State Of The Russian Economy (How Strong Is It Really? )

As the war in Ukraine continues, despite negotiations between Russia and the United States, one of the key factors is whether Russia’s economy is strong enough to continue to weather the continued pressure that the U.S. and the West is putting on it. At the beginning of the war, it was asserted that massive Western sanctions would cause Russia’s economy to collapse and force Putin to abandon his activities in Ukraine. This clearly has not happened, and as of this writing, it is Ukraine that appears to be under significant pressure on the battlefield. The war has turned into a battle of attrition. In such a war, it is the side with the larger population that has an advantage.

It appears that many commentators are coming around to the conclusion that if Ukraine (and the West) are to have some sort of a ceasefire, Russian forces will have to become exhausted. This will only happen if Russia’s economic strength is seriously degraded from its current position. Propagandists on both sides are trying to either project a picture of the Russian economy that is teetering, or a strong Russian economy that is impervious to western pressure. What can be noted is that Russia does appear to have switched its economy to a war footing. It is spending money in producing war materials, and employment opportunities do appear to be at least somewhat plentiful. This is not entirely unlike what happened to the U.S. in World War II where government spending on war munitions eventually ended the Great Depression. In some sense, the war has improved economic prospects for at least some segment of Russian society. However, it also does not appear that Russia has the capacity to produce the entirety of the munitions that it is expending in Ukraine and it’s still dependent to some extent on shipments from Iran, North Korea, and likely China, for some portion of its war materiel.

While Russia has held up economically far better than could have been expected, there are a couple of areas that could pose a serious problem for Russia. The first is that the Russian Central Bank (RCB)still feels the need to keep its benchmark interest rate at 21%. This is a sign that inflationary pressures are still very high. One can read their press releases for positive spin, but the fact of what they are doing (keeping the rate high) is the important factor. When one considers that that this rate was at 7.5% two years ago, that it is now so high speaks to an economy under pressure. On the other hand, the fact that the RCB has not felt it necessary to increase the rate over the last 6 months while the value of the ruble relative to the dollar has strengthened by 14%, could mean that the inflation pressures, although still high, may be easing somewhat. Regardless, an interest rate of 21% is liable to be an economic headwind for Russia.

The second area of potential difficulty for Russia is the price of oil. Russia’s economy is still very dependent on the international price of oil. One of the major factors that led to the fall of the Soviet Union were the relatively low oil prices in the latter half of the 1980’s. While Russia’s economy today is much more flexible than was the Soviet Union’s, protracted low oil prices could cause a serious disruption in Russia’s economy and the state budget. Since January, the price of oil has fallen roughly 22% as of this writing. Continued deterioration could put more financial pressure on Putin’s efforts to finance the war.

Western Options:

The West has tried to sanction Russia’s economy into collapse (to stop the war in Ukraine), and it clearly has not worked. Apart from the West, the rest of the world really has not enthusiastically participated in the sanction regime. The U.S. and the E.U. still have significant economic clout to the extent that the rest of the world cannot simply ignore the sanctions. However, many countries (not just Iran and North Korea) have been willing to pursue work-arounds meaning that the sanctions have not been as effective as they might otherwise be. Putting more sanctions might have an effect, or it might not. However, there is one option that the U.S. could pursue if it is interested in pushing quickly to put the Russian economy under the kind of pressure that would force Vladimir Putin to take notice. The U.S. is the world’s #1 oil producer, producing 16% of the world’s oil. Saudi Arabia is #2 in producing 13% of the world’s oil (as does Russia which is the world’s #3 oil producer)  (source is Wikipedia for December 2024). The U.S. could open up the oil spigot (and encourage its allies to do the same) and drive down the price of oil. Prolonged low prices for oil and gas would have the biggest chance of forcing Russia to seriously negotiate an end to the Ukraine war. If one takes countries that could be considered to be “The West” (NATO countries + non-NATO English speaking countries, plus non-OPEC+ South American countries), oil production accounts for about 29% of the global total. These plus Saudi Arabia (13%) accounts for 42% of the global total. A massive concerted increase in production could drive the oil price down and threaten the stability of Russia’s economy to the point that it would have some hard choices to make regarding continuing the war.

Currently, despite ongoing discussion between the U.S. and Russia regarding ending the war, Putin does not seem to be negotiating in good faith. The discussions do appear to be more broad-based than just this one issue, and seem to be touching many different aspects of the U.S.-Russia relationship. But on the issue of the war, Putin appears to think that he has military strength and economic stamina to continue the war until he obtains all of his initial goals, i.e. the destruction of the Ukrainian state and its absorption back into the Russian sphere of influence. It would appear based on the effectiveness (so far) of the sanctions that perhaps the only thing that could change his calculus would be a sustained drop in oil prices.

If the West wants to ramp up economic pressure, then it would be advised to make a concerted push in this direction.