Five months into the invasion of Ukraine, if you took a cursory glance at what’s
going on in Russia, Vladimir Putin would appear to be in a pretty good position.
Russia started the war with Ukraine like this
And has made substantial territorial gains since then, though perhaps at a high casualty count.
There does not seem to be much in the way of domestic opposition to Putin’s regime,
either politically or in the form of active popular uprisings.
And Russia’s “fortress” economy has survived Western sanctions. Banks appear to be operational,
and the ruble is trading at a significantly better rate than before the war began.
But looks can be deceiving. The statistics that are widely available
come straight from Moscow—and they have all sorts of incentives to misrepresent what is happening.
In fact, the Russian economy is a mess.
And that can unravel Putin’s political stability,
and in turn the Russian successes in its invasion of Ukraine.
A new report finds glaring problems for Russia in four major issue areas:
capital flight, trade, the Russian economy overall, and cash reserves.
Assuming these trends continue—and that’s a big assumption—this
might be the best piece of news Ukraine has received since the start of the war.
The sanctions are, in a single word, working.
Let’s start with the capital flight, as these are direct consequences of the sanctions.
The sanctions regime has made it difficult for foreign companies to do business with Russia.
Major corporations began fleeing the country, including
MasterCard, McDonald’s, Shell, PPG, 3M, and Nike.
One thousand companies have left so far, representing $600 billion in investment,
or more than a third Russia’s 2021 GDP.
That is basically the entirety of foreign investment since the fall of the Soviet Union.
Now, to be clear, not all of that value is lost. Some companies are still winding down operations.
Others are only doing partial withdrawals, like Dunkin’,
which is halting corporate support for franchisees.
Some were sold to Russian entities, though this last group now has western businesses without the
western knowledge specializations, meaning that they will not be as productive as they once were.
People have also been leaving—about 500,000 of them.
That is a small portion of Russia’s population of 145 million.
But think about who is more likely to leave: high-skilled workers with
knowledge of international immigration systems and those with high wealth.
In other words,
the exact people you’d want to keep around if you wanted to maximize your country’s wealth.
On the other hand, there is a minor win for Putin here: they are also the people
most inclined to cause domestic political trouble. But it is still cause for concern.
At the start of 2022, Russia had 101,000 “high net worth individuals”—those
who hold a million dollars or more.
It is estimated that 15,000 will leave the country this year,
or about 15% of them. This is enormous.
By comparison, China has the next largest expected outflow at only 10,000,
but they have more than 800,000 as a starting point.
Where are all those wealthy Russians departing to?
The United Arab Emirates, it seems. Dubai has reported a housing crunch, apparently from
that influx of openly-available Russian money suddenly looking for a nice new place to live.
Connected to the problems of capital flight is trade.
Western trade mostly ground to a halt after the invasion.
The key exception to this has been energy exports.
The US banned the importing of Russian oil and gas on March 8, 2022.
But European countries were slower to reduce their intake.
Still, this ultimately left a glut of Russian oil.
China, the natural alternative outlet, has not picked up the slack partly due to transit issues.
It only takes two days for sea tankers to ship oil to Eastern Europe,
four days to Northern Europe,
and seven days to Western Europe.
In contrast, it takes 27 to reach Southeast Asia
and 35 to reach East Asia.
There is also a limit to what China can do with the surplus oil.
The result is an enormous price difference between Brent barrels and Russia’s Urals barrels,
despite historically trading at a few dollars different.
The import side of the equation has also been troubling. This tends to receive less
attention because it is not a significant source of direct government funding.
However, the absence of imports hurts consumers
and could be a source of long-term political instability.
Some imports are also used as inputs for Russian goods, especially in the transportation industry.
This means that their absence ultimately hurts the Russian economy.
The raw numbers here are rough, showing about a 50% decline.
China hasn’t helped with this at all. In fact,
their exports to Russia declined from $8.14 billion in December 2021
to $3.8 billion in April 2022.
The reason, it appears, is that Chinese companies are worried about secondary sanctions.
In this case, that would be if the west imposed sanctions on a Chinese company
for doing business in Russia when western firms are not allowed to.
The solution for a government having such problems is “import
substitution”—essentially doing it yourself.
