The European Union (EU) has recently implemented its tenth set of sanctions against Russia and its supporters due to the ongoing conflict in Ukraine. This new package introduces additional trade and financial restrictions, affecting EU exports valued at €11.4 billion based on 2021 figures. This is in addition to the €32.5 billion worth of exports already impacted by previous sanctions. With this latest round, almost half (49%) of the EU’s 2021 exports to Russia have been sanctioned.

Simultaneously, the EU has prohibited the import of certain high-revenue Russian goods. These new import restrictions apply to EU imports valued at nearly €1.3 billion, adding to the €90 billion already under sanction, which represents 58% of the EU’s total imports from Russia in 2021.

The question arises: what effect are these sanctions having on Russia’s economy?

In December of the previous year, when Russian President Vladimir Putin approved the Federal Budget for 2023, Russia’s economic situation was significantly better than it is currently. This is attributed to several factors that initially benefited Russia’s economy following its invasion of Ukraine.

These benefits can be categorized into several groups: increased revenues from energy price hikes, value-added from parallel imports from alternative markets and domestic production replacing imports, additional income from the expansion of local services and domestic tourism sectors, and a de-dollarization process that resulted in increased gold reserves and a strengthened rouble.

As stated by Russia’s Deputy Prime Minister Alexander Novak, revenues from the oil and gas sector rose by 28% in 2022. This increase was not solely due to global price increases but also a 2% increase in oil production and a 7% increase in oil exports from Russia, despite sanctions.

However, according to Rosstat, total gas production in Russia decreased by 12% in 2022, with commodity gas production decreasing by 13.4%. Despite this, liquefied natural gas production increased by 8.1% to a record 32.5 million tons in 2022. As for coal production, despite an EU embargo on the coal industry, coal production in Russia increased by 0.3% compared to 2021, reaching a record level of 442 million tons.

Following Russia’s annexation of Crimea in 2014, sanctions were imposed that encouraged domestic production. This production, aimed at import substitution, relied not on new technology or modern equipment, but on existing resources. Consequently, the processing industry, which is largely dependent on agricultural production, experienced accelerated growth.

Before Russia’s invasion of Ukraine in February 2022, Russia had achieved a high level of self-sufficiency in essential food products. For example, Rosstat reported that in 2020, self-sufficiency levels were 89.2% for potatoes, 84% for milk, over 100% for meat, 86.3% for vegetables and melons, and 42.4% for fruits and berries.

As a result, Russia significantly improved its standing in the Global Food Security Index of The Economist Intelligence Unit in 2020. Among the CIS countries, only Belarus ranked higher in terms of food security. The sanctions imposed on Russia since 2014 played a crucial role in this achievement. The increased demand for local products led to a 6.6% economic growth in agriculture, forestry, hunting, and fishing sectors in 2022.

The collective western sanctions against Russia following its invasion of Ukraine in February 2022, along with the voluntary trade restrictions imposed by western companies, have led to a significant restructuring of both domestic and foreign trade. Russia has successfully expanded parallel import operations from new markets.

According to the Federal Customs Service, China, Turkey, and the Netherlands were Russia’s top trading partners in 2022. Trade turnover with China increased by 28%, with Turkey by 84%, and with Belarus by 10%. Conversely, trade with Germany decreased by 23%, and with the Netherlands by 0.1%. In the first nine months of 2022, trade turnover between Russia and the CIS countries increased by 6.8% compared to the same period in 2021, reaching $72.6 billion.

Travel restrictions on Russian citizens due to the conflict in Ukraine have spurred growth in domestic tourism, the service sector, and investment in construction. As per Rosstat, there was a 5% increase in construction, a 4.3% increase in hotel and catering services, and a 0.6% increase in information and communication services in 2022.

The Russian ruble, which initially depreciated following the invasion in February 2022, subsequently strengthened significantly. Since 2014, Russia has been exploring alternatives to the euro and the dollar. As the world’s second-largest gold producer, increasing gold reserves has been an effective strategy for mitigating the impact of sanctions and managing associated risks. In 2022, Russia nearly tripled its gold reserves. Gold transfers from Russia to China were also expected to have increased by 67% (with a 30% price reduction) during 2022.

However, the positive initial effects on the Russian economy began to shift towards the end of 2022. The increase in oil production continued until December 5th when the G7 approved a cap on Russian oil prices. Consequently, Russia’s average daily oil production in December was approximately 520,000 barrels per day lower than the daily production quota set by Russia for November 2022 to December 2023, according to the OPEC+ agreement.

Significant deviations from forecasts were recorded in January 2023. Russia’s oil and gas export revenues were $18.5 billion in January, a decrease of 38% compared to the $30 billion received in January 2022 (a month before its invasion of Ukraine), according to IEA numbers shared with Reuters. This will likely have negative implications for Russia’s federal budget moving forward.

Preliminary estimates suggest that federal budget revenues in January 2023 were 1.356 billion rubles, a decrease of 35% compared to January 2022. Oil and gas revenues amounted to 426 billion rubles, representing a decrease of 46% compared to January 2022. This is primarily due to a decline in Urals oil quotations and a reduction in natural gas exports.

Preliminary estimates indicate that federal budget expenditures in January 2023 were 59% higher than the same period last year. Consequently, the federal budget deficit for the first month of 2023 was approximately 1,760 billion rubles (about $25 billion). However, according to the 2022 Federal Budget Law, the total deficit for the year was projected to be -2,925 billion rubles. Remarkably, within just one month, the budget deficit has already exceeded 60% of the annual forecast. It’s important to note that there are still eleven months remaining in the year.

In terms of defense spending, Russia has allocated 4,981 billion rubles ($66.41 billion) for 2023, which is an increase of 302.9 billion rubles compared to 2022. The evolving nature of the conflict and the supply of defensive and offensive weapons to Ukraine suggest that the war will become increasingly costly for both parties.

While Ukraine’s expenses are expected to be covered by financial aid and military support from the West and international financial institutions, Russia will have to finance these costs from its internal resources and reserves. Given that the G7 and its allies have approved a cap on Russian oil prices, these additional expenses will need to be met amidst declining oil and gas revenues. This presents new financial risks for Russia and its currency.

Considering the low level of business activity in Russia, the government may have no choice but to deplete its foreign exchange reserves and the assets of the National Welfare Fund. All these factors indicate that while Russia’s economy managed to weather the first year of the war in Ukraine, the upcoming months and years could pose significantly greater challenges.