Joachim Klement, CFA, is the author of Geoeconomics: the interaction between geopolitics, economics and investments from the CFA Institute Research Foundation.
In response to its invasion of Ukraine, Russia has been the target of severe economic sanctions. What impact will they have? We have yet to see serious data-driven analysis.
Some predict that the embargo will start a Russian financial collapse very quickly, while others expect it to be a longer, slower drag on the economy.
We wanted to put some numbers on the table to understand how well Russia could resist the Western sanctions regime. We divide our analysis into two parts: the first considers the Russian economy’s ability to access dollars and euros and generate domestic revenue to finance war and other non-discretionary spending. The second explores whether the reserves accumulated by the Russian central bank and the sovereign wealth fund will be sufficient to finance these expenditures.
International income: the trade deficit
Ironically, the sanctions imposed on many Russian commercial banks, investments and exports mean that in order to generate hard currency income, Russia must become a barter economy.
Under normal circumstances, the country can acquire dollars and euros through foreign investments or by exporting goods and services. The export embargo has made it nearly impossible for Russia to generate export revenue just as sanctions against Russian stocks and other assets have made it impossible to raise capital by issuing stocks and bonds to foreign investors .
Practically, the only way Russia can obtain dollars or euros is through oil and gas exports and settlement through Gazprombank, one of the few major Russian financial institutions not yet excluded from the SWIFT system. Of course, Russia can channel its oil and gas exports to other countries and receive payment in different currencies, but it will have little leverage in setting the price, and since those currencies are not freely convertible, dollars and euros will remain hard. come and be scarce.
This is important because Russia needs dollars and euros to pay for vital imports of food, medicine and other civilian goods. In 2021, Russia’s total exports of goods and services amounted to $493.3 billion, according to Bloomberg data. Oil and gas accounted for $235.6 billion of that, while metals, coal and wheat, most of which are now embargoed, accounted for most of the remaining $257.8 billion.
In our estimation, with the sanctions, Russia will be able to export oil and gas and food products such as wheat, as well as chemical fertilizers and potentially cotton and wood products. But with fewer imports from the West, Russian domestic demand for these commodities, wheat in particular, will increase. Therefore, much of what is produced will probably have to go to domestic use rather than being sold abroad. In the end, Russian gas and oil exports will likely be reduced to about $25 billion.
So if we ignore the current buyer’s strike and the potential for further sanctions on energy exports and assume that Russia finds a market for its oil and gas, the country will have $260 billion in total exports this year. This represents a decrease of around 48%.
Meanwhile, Russia’s total imports of goods and services were $293.4 billion in 2021, according to Bloomberg. Of this, about $10.6 billion was food, $9.4 billion was clothing and shoes, and $9.7 billion was medicine and antibiotics. The lion’s share, $144.3 billion, was machinery and equipment. If we exclude passenger cars, furniture and other non-essential goods from the import list, but keep machinery imports at current levels, Russia’s total imports are likely to drop to $270 billion.
Thus, Russia faces a trade deficit of between 10 billion and 20 billion dollars that needs to be financed. Of course, the more machinery imports are reduced due to sanctions, the more the deficit shrinks and eventually turns into a surplus, reducing the Russian government’s financing needs.
$488 billion in hard currency?
The trade deficit compounds the challenge for Russia. Beyond what it will have to pay for essential products, the country, in theory, needs to pay off its debt and finance the war. This will be expensive.
Russia’s invasion of Ukraine cost $7 billion in just the first five days, according to analysis by the Center for Economic Recovery. This includes an estimated loss of $2.7 billion in GDP from the estimated 6,000 Russian casualties. Excluding the toll on human capital, that’s $4.2 billion in less than a week. Over three months at the same rate of spending, the cost to the Russian military in materiel alone would amount to about $50 billion.
External debt is another composition factor. According to Bloomberg, the Russian Federation had $490 billion in external debt in 2021. Of that, $67.7 billion was Russian public debt and $78.5 billion was bank debt. Total debt service on that $490 billion hovers around $100 billion a year. Total debt service on Russian public debt in 2022 will rise to $7.3 billion and rise to $10 billion in 2023.
So for the nine months left in the year, Russia will have to finance a trade deficit of $7.5 billion to $15 billion, $7.3 billion in external debt with government bonds alone, and roughly the same amount in debt banking Ultimately, Russia will need $50 billion or more, depending on how long the conflict lasts, to pay for its military operations, much of which is owed to domestic defense contractors that will be paid in rubles.
To cover these costs, Russia will have to tap into the reserves of its central bank and its sovereign wealth fund, the National Welfare Fund. At the end of 2021, the Central Bank of Russia held $630 billion in international reserves, according to Bloomberg, with roughly $468 billion in foreign currency and $132 billion in gold. Of the foreign currency, 61.3% is held by the G7 central banks, the IMF and the Bank for International Settlements (BIS). Sanctions have frozen this entire 61.3%. Because gold reserves are held domestically, the Central Bank of Russia still has access to the $132 billion, as well as the remaining $181 billion in foreign exchange reserves. The National Welfare Fund has another $174 billion in available reserves, while the Russian government has about $488 billion in available hard currency.
From there, the purely financial calculation is elementary: Russia still has enough assets to finance the war and survive sanctions for years to come.
Of course, this is just the holder’s number. Economic sanctions will drastically reduce economic output and with it business and government revenues. The Russian Federation had $329 billion in total government spending last year at the end-2021 exchange rate. The current embargo will reduce Russian GDP by about 9.5% annually, assuming exports of oil and gas remain in line with those in 2021, according to analysis by the Kiel Institute for the World Economy. This implies that tax revenues will fall by about $18 billion, which is not a huge sum compared to the available reserves. But if Russia can’t export its oil and gas, it will have to make up an additional $120 billion in revenue shortfall.
The conclusion of all these calculations is simple: as long as Russia can continue to export oil and gas, it can finance the revenue shortfalls generated by the sanctions for a long time. But the economic toll will be huge: GDP will fall by almost 10% in the next 12 months alone, and it may not stop there.
But if Russia loses its oil and gas revenues, it will run out of money in a year or two.
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All posts are the opinion of the author. Therefore, they should not be construed as investment advice, nor do the views expressed necessarily reflect the views of the CFA Institute or the author’s employer.
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Joachim Klement, CFA
