It has been nine months since the Russian military launched a full-scale invasion of Ukraine. What was supposed to be a quick military operation to overthrow the Ukrainian government has now turned into a protracted war that has claimed tens of thousands of civilian and military lives.
Although the war is taking place on Ukrainian territory, which suffers the heaviest human and material losses, Russia also faces serious challenges affecting its economy.
The European Union, the United States and their allies have imposed a series of sanctions on Moscow, targeting government officials, imports and exports, heavy industry and oil and gas revenues.
Many experts believe that the sanctions will significantly affect the Russian economy and thus force the Kremlin to end its war of aggression. However, my analysis of the Russian state budget shows that such assumptions do not reflect reality. Moscow will not experience significant short-term economic constraints that could force it to change policy.
Exceptional penalties and profits
Economic sanctions imposed by Western countries have led to an economic decline in Russia, but perhaps not as much as expected. According to the Russian government, in 2022 GDP will fall by around 2.9% and the Central Bank says it will fall by 3-3.5%, half of what some experts had calculated in March.
Shortly after the sanctions were imposed, Russia faced a spike in inflation. Consumer prices rose 10% in the eight weeks after the invasion, but in May stabilized.
The Russian ruble also fell significantly in February and March, from 75 rubles to the dollar to 135, raising inflationary expectations and increasing panic among the general population. Aware of the danger of continued devaluation, the Russian authorities imposed severe financial and monetary restrictions on current and capital transactions. The ruble eventually fell to 50 per dollar and stabilized at 60.
Western sanctions, alongside falling demand, have also led to a significant reduction in imports to Russia; they fell 23% and 14% in the second and third quarters of 2022, respectively. This, in turn, resulted in a 20% drop in budget revenue related to imports – including taxes and customs duties – in the first 10 months of the year.
The confrontation with the West over the war in Ukraine has also affected Russia’s hydrocarbon exports, which in 2021 accounted for almost 50% of total exports and 45% of federal budget revenue. Even before the Russian invasion, Gazprom had started cutting its gas supply to Europe in 2021, causing prices to spike.
In April, President Vladimir Putin signed a decree requiring that payments for Russian gas by European companies be made in rubles only. A number of European countries refused to comply and their gas supply was cut off. In April and May, the flow of Russian gas through the Ukrainian gas pipeline network and the Yamal-Europe gas pipeline through Poland was also disrupted. Then the sabotage of the Nord Stream pipeline cut off gas to Germany in September.
Thus, in mid-November, Gazprom’s exports to Europe (including Turkey) fell by 43%. The company – Russia’s largest gas exporter – has cut production by almost 20%.
But that didn’t lead to a drop in revenue; on the contrary, Gazprom and the federal budget recorded a windfall of profit due to the sharp rise in gas prices. In August, at the height of this trend, gas prices rose 460% year-on-year.
Gazprom’s profits have risen so much that the government introduced a temporary tax on its revenues from September to November, bringing 1.248 billion rubles ($20 billion) into state coffers.
The situation in the oil sector was similar. The EU plan to introduce restrictions on imports of Russian petroleum and petroleum products has forced Russian companies to seek out new consumers and accept a steep price discount – up to 25%.
However, due to high oil prices, reaching $120 in spring and summer, the price of Russian oil was still higher than in 2021, even with the discount.
Overall, in the first 10 months of 2022, Russia recorded a 34% increase in budget revenues from hydrocarbon production and exports compared to 2021.
The cost of war
While high hydrocarbon prices have led to high revenues, the Russian budget has also seen a sharp increase in military spending this year.
In mid-September, the Ministry of Finance announced that by the end of the year, defense spending would increase by 31%, from 3,573 billion to 4,679 billion rubles (57 to 74 billion dollars). ). This includes the additional 600-700 billion rubles ($10-11 billion) the Defense Ministry is spending this year on buying and repairing weapons.
Another federal budget item that has seen an extraordinary increase in 2022 is “General National Matters”; it jumped 50% to 2,629 billion rubles ($42 billion). Expenditures under this heading normally arise from the administrative activities of all branches of government. Assuming that the excess funds in this item are war-related, this amounts to an additional 869 billion rubles ($13.8 billion) in defense spending.
