Russia built an economy like a fortress but the pain is real

Sanctions are hitting Russia’s economy hard.

Western sanctions are dealing a severe blow to Russia’s economy. The ruble is plunging, foreign businesses are fleeing and sharply higher prices are in the offing. Familiar products may disappear from stores, and middle-class achievements like foreign vacations are in doubt.

Beyond the short-term pain, Russia’s economy will likely see a deepening of the stagnation that started to set in long before the attack on Ukraine.

But a total collapse is unlikely, several economists say. Despite the punishing financial sanctions, Russia has built “an economy that’s geared for conflict,” said Richard Connolly, an expert on the Russian economy at the Royal United Services Institute in Britain.

The Russian government’s extensive involvement in the economy and the money it is still making from oil and gas exports — even with bans from the U.S. and Britain — will help soften the blow for many workers, pensioners and government employees in a country that has endured three serious financial crises in the past three decades. And as economists point out, Iran, a much smaller and less diversified economy, has endured sanctions misery for years over its nuclear program without a complete breakdown.

Still, the Russian currency has fallen spectacularly, which will drive up prices for imported goods when inflation was already running hot at 9%. It took 80 rubles to get one U.S. dollar on Feb. 23, the day before the attack. By Thursday, it was 119 — even after Russia’s central bank took drastic measures to stop the plunge, including doubling interest rates to 20%.

Marina Albee, owner of the Cafe Botanika vegetarian restaurant in St. Petersburg’s historic city center, has already heard from her fruit and vegetable supplier that prices will be going up 10% to 50%. Other suppliers can’t say how much.

The cafe imports dried seaweed and smoked tofu from Japan, mini asparagus from Chile, broccoli from Benin, basmati rice and coconut oil from India.

“We’re waiting for the tsunami to hit — the tsunami being the price increases for everything we purchase,” Albee said. “We need to keep our eye on the situation and, if we need to, take those dishes out of the menu.”

“We can reengineer our menu to make more Russian-based dishes,” she said. “You have to be quick on your feet.” After surviving two years without tourists because of the Covid-19 pandemic, “it takes a lot to faze us,” Albee added.

Although sanctions have frozen a large portion of Russia’s foreign currency reserves, state finances are in good shape with low debt. When the government does need to borrow, its creditors are mostly domestic banks, not foreign investors who could abandon it in a crisis. The government announced support this week for large companies deemed crucial to the economy.

Estimates of the short-term impact on Russia’s economic growth vary widely because more sanctions could come and the fallout from President Vladimir Putin’s war are uncertain.

“Russians will be a lot poorer — they won’t have cash to holiday in Turkey or send their kids to school in the West — and even then, because of Putin, they will not be welcome,” said Tim Ash, senior emerging market sovereign analyst at BlueBay Asset Management.

He sees economic growth dropping 10%, while other economists see a drop of as little as 2% or something in between.

Long-term prospects for a growing economy are not good — for enduring reasons that predate the war: A few favored insiders control major companies and sectors, resulting in a lack of competition and new investment. Russia has failed to diversify away from its dominant oil and gas sector. Per capita income in 2020 was roughly what it was in 2014.

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“That may not translate into open dissension, let alone revolt, but it will hardly bolster support for the autocrat,” he said.