Are Sanctions Hurting Russia?

SOURCE:

theamericanconservative.com 

 

"Russian businessmen view sanctions as manageable and even a blessing in disguise.

Sanctions against Russia are a blessing in disguise, according toAlexey Butrimov, the general director of BJet, a Russian aviation company. Although he readily admits that the new restrictions have created significant complications for businessmen such as himself, he is confident that in the long-term, they will provide Russia with the much-needed stimulus to revive its long-dormant aviation industry. 

 

“On the one hand, we look at all the problems caused by sanctions with sadness, but we also understand deep down inside that we can finally resurrect our aviation,” he said. “When times are good, you don’t have much incentive to develop anything quickly. But now that we find ourselves in a situation where we don’t have anything, the only path forward is to build up our own aviation system.” 

Since Russian President Vladimir Putin’s decision in late February to send troops into Ukraine, Russia has quickly surpassed longtime pariahs such as Iran, North Korea, and Syria to become the most sanctioned country in the world. Almost overnight, the U.S. and its allies in Europe and Asia moved to freeze nearly half of Russia’s financial reserves, severely restrict Russia’s access to their financial and technological systems, and ban Russian planes and ships from entering their airspace and ports. Simultaneously, hundreds of multinational corporations have either suspended or downsized their operations in Russia since the start of the conflict. 

The Biden White House has vowed that as a result of these new sanctions, “Russia will very likely lose its status as a major economy, and it will continue a long descent into economic, financial, and technological isolation.” Meanwhile, on the political front, National Security Advisor Jake Sullivan told CBS News in April that sanctions were meant “to make it harder for [Russia] to fuel their war machine,” and thereby overtime help “improve Ukraine’s position at the bargaining table and make an outcome of this war that Ukraine wants to see more likely.” 

So far at least, sanctions have done little to alter Putin’s geopolitical calculus or undermine his domestic support. The Biden administration’s most dire predictions for the Russian economy have also not been borne out, at least not yet. Although Western-led sanctions undoubtedly initially caused the Russian ruble to plummet and many ordinary Russians to visibly panic, over three months later, the economic situation in the country appears much calmer. 

None of this is to say that tumultuous waters are not ahead for the Russian economy.

Following three decades as part of the globalized economy, Russia will have to completely restructure its supply and production chains away from the West and do so rapidly. Even more dauntingly, it will have to find ways to promote technological innovation despite having its ties with many of the world’s leading scientific powerhouses severed. 

Russia has spent years trying to sanctions-proof its economy. Since 2014, when the U.S. and European Union first imposed major sanctions against Russia over the annexation of Crimea, the Kremlin promoted import-substitution and greater economic ties with Asia as a way of reducing Russia’s dependence on Western technology and trade. At the same time, Moscow built up its financial reserves to $640 billion in order to have a significant cushion in the event of a crisis. Finally, Russia slashed its foreign debts and began cutting back its use of the dollar for trade settlements or as a reserve currency. This laid the groundwork in Russia for a potential sudden economic decoupling from the West. 

But that’s much easier said than done. Despite the Kremlin’s import-substitution push, many sectors of the Russian economy still remained heavily dependent on the West. A study by the Higher School of Economics, one of Russia’s top universities, published in April found that the U.S., Canada, and E.U. accounted for half of Russia’s foreign value added, including components for machinery, medications, and cars. 

Likewise, although Russia succeeded in accumulating vast financial reserves over the past eight years, it stored nearly half of that money in Western and Japanese banks. Consequently, when Russian troops crossed the border into Ukraine, those reserves were quickly frozen. It’s not clear when, if ever, Moscow will be able to recover them. 

Oleg Buklemishev, director of Moscow State University’s Center for Economic Policy Research, explained that notwithstanding the growing political tensions over the years, most of Russia’s trade outflows, ports, railroads, and financial infrastructure were oriented around the West. Consequently, many Russian business people opted to continue doing business as usual even as the Kremlin urged them to localize production or pivot to Asia. 

“My hypothesis is that 2014 convinced the Russian elite that it was possible to live under sanctions and that what new sanctions will be imposed won’t be critically important,” he said. “There seems to have been the expectation that the West would rattle its sabers as usual, but that business would prevail at the end of the day.” 

Therefore, when the West imposed unprecedented sanctions against Russia over its decision to send troops into Ukraine, the initial economic shock was unsurprisingly immense. In late February and early March, the Russian ruble lost almost 30 percent of its value against the dollar, prompting Biden to boast that the currency had been reduced to “rubble.” This rapid devaluation of the ruble caused many Russians to scramble to safeguard their finances. I personally observed long lines at banks and ATM machines in Moscow, as ordinary people tried to withdraw any foreign currency they could. At the same time, instances of panic buying were reported all across the country, with Russians seeking to stock up on everything from buckwheat to electronics. 

