Russia’s war in Ukraine has taken a heavy toll on its economy, which is facing unprecedented sanctions, currency collapse, inflation, and recession. But the Kremlin still has some cards to play to keep its war machine running and avoid a financial meltdown.
How Russia is financing its war
According to the Financial Times, Russia has been using various methods to fund its military operations in Ukraine, which have cost an estimated $100 billion since February 2022. Some of these methods include:
- Selling gold and foreign currency reserves. Russia has depleted its reserves by about $200 billion since the start of the war, leaving it with about $430 billion as of August 2023. This has helped to stabilize the rouble, which has lost more than half of its value against the dollar since the invasion.
- Borrowing from domestic banks and state-owned enterprises. Russia has increased its domestic debt by about 50% since the war began, reaching 17% of GDP as of July 2023. This has allowed it to finance its budget deficit, which widened to 7% of GDP in 2023, up from 4% in 2021.
- Raising taxes and cutting spending. Russia has implemented a series of fiscal measures to boost its revenues and reduce its expenditures, such as increasing the value-added tax, introducing a wealth tax, slashing social benefits, and postponing infrastructure projects. These measures have helped to reduce the budget deficit by about 2 percentage points of GDP in 2023.
How sanctions are hurting Russia’s economy
The Western allies have imposed a series of sanctions on Russia since it invaded Ukraine, targeting its energy sector, financial system, central bank, and key individuals and entities. These sanctions have had a severe impact on Russia’s economy, such as:
- Reducing its oil and gas exports. The sanctions have restricted Russia’s access to global energy markets, forcing it to offer steep discounts to its remaining customers, mainly China and India. This has reduced its oil and gas revenues by about 40% since the start of the war, accounting for about half of its export earnings and a quarter of its GDP.
- Isolating it from international finance. The sanctions have cut off Russia’s access to foreign capital, limiting its ability to borrow, invest, and trade. This has increased its borrowing costs, reduced its foreign direct investment, and hampered its trade flows. According to the World Bank2, Russia’s external debt fell by about $100 billion in 2022, while its foreign exchange reserves declined by about $150 billion.
- Weakening its currency and stoking inflation. The sanctions have triggered a sharp depreciation of the rouble, which has lost more than half of its value against the dollar since the invasion. This has increased the cost of imports, especially food and medicine, and fueled inflation, which reached 15% in July 2023, up from 5% in January 2022.
How Russia can cope with the economic pressure
Despite the mounting economic challenges, Russia still has some options to sustain its war economy and avoid a financial crisis. Some of these options include:
- Negotiating a ceasefire or a peace deal with Ukraine. This could ease the diplomatic tensions and pave the way for a gradual lifting of some sanctions, especially those related to energy and finance. This could improve Russia’s economic outlook and restore some confidence in its markets.
- Seeking more support from China and other allies. Russia could leverage its strategic partnership with China to secure more loans, investments, and trade deals. It could also seek more assistance from other friendly countries, such as Iran, Turkey, India, and Venezuela.
- Reforming its economy and diversifying its sources of income. Russia could use the crisis as an opportunity to implement structural reforms that could enhance its economic efficiency and competitiveness. It could also diversify its economy away from oil and gas dependence and develop other sectors, such as agriculture, manufacturing, services, and technology.