Many of us are contemplating lessons over the last year following Russia’s 2022 invasion of Ukraine – I tackled some lessons about sanctions effectiveness and surprises in another post. This one addresses the state of play in Russia’s economy and the outlook for sanctions. Overall, with the US government relatively satisfied with the oil price cap and cuts to Russian revenue, focus will shift to enforcement both in energy (but primarily on direct sanctions violations) and in increasing the costs for Russia’s military. While there are many risks of discontinuities, many of these are long-term in nature. for 2023, the bigger market risks of misplacing remain around US and Chinese domestic policy.
Overall the war has been painful to Russia’s economy but past savings, lack of growth and willingness to jettison long-term economic interests have helped to temper these effects. So too has the choice of sanctions targets and focus on insulating the global economy from oil spikes, which deferred any major cuts to Russian , Russian revenues have fallen, intermediaries (some Russian) take on more of the value chain and costs of the conflict are rising. Also, the economy has consolidated around the state/military, undermining the private sector and certain sectors like the auto-sector not deemed strategic.
The last year maps to three broad phases in terms of economic impacts
1) financial shock and awe, freezing of CBR assets, banks de-swifted and Russian defensive economic measures (defensive rate hike. reinforced by self-sanctioning. Russian revenues strong, but unable to spend them.
2) Some stabilization of economy, fuel revenues still strong, imports beginning to pick up – but still a large surplus, as cuts to gas revenues were managed. Russia became increasingly reliant on a small number of suppliers and intermediaries, took a large share of increased transport costs.
3) economic hit of mobilisation followed by energy sanctions finally coming into effect at the end of the year Hit to revenues began even as Russian spending went up and despite relatively high oil price cap. The economic hit of the embargo was softened by a) price cap for both Russian and global economy and b) the loophole of allowing non-G7 service providers to transport fuel
Looking forward the economic trends will be shaped by the ability of the Russian fuel suppliers to redirect fuel, the balancing act between cuts to production to elevate prices and discounts and the impact of new enforcement actions on Russian imports. While the most recent phase of economic activity involved export revenues falling and import costs rising sharply due to increased demand from mobilization and restocking the military supply chain, the next phase may involve declines in imports if the US/G7 threat to step up enforcement holds true. Impact is unlikely to be as sharp as in February -April 2022, given the lack of sharp capital outflows from Russia and self-sanctioning, but the payment issues and compliance costs for parallel imports are likely to increase.
Sanctions update: Enforcement Mode
On the sanctions side, the key priorities will be recalibrating the energy sanctions, including the upcoming review of the price cap on oil (set for 5 March by the EU) and a considerable enforcement push to limit trade for the military industrial complex. The focus seems mostly to be on the latter , though the US and allies will likely be digging more closely into energy transactions to make sure that Russian energy is not using G7 services at higher prices (a sanctions violation). Overall the US government seems to be mostly satisfied by the price cap, believing that it cut Russian revenues while shielding the global economy. That seems to be true though the level of the price cap likely facilitated the latter more than the former. One big question going forward will who benefits from the increasing costs of shipping Russian oil and products, and indeed LNG and how that supports Russian revenues and the war. While some intermediaries are individual Russians or foreign companies (including those based in the UAE), which may be beyond the grasp of Russian tax collectors and may amplify governance issues, I would expect Russia Inc would find some way to capture some of these funds. Overall, enforcement is likely to be even more extensive in other areas.
Deputy Treasury Secretary Wally Adeyemo’s speech earlier today set out plans to step up enforcement actions. These include plans for new sanctions, export controls and new listings. It also involves a renewed push to raise costs for countries willing to operate in the grey zones and supply Russia and stop companies from moving more extensively into black market trends. As more trade relies on intermediaries or parallel trading, enforcement actions may be challenging and tradeoffs will increase. The US and allies might find themselves using more blunt tools to try to choke off parallel imports, increasing the obligations of companies to better research the end users of their products. A market of the seriousness of the approach may come from the size of designated companies. The US could look to find some more prominent or medium-sized companies to send a broader deterrence message for other countries.
Ultimately these tools will likely have an impact, cutting volumes, but it may be challenged by the limitations on export control enforcement in some US allies, as well as the fact that more goods are being subverted in countries with less direct US partnership. While the power of OFAC and power of the G7/G10 is still strong, the weight of collective emerging economies is also large. More of them are hedging and seeking their own interests in a more extensive way. The world is set to become harder to navigate and intermediaries will be among those that benefit most.
From a market perspective, the oil market uncertainties remain a source of uncertainty particularly if a combination of OPEC+ market restraint and Chinese demand pick up. Beyond that, the bigger risks of market mispricings still seem to be concerning US and Chinese domestic policy and to a lesser extent bilateral relations. The latter are likely more relevant for sectoral trends than overall macro ones, while the risks of trying to encourage a soft landing, risk overoptimism.
Ziemba Insights 