 dip and are now at an all-time high of almost half a trillion dollars. (That’s equivalent to one-third of Russia’s GDP and can cover 17 months of imports.)
Although Western politicians love to talk about the falling value of the ruble, the 25 percent drop in the currency so far this year is actually a blessing for the state budget. Luckily for President Vladimir Putin, Russia’s dollar inflows are driven by hydrocarbon exports, and the government’s social spending and pet projects are priced in rubles.
Russia’s sovereign debt levels are eminently manageable, accounting for a mere 17 percent of its GDP (as of 2017), or approximately 50 percent of reserves. While some sanctions advocates want to choke off new sovereign debt issuance, the government has little desire or need to raise money since its coffers are already flush with oil revenues.
The state’s relentless domination of the economy provides the Kremlin with additional protection. At least 80 percent of the Russian economy either belongs to the state or is controlled through so-called oligarchs who are essentially appointees of the regime. About 38 percent of the workforce is employed by the state itself. That means most Russians’ economic well-being depends not on the ups and downs of the market but rather on the state’s willingness to redistribute a portion of the revenues from its hydrocarbons exports.
The Kremlin has wasted no time exploiting the sanctions regime for political purposes. As Putin tells it, any problems are obviously all Washington’s fault, not the Kremlin’s. The sanctions have dramatically reduced capital flight from Russia. The state has used the retained funds to consolidate its political power by mobilizing the elite and revving up public anti-Western sentiment. The country’s unpopular (and, arguably, unnecessary) pension reform is also being blamed on the West: The government is short of money, so the argument goes, because the West imposed sanctions and distracted foreign investors.
Crucially, the sanctions have put serious pressure on Russian asset prices. According to recent polls, 89 percent of Russian entrepreneurs want to sell their businesses, which is great news for the 12 or so key families around Putin that want to monopolize the country’s sources of wealth and rents. They are now buying such assets on the cheap, using loans provided by state-owned banks.
But the most useful sanctions for the Russian government are personal ones. Imposing sanctions on various oligarchs simply drives them closer to the Kremlin. That’s because there is no true ownership of companies in Russia, only temporary management. Any oligarch who deviates from the regime’s wishes stands to lose everything the very next day. The hungry mouths around Putin are all too happy to help arrange a sale of their assets.
Take the case of Oleg Deripaska, an aluminum tycoon caught by U.S. sanctions this year together with his company, the aluminum producer Rusal; the energy group En+; and many other enterprises. (He might be forced to sell part of his shares in En+ to state-owned entities in order to save its business.) While shares of Rusal plummeted in the wake of the April sanctions announcement, the company’s market capitalization and earnings are actually small potatoes compared with that of Russian oil and gas giants. Nor did Russia’s aluminum exports suffer because the Trump administration has been busy issuing licenses and waivers from the very sanctions designation it had just issued. That’s because no one in the administration is comfortable disrupting global supply chains or throwing U.S. or EU workers out on the street.
To be sure, the Russian economy’s main structural vulnerability is the overwhelming dependence on exporting hydrocarbons and other raw materials, mostly to Europe. However, the government is betting that the West won’t cut off such sales since the negative impact would be felt first and foremost by European consumers.
Russia could also be vulnerable to restrictions on critical imports of advanced technology and equipment. But those kinds of sanctions would also hurt international companies such as Siemens and ABB. Likewise, the Russian civil aviation sector depends on the United States for spare parts, services, and aircraft—but curiously, sanctions on that sector have been neither widely discussed nor implemented.