Sanctions on Russia are working

Unlock the Editor’s Digest for free

Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

We are coming up to a series of high-powered summits in quick succession: G7 leaders meet in Canada this weekend, Nato leaders gather in The Hague next week and the European Council of all EU leaders takes place later in the month. The general challenge at all such meetings these days is to avoid a bust-up with US President Donald Trump. But the most important specific issue that the “rest of the west” is struggling to manage as the US goes rogue is how to deal with Russia.

At Nato, the hope is that members will commit to spending much more on defence. At the other summits, what I will be watching most closely is whether sanctions on Russia will be tightened — and whether this will happen with or without US co-operation. The EU has set things in motion with the punchy new sanctions package proposed by Brussels this week.

The impact of further sanctions — and therefore the debate around imposing them — hinges on how badly they will hit Moscow’s resources. So today I take stock of the latest signs coming out of the Russian economy, which is developing not necessarily to the Kremlin’s advantage (to paraphrase Japan’s second world war Emperor Hirohito).

Russia may not be quite the riddle wrapped in a mystery inside an enigma that Winston Churchill described in late 1939. But the current strength of the Russian economy remains difficult to assess. Partly that is because President Vladimir Putin’s regime has every interest in misrepresenting it (to his own people and to the outside world) as more robust than it is. Partly because something can be both strong and brittle: the most obvious ways in which the Russian economy could break — a credit crisis or a popular revolt — are virtually impossible to predict the timing of.

A few months ago, I described Russia as a financial house of cards (though note that a house of cards can remain standing for a long time, even if it collapses quickly once it does). In an opposite take for the FT, Alexandra Prokopenko warns against the “dangerously misguided assumption that Russia’s economy will crack under the staggering cost of militarisation, anaemic growth and decreasing oil prices”.

I don’t agree with Prokopenko’s suggestion that western policy is “anchored” in this assumption — my impression is that most western policy is resigned to the flawed premise that Putin can at best be contained, not defeated. But it is clearly unwise to base plan A on an expectation of economic collapse. That is compatible, however, with putting maximum pressure on Russia’s economy to erode as much as possible the material and political resources enabling Putin’s criminal war.

And this is a time when such pressure should be particularly effective. A new report from the Center for Strategic and International Studies (CSIS), with a detailed up-to-date overview of the state of the Russian economy, shows that Putin has maxed out the benefits of “war Keynesianism” of fully mobilising domestic and available foreign resources. There is no slack left to exploit, and the damage to non-war-related sectors and activities is beginning to show — to the point where policy is increasingly shaped by the need to protect them and not just boost the war industries.

Here are some of the signs that the economy is increasingly straining under the pressure of war management. My colleagues recently updated their investigation of the Russian labour market through salary offers in job ads, finding that the heady wage growth driven by recruitment to war and defence industries has begun to taper off.

The CSIS reports several other signs that the war boom is waning. The economy has run out of workers to boost the labour force, because of the number of men killed or injured in attacking Ukraine or who emigrated to avoid having to do so. The CSIS authors assess that “somewhere between one to two million labourers are estimated to have functionally left Russia’s productive economy since February 2022”. They also assess that “non-military industrial production has stagnated since mid-2023”, and overall manufacturing, including defence, is slowing down, with some indicators pointing to outright contraction in the past few months.

Then there are financial markets. Economists Thore Johnsen and Ole Gjølberg have drawn my attention to the Russian yield curve — the difference between long- and short-term government borrowing costs — which has been negative for more than a year. This unusual situation (the norm is that long-term borrowing costs more than short-term) is a common financial signal that an economy is entering recession.

When I hosted the exiled Russian economist Sergei Guriev (now dean of the London Business School) for a podcast in February, he was then a little less sceptical than I was about Russia’s economic resilience. So I returned to him now for his updated view, which is that the seeming slowdown in the past few months is real. “Overall, the economy is now in significantly worse shape,” he told me, but “it is still not collapsing”.

Lower oil revenues are a big part of the economic strain. Since the start of the year, a last-minute tightening of sanctions by the outgoing administration of Joe Biden and the fall in oil prices due to the economic uncertainty caused by Trump have combined to take a big bite out of Russia’s oil revenues. The public finances will rely on higher taxes and deficits than was foreseen a year or two ago.

The CSIS report highlights how oil prices have always been a big political vulnerability for the Kremlin:

For example, various western constraints and sanctions against the Soviet Union only truly delivered when combined with the collapse of energy prices in the mid-1980s . . . Low oil prices were also a significant factor in instigating the 1998 economic crisis . . . By some estimates, an oil price decline to $30 per barrel would deprive the Russian budget of an amount comparable to all current military expenditures, making the foreign trade balance negative in the context of continuing war and sanctions.

It’s clear that the Russian leadership has realised it couldn’t go on as before. In January, I reported on Craig Kennedy’s study of the off-balance sheet financing of the war industry through state-directed subsidised bank loans. Kennedy tells me such lending stopped abruptly around the end of last year, presumably because it was recognised as unsustainable and harmful to the non-war-related sectors and broader macroeconomic management. But the result has been to make visible what was hidden, with the public budget now showing greater spending, deficits, and pressure to raise taxes. “So, if you’re not making major breakthroughs on the battlefield, and if the west manages to persuade Moscow that it will continue to provide adequate resources to Ukraine (Moscow doesn’t yet appear convinced it will), this rising financing risk could increasingly weigh on Russia’s war calculus,” Kennedy emailed me.

This also means that more sanctions and better enforcement of existing ones would come at exactly the right time: the Russian economy is stumbling and an extra hit would have an outsize impact. What is more, the EU’s 18th package now under consideration aims at precisely the right things: lowering the price cap on oil exports that can be serviced by western shipping and insurance companies, putting the Nord Stream pipelines permanently out of business, imposing sanctions on more of the “shadow fleet” of oil tankers and cracking down further on the remaining financial channels open to Russian trade.

There are more things that could be done. In particular, moving forward with segregating Russia’s hundreds of billions of reserves immobilised in the EU (mostly at the Euroclear depository in Belgium) so that they can be transferred to Ukraine as compensation for damage, and stopping other moneymakers for Moscow. The EU still imports Russian-made steel, for instance, which is not only a nice earner for Putin but keeps prices lower than they could be for Europe’s own steelmakers.

If the Russian economy has proved resilient, it is because Ukraine’s western friends have refrained from putting it under as much pressure as they are capable of. And the expectation that they won’t do so plays a large part in how Putin chooses to pursue his assault on Ukraine. Change that expectation and you can turn the tide of the war.

Other readables