Interestingly enough, however, this wave of economic insecurity appears to have had little impact on the Kremlin’s political support. The Levada Center, Russia’s leading independent polling agency, found that Putin’s approval rating jumped from 71 percent in February to 82 percent in April, his highest mark since the start of his fourth presidential term back in 2018. At the same time, 74 percent of Russians expressed support for Moscow’s military campaign in Ukraine compared to 19 percent who opposed it. When asked whether Russia should make any concessions to the West in exchange for lifting sanctions, 80 percent of respondents said no. 

A similar consolidation process is visible among Russian elites. To date, only two high profile officials have resigned: Anatoly Chubais, the Kremlin’s special envoy for climate change and infamous architect of Russia’s privatization reforms during the 1990s, and Boris Bondarev, a veteran diplomat at the Russian mission in Geneva. 

Sergey Karaganov, head of Russia’s Council on Foreign and Defense Policy, a research group that advises the Kremlin, told me that Russian elites increasingly viewed the Ukraine crisis as an existential struggle for the future of their state. “A majority of people understand that a failure to achieve victory could undermine the regime’s stability and lead to the repetition of February 1917 or 1991,” he said, referring to the downfall of Czarist Russia and the Soviet Union. “The biggest fear for Russian elites is collapse, so they will fight until victory and if necessary, will pursue any escalation in pursuit of that goal.” 

Karaganov added that sanctions had further weakened the influence of Russia’s oligarch class, the faction within the Russian elite most closely affiliated with the West. “What happened with the oligarchs showed everybody that you should not do business with the West under any circumstances,” he said. “For decades, Russia’s wealthy classes have invested their wealth abroad with the expectation that they will spend their old age in Europe. That has now come to a rapid halt.” 

More than three months after sanctions were imposed, life in Russia has a surprising air of normalcy. Following its initial plunge, the ruble has recovered all of its pre-war value and then some in recent weeks thanks to a combination of high global energy prices and the Russian government’s strict capital control measures. Some of the early signs of economic anxiety have also appeared to dissipate: Moscow’s restaurants, cafes, and bars are as packed as ever. Although grocery prices have noticeably increased, supermarkets are still fully stocked with a wide range of products, including foreign snacks. The biggest difference can be seen in shopping malls, where some Western-owned stores have closed their doors. Nevertheless, local and Asian brands are continuing to work as usual and appear to have a fair share of clients on any given day. 

Are these signs that the Russian economy is quickly stabilizing or is it merely the calm before a storm? Buklemishev of Moscow State University suggested that it was closer to the latter option. He told me that the ruble’s recent appreciation showed that the Russian economy’s longtime dependence on hydrocarbon exports had reached “new absurd proportions,” since the currency’s current value is primarily driven by the fact that although imports have dropped steeply, energy sales continue to bring significant foreign currency revenue into Russia. Under the current capital controls regime, however, exporters are forced to convert a majority of their foreign currency earnings into rubles.

“There are not a lot of outward signs of economic problems, in Moscow at least, but we are beginning to see rising prices, a gradually disappearing assortment on shelves, and the closing of stores and factories,” he added. “What we are seeing now are probably the final days of a happy, calm existence. Going forward things will be different.”

Buklemishev is not the only one who is warning that hard times are ahead. In April, Russian Prime Minister Mikhail Mishustin admitted that Russia was facing its most difficult economic situation in three decades. Russia’s Central Bank has forecast that the country’s GDP could decline by 8 to 10 percent in 2022, while annual inflation is expected to reach 18 to 23 percent. Similar figures have been put forth by international observers, with the International Monetary Fund and World Bank projecting Russia’s economy to shrink this year by 8.5 percent and 11.2 percent respectively. 

During a press conference in late April, Elvira Nabiullina, the head of Russia’s Central Bank, warned that the new trade and logistical restrictions would make it substantially more difficult for Russian consumers and manufacturers to acquire a wide range of finished goods and components. Even highly localized industries of the Russian economy would be affected, she explained, since all it takes is to have one small but key component missing to disrupt production. Nabiullina predicted that Russia would begin to meaningfully feel the sting of sanctions in the second and third quarters of this year, as existing stockpiles begin to run down. Economic recovery, she said, would largely depend on how quickly Russian businesses will be able to establish new production and supply chains. 