Federal spending on the security apparatus also rose more than 19% from 2021 to 2.788 billion rubles ($44.5 billion). Part of these additional funds is allocated to the Russian National Guard whose forces are actively involved in supporting the Russian occupation regime in Ukraine.
Shortly after the publication of the planned budget, the Kremlin announced a “partial mobilization”. As a result, some 318,000 people have been drafted into the army, which will require a further increase in defense spending of at least 372 billion rubles ($6 billion) to pay their salaries and other expenses until the end of the year.
The 2023 budget was drafted by the government and submitted to parliament before the presidential decree on mobilization. It would therefore not be surprising if the actual military expenditures for 2022 and 2023 are higher than what has been officially announced. In any case, even with these figures, Russia’s military spending in 2022 will exceed 5% of GDP, which is unprecedented.
Yet windfall oil and gas revenues to some extent offset war-related expenses. Thus, Russia will end this year with a deficit of 0.9% of GDP, or about $15 billion.
Since external debt financing markets are closed for Russia after the introduction of Western sanctions and the potential for domestic borrowing is limited, the deficit will be financed, mainly, from accumulated reserves, such as the announced Russian Prime Minister Mikhail Mishustin.
As of October, the fund held some 10.7 trillion rubles ($171 billion); the cash portion of it, which can be used for such payments, amounted to 7.5 trillion rubles ($120 billion) – more than enough to pay the 2022 deficit.
A demanding year 2023
In the 2023 budget, the government provided for a 6.5% increase in defense spending, which is equivalent to offsetting inflation. This assumes that war spending will not increase next year.
I have doubts about this assumption. Spending for additional mobilized troops was not included in the 2022 budget, which, together with the possible delay in paying compensation to families of war victims, will likely force the government to revise this figure.
Also, Defense Minister Sergei Shoigu announced a 50% increase in military purchases for next year and he did so after the State Duma passed the 2023 budget. room for that in the budget figures.
Revenues, like expenditures, cannot easily be predicted for 2023 either. first quarter of next year.
Many experts do not share the government’s optimism. Even official forecasts from the Bank of Russia suggest that Russian economic growth will pick up in the second half of 2023.
A key unknown in next year’s budget is also hydrocarbon revenues, especially oil. The EU stopped imports of Russian crude oil on December 5 and will stop the purchase of Russian petroleum products on February 5. The Union, along with the G7 and Australia, also imposes a $60 price cap on Russian oil.
As a result, Russia is unlikely to be able to increase its oil exports next year to pre-war levels. The average price of Russian oil exported in 2021 was $69 per barrel. The current ruble-dollar exchange rate is 15% above the 2021 average, which is expected to continue in the new year. These factors could reduce 2023 fiscal revenues from hydrocarbon production and exports by 15-20% ($22 billion to $29 billion) from 2021 levels.
In response to the expected decline in revenue, the government announced an increase in taxes on oil and gas companies as well as metal and coal producers. These could bring in enough revenue to offset up to 75% of the revenue reduction.
Thus, the risk of not achieving projected revenue in 2023 remains, but it will be limited to 5-6% of total budget revenue, according to my estimates.
Enough money for the war, unfortunately
Although the budget is planned under great uncertainty, it cannot be called unstable. Under different circumstances, his income may turn out to be higher or lower than the expected level. Yet the magnitude of this gap, in my assessment, is no more than 1% of GDP ($17.2 billion) in either direction.
Therefore, even if incomes are lower, the budget deficit would not exceed 3% of GDP ($52 billion), which can be fully financed from reserves (currently at $120 billion).
At the same time, there seems to be no opportunity or desire on the part of Western countries to step up the sanctions pressure on Russia. This means that the Russian budget would suffer no sanctions-related shocks in 2023.
With all of this in mind, I do not foresee any major financial constraints that could force the Kremlin to drastically change its aggressive policy toward Ukraine.
The opinions expressed in this article are those of the author and do not necessarily reflect the editorial position of Al Jazeera.
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