As winter storms sweep across the Ukrainian flatlands and Russian missiles target electrical grids and power plants there, the question of whether Ukraine can endure the brutal trench warfare confronts Western supporters in an urgent way. President Vladimir Putin clearly believes that his vast Eurasian power can outlast the resources and will of both its target and the Western powers that support it. However, Western observers would be well advised to look closely at the resilience of the Russian war machine and its people in this war of attrition.
Signs of fatigue and economic deterioration in Russia can be seen amid the fog of misleading Russian data and propaganda.
Official Russian economic data is highly suspect. Yale economists Jeffrey Sonnenfeld, Steven Tian, and Stephen Roach label it as “invented.” Russian statistics claim that the economy expanded at a 5.5% rate in the third quarter and will expand by 2.2% for the full year. These numbers, however, are in comparison with the weak data of the past year. What growth Russia has been able to muster is largely in the defense and agricultural sectors, the former obviously a result of the war and the latter of an exceptional harvest and the disruption of Ukrainian exports.
Despite Western sanctions on crude oil sales over $60 per barrel, Russia has managed to keep exports flowing, with 70% now going to China, India and Turkey. Urals oil has been selling at a sizable discount compared to world market prices, and Russia’s need to ship it in “ghost fleets” to distant destinations adds some $12 to the price of each barrel. Due to these factors, Russian tax revenues, which before the war accounted for nearly half of the national budget, have fallen. Government tax revenues on sales of crude oil fell by 41% in the first three quarters of 2023. Most of Russia’s income from exports are in yuan or rupees, neither of which are easily convertible to dollars or euros.
Falling revenues from taxes on oil sales contribute to what an exiled Russian economist and former deputy minister of energy in the Russian Republic, Vladimir Milov, calls a “crisis of government finances.” Ever-increasing expenditures for the war along with falling taxes have led to extraordinary measures such as windfall profits taxes on key industries, including natural resources, and of large drawdowns of the Russian National Wealth Fund. Putin and his economic advisors tout a budget deficit of about 1% of GDP as evidence of their ability to finance the war. But this ability comes at a cost. Putin is imposing new taxes that have reduced investments in sectors like mining and technology, limiting public services, and selling off Russia’s “rainy day” reserves. At current rates of drawdowns, this fund could be depleted within two years.
Apart from the defense and agriculture sectors, the Russian economy is experiencing a recession. Auto production is down by two-thirds since the war began, medical products by 13%, and retail sales by 25%. Investment in agriculture, food processing and telecommunications is off by double digits in each case. Dozens of popular Western retailers such as McDonalds and Danone have left Russia due to pressure from the Kremlin or from their boards, depriving citizens of quality and diversity of retail choice.
To avoid the exodus of capital from Russia and the further decline of the value of the ruble, authorities have put draconian capital controls in place, which require exporters to sell their dollars and euros to the Bank of Russia and to limit capital outflows. Another measure the Kremlin has taken to keep the ruble from further decline and prevent capital flight is raising interest rates to double digits, which have been at 13% and higher since the summer.
All of these measures contribute to depressed levels of investment and to reduced public services. Sonnenfeld noted that hundreds of thousands of people have fled Russia, contributing to a shortage of skilled workers. Russian authorities frequently tout the low official unemployment rate of 3%. But Milov suggests that if one includes workers categorized as “on current unpaid leave,” the number is closer to 10%. With inflation remaining elevated and a weak currency limiting Western imports, the cost and quality of living of average Russians has also deteriorated. The price of infant formula has quadrupled since before the war. According to prominent, now-exiled Russian economist Igor Lipsits, about 20 million Russians, 14% of its people, live in poverty. Over 1 million young men, potential breadwinners and workers, have either fled the country or been casualties of the war.
It is not surprising that Putin has reverted to a religious revival, invoking a primitive nationalism, and to anti-Western nativism to justify the privations being visited on the long-suffering Russian people. Concentrating investment and current expenditures, not to speak of the national wealth fund, on the war economy challenges the patience and pocketbooks of the Russian people and compromises their economic future.
The question of whether Putin can sustain his economy, keep paying for the military buildup, and avoid runaway inflation that results from issuing new bonds and depleting reserves does not admit of an obvious answer, and skepticism is fully justified. He now depends on China, North Korea and Iran for weapons, including technologies such as semiconductors, ballistic missiles, and high-performance drones. Selling oil, coal, and natural gas to China compensates for only a small part of the losses incurred due to Western sanctions since Feb. 22, 2022.
The U.S. and its allies can complicate Putin’s task in a number of ways. They should work more aggressively to enforce existing sanctions on critical military and dual-use technologies. They should invoke full sanctions on Russian oil sales and drop the ineffective price cap. In lieu of depending on Russia and its authoritarian allies to keep the global market supplied and prices reasonable for oil and gas, the U.S. ought to increase its own production and export capacity of these two critical resources and push OPEC to help keep prices stable.
The U.S. and allies should also press for more information on the role of the cryptocurrency exchanges and on money laundering by Chinese banks. Based on this assessment, Western authorities should sanction activities facilitating sanctions avoidance by not only China, but Iran, North Korea, and Venezuela as well.
Stricter enforcement of sanctions, including for illicit money laundering, could go a long way to diminishing Putin’s war fighting capabilities. Such actions would then raise the question of how long the Russian people can tolerate poor Russian government services, availability of quality consumer goods and medical services, and the sacrifice of Russian youth to support the war of aggrandizement. They would also further weaken an already weak economy. The balance of these factors ranked against the steely will of the Ukrainian people with support from the West is not at all in Putin’s favor.