But that has largely failed. The Russian automotive industry provides a helpful case study.
Previously, Russia would import brakes and semiconductors for their domestic vehicles.
Russian firms first exhausted the excess supplies on hand.
Since then, they have been unable to replace those at scale.
In some cases, they have resorted to cannibalizing existing equipment.
U.S. secretary of commerce Gina Raimondo has reported Ukrainian intelligence has discovered
Russian tanks retrofitted with semiconductors scavenged from dishwashers and refrigerators.
The end result is that Russian vehicle sales declined 75% year-over-year in May 2022,
and parts accessories declined 54%.
That should leave Putin worried.
Indeed, all of this has been disastrous for traditional metrics of the Russian economy.
MOEX, the main Russian stock market index,
dipped from 3600 on February 16 to 2213 on July 29, a 39% sell off.
As a basis of comparison, the S&P 500 lost 56.8% during the Great Recession,
but that was over the course of 18 months.
Surprisingly, this understates Putin’s real trouble.
Russia initially responded to the sanctions by outright closing the exchanges.
When they finally reopened a full month later, foreign holdings remained locked.
That means that the prices of Russian stocks that we see
are a reflection of what Russian investors think—
which would seem to be systematically biased to produce higher prices.
A similar manipulation confounds the interpretation of the value of the ruble.
On February 14, one hundred rubles bought $1.30.
After briefly going into freefall down to $0.74 on March 10,
by the end of July, they bought $1.61, seemingly in a better position than before the war.
These figures accurately capture how Russia has succeeded in keeping the
ruble from totally collapsing, which was not guaranteed at the start of the war.
However, ruble trading has evaporated. Prior to the war, $10 billion in rubles were traded daily.
During the war, it dropped to just $2 billion.
What this tells us is that the published value of the ruble
is a representation of Russian government transactions.
It is hard to ascertain the ruble’s actual market price
on the black market—it is a black market after all—but suffice it to say that it is lower.
Meanwhile, inflation is elevated. Russia headed into the war at 9.2%,
a rate that western economies would ordinarily find alarming.
It then jumped to 16.7% in March,
17.9% in April,
17.1% in May,
and 15.9% in June.
Retail spending correspondingly plummeted 20% year-over-year in May.
Overall, Russian economists have worked a minor miracle to limit the damage to what it is.
But that takes us to the final topic: Russia is running out of money,
both as a consequence of managing the war and keeping the economy afloat.
Russia’s own projections show a budget deficit of 2% of GDP for 2022.
That might not seem too bad given that the Congressional Budget
Office projects a US deficit of 5.8%.
But the key difference is that the US has lenders aplenty
and can go on Christmas shopping sprees whenever it wishes.
Putin [checks notes] doesn’t even have access to the credit markets.
Russian companies have the same problem,
with no new equity or debt issuances since the start of the war.
How has Russia survived this? The answer is its vaunted rainy day fund.
Following the annexation of Crimea in 2014,
the West hit Moscow with some relatively minor sanctions, at least by today’s standards.
Putin responded by building a savings account
of foreign currency reserves and gold, largely compiled from energy sales.
The fund sat at $643.2 billion on February 18.
Within five months, Russia had burned through $75 billion of it.
That might not sound like much, but there is a big problem for Russia.
As it turns out, Russia had stored $300 billion of their reserves in western banks.
Western governments did the obvious thing and froze those accounts at the start of the war.
What this means is that Russia is down to about $268 billion in accessible funds.
At the current burn rate, that means Russia only has 18 months before that funding disappears.
That timeline is subject to change, of course.
Russia’s ability to right its own economy will determine whether it can pay for the war itself.
Meanwhile, it also depends on Europe implicitly paying for it through oil and gas sales.
Or Saudi Arabia’s decision on whether to flood the market with oil
and thereby sabotage Russia’s income by other means.
Of course, it is unlikely Russia will actually run out of money.
At some point before that, the eventual outcome of the war will become clear, and the parties
might agree to a settlement that matches it and save on the further costs of fighting.
And you thought you were about to get through an entire video
without any lines on maps, didn’t you?
If you enjoyed those lines on maps, let me know in the comments.
You can also check out my book on the causes of the war.
And don’t forget to like, share, and subscribe, and I will see you next time. Take care.