The E.U.’s recent decision to ban 90 percent of Russian crude oil before the end of the year could further complicate matters for Moscow by potentially depriving it of a major source of revenue. 

To better understand the new challenges posed by sanctions, I spoke to several Russian entrepreneurs across different industries about how their life had changed and what they expect going forward. To my surprise, I discovered that many of them expressed confidence that they could not only adjust but even thrive in their new reality. 

“Sanctions have activated and mobilized the Russian business community,” said Nikolai Dunaev, the vice president of Opora Russia, a national association of small and medium business owners that counts its membership in the hundreds of thousands. 

“Over the past three months, almost everyone we talk to has found some ways to adapt,” Dunaev explained. “Some have found alternative suppliers in China, India, Turkey, and the Middle Eastern countries, while others have had to temporarily lower production or change the assortment of goods they produced. However, the important thing is that everyone is finding solutions to their problems, one way or another.” 

Some entrepreneurs have even reported that sanctions are providing their businesses with an unexpected boost. Valentina Andreeva is the owner of Mrs. Ruby, a Moscow-based premium furniture company. She told me that over the past five months, her business had already generated an entire year’s worth of revenues. “Right now we can’t process new orders because our current production capacity is just not enough,” she said. “We are expanding our productive capacity to meet this growth in demand because new orders are coming on every day.”  

Andreeva explained that previously, domestic luxury furniture producers such as herself faced stiff competition from Italian brands, which had expended substantial resources over the past few decades to establish a strong foothold in the Russian market. Following the imposition of sanctions, however, the logistical and financial chains connecting Russia and Italy were quickly severed. At the same time, sanctions helped to spark a “wave of patriotism” among wealthy Russians, causing them to flock to domestic brands as a sign of defiance. 

“For people in Russia who have become accustomed to exquisite furniture, there is nothing in the world that will cause them to turn away from this luxury,” Andreeva said. “And since the money is still there, they continue to order new furniture. The only difference now is that they buy it from Russia instead of Italy.” 

Andreevna predicted that even if sanctions are removed over the next two years and Italian brands can return to Russia, they will struggle to regain their previous market share. After all, why go through the extra trouble and risk of ordering something from abroad when you can just as easily buy that good closer to home? 

“If Russian producers can demonstrate that they can produce as well as Italy, then no one will order from Italy in the future because there are numerous barriers involved,” she said. 

Butrimov of BJet is similarly confident that sanctions will benefit his industry in the long run. That is undoubtedly a bold position considering that aviation is widely regarded as one of the sectors of the Russian economy that is most vulnerable to sanctions. Butrimov admits that it will be difficult for airplane manufacturers to find replacements for certain Western imports, especially high-tech components such as advanced engines and electronics. However, he believes that Russia will be able to develop its own alternatives over the next five years. 

In the meantime, Butrimov contended that Russian manufacturers had ways to “simplify” their designs without meaningfully sacrificing quality or safety. “For example, if you have a cockpit with electronic monitors, nothing is stopping you from temporarily installing an older solution,” he explained. “Yes, we will have to take a few steps back technologically, but once we are able to develop and produce our own monitors, that will help us make a major jump forward.”

According to Butrimov, one of Russia’s biggest advantages is that it possessed its own well-developed aviation industry just a few decades ago. During the Soviet era, the country not only designed its own aircraft but also fully controlled their production cycle. Although much of that capacity was degraded in the decades following the collapse of the Soviet Union, Butrimov told me that Russia still retained a large cohort of well-trained engineers and the ability to produce workable models.  

“Russia still has factories for the production of military airplanes, and in the current situation all we have to do is to expand the production of military aircraft to the civilian sector,” he said. “For example, we are still releasing the Il-96 and Il-76 airplanes. Nothing is preventing us from boosting our output of the Il-96, but this time with an upgraded engine and new avionics.” 

Butrimov already sees some signs that the Russian aviation sector has begun adjusting to its new realities. “We are seeing the emergence of new small companies that produce key components and the government is trying to promote the manufacturing of Russian equipment,” he said. “So on the one hand you have problems, but on the other hand these problems have finally kicked off the process of import-substitution, the result of which Russia will no longer be dependent on everyone.” 

Over the long run, perhaps the most important question is to what extent Russia will be able to continue producing technological innovations while under sanctions. The Russian economy certainly has enough natural resources and industrial know-how to survive, but can it thrive in a world where advanced technologies increasingly reign supreme? As I discovered, the answer to that question is very much up in the air at the moment. 

Sergei Abramov is the director of the Institute of Program Systems at the Russian Academy of Sciences, but he is perhaps best known for his work as the chief designer of Russia’s “SKIF-Aurora” supercomputer. Abramov told me that as a result of financial sanctions against Russia, his institute could no longer pay for services such as IP addresses, telecommunication infrastructure, servers, and even apps like Zoom or Dropbox. “You previously didn’t think about these issues,” he admitted. “All of us were so used to the fact that we could easily pull up a browser page or write a line of code, that we didn’t really think about the services that make these simple actions possible.” 

The more pressing issue for Abramov, however, is the danger of Russia falling technologically behind as a result of sanctions. As he explained to me, developing cutting-edge technologies in the Internet age is only possible through international cooperation since innovation requires large financial, technological, and knowledge resources. Abramov noted that when his institute developed the “SKIF-Aurora” supercomputer, it formed an alliance with Intel and Italy-based Eurotech company, both of whom significantly contributed to the final product. 

“Could we do this all without international cooperation? No, we could not,” he said. “Even though we had some solutions that were technologically cutting-edge, they were not enough to create the final product. A supercomputer requires hundreds of cutting-edge solutions, and that is very difficult to develop completely yourself.” 

Sanctions also created other barriers to innovation, Abramov warned. In addition to restricting technological imports, sanctions threatened to force the Russian economy into a prolonged slump, which would mean that other sectors will have fewer resources to order solutions from the IT industry. Perhaps even more worrisome, the difficulty of working under sanctions could push many talented Russian IT specialists to seek better opportunities elsewhere. Abramov said that of his five best students, four had left Russia. 

“The IT sector will continue its work and there will be some domestic solutions in software and hardware, but all of this work will be monstrously complicated,” he said. “Under such circumstances, it will be very difficult to talk about Russia developing products with competitive superiority.”

The mass exodus of IT workers since late February has sparked fears that Russia could soon face a major brain drain, although the exact scale of the problem is up for debate. The Russian Association for Electronic Communications caused a sensation when in March it reported that 50,000 to 70,000 specialists had fled the country and that another 100,000 were expected to leave the following month. 

By contrast, a study published in late May by the Russoft software developer’s association estimated that only 40,000 IT workers had moved abroad so far this year. Perhaps even more significantly, the Russoft study concluded that up to half of those specialists could return to Russia before the end of the year. 

Valentin Makarov, the head of Russoft, told me that there are several reasons why he expects so many Russian IT workers to return home. First, the influx of well-paid Russian professionals to neighboring countries has caused real estate prices in those places to sharply increase, making long-term relocation far more costly. Second, many Russians who moved abroad reported experiencing hostility from locals. Finally, Makarov believes that the Russian government’s new package of incentives for IT companies and workers, which includes exemptions from taxation and military service, could help entice many back to Russia.

“Losing 20,000 specialists is of course very bad, but it’s not enough to seriously affect the quality of the industry’s work,” he said. Looking ahead to the future, Makarov argued that although adapting to the new post-sanctions reality would undoubtedly be difficult, the Russian IT sector was up for the challenge. He noted that some Russian companies had seen their sales increase by 2-8 times in recent months, fueled by a growth in demand for domestic IT solutions following the exodus of Western tech giants from Russia. The next step, according to Makarov, is to look for opportunities to expand into the markets of developing countries, which he says accounts for 40 percent of the total global IT market share. 

While Makarov conceded that it would not be possible to fully compensate for the loss of access to Western advanced technologies, he contended that Russia could join forces with companies in emerging tech markets such as China, India, Malaysia, and Indonesia to develop their own cutting-edge innovations. Makarov believes that geopolitical independence from the U.S. could be a powerful selling point for Russia, especially when it comes to establishing closer technological cooperation with Beijing.

“China is obviously more economically integrated with the West than with Russia, but geopolitical confrontation between China and the US is not going anywhere anytime soon,” he said. “On the contrary, as more and more sanctions are imposed against China, it will need to find new partners in technological development and all other areas. Since both Russia and China have very strong programmers, it makes sense for us to work together in building a new technological space rather than remain dependent on the United States.” 

In just three months, Russia’s relationship with the outside world has been completely upended. The post-Soviet era of globalization, in which Russia sold natural resources to the West in exchange for key components, technologies, and finished goods, is likely gone for good. But what comes next is far from certain. Will Russia find a way to defy the odds and retain its status as a major global economy? Or is it doomed to become an international pariah that will increasingly find itself technologically left behind? I suspect that we will have a definitive answer to that question only in a few years’ time."

"Author Dimitri A. Simes has written for the National Interest and Nikkei Asia, and was a 2020 Robert Novak Journalism Fellow.