Russia’s GDP has been hit by the war and sanctions, albeit less severely than independent forecasts predicted last year. The IMF estimates that the Russian economy shrank by 2.2 percent in 2022; a growth rate of 0.3 percent is forecast for 2023, while the IMF now expects growth of 2.1 percent for 2024.
This is a significant upward revision compared to previous IMF forecasts. Thanks to high oil and gas revenues in 2022 and the use of fiscal policy, Russia was able to absorb the shock and to a large extent preserve its economic base. In short, Russia’s economic base is not much weaker than it was a year ago.
However, in order to endure a protracted war with significant material losses, Russia had to convert its economy to a war economy. Russia has lost significant amounts of weapons, ammunition and equipment. According to British Defense Secretary Ben Wallace, as of mid-December 2022, Russia has lost 4,500 armored vehicles, 63 aircraft, 70 helicopters, 150 unmanned aerial vehicles (UAVs), 12 naval vessels and over 600 artillery systems. At the height of the invasion, Russia was firing about 20,000 artillery shells a day, according to US officials.
Accordingly, Russia has had to devote an increasing part of its economy to its defense industry. Federal military spending rose to at least 5 percent of gross domestic product (GDP), or about $90 billion. Russia has reduced the transparency of its budget, so actual spending is unknown but could well be higher.
In addition, the Kremlin has committed regional and local authorities to use their funds to equip soldiers with basic military supplies provided for in the draft. Russia’s fiscal position has gone from a 1 percent surplus to a 2 percent deficit, despite record oil and gas revenues in 2022. In other words, the Russian economy is now heavily war-oriented.
Compared to Ukraine’s military spending of just $30 billion, Russia seems to have the upper hand. But in the battle for material and will, two important factors improved Ukraine’s chances.
First, the Western coalition’s total military commitment to Ukraine is €41 billion, according to December Kiel Tracker data. The challenge of maintaining such a level of support is less of a financial one. After all, 41 billion euros correspond to only about 0.1 percent of the GDP of the five largest arms suppliers in the West.
An increase in defense spending and arms supplies by Ukraine’s top five allies would mean that Ukraine’s defense materiel would far outstrip Russian military production. Rather, the challenge lies in overcoming bureaucratic, logistical and political hurdles in increasing arms and ammunition production.
Despite the West’s comparatively large arms industry, supplies have not kept pace with the massive numbers of ammunition and weapons used in Ukraine. In short, the West doesn’t need a war economy, but it does need to solve its logistical (and political) problems.
Second, economic sanctions have degraded Russia’s military capabilities. The sanctions imposed since 2014 have hit Russia. For example, the delivery of French Mistral-class helicopter-carrying vessels was canceled by France in 2014; the development and production of 4th generation Sukhoi Su-57 stealth fighters has been significantly slowed down; and the PAK DA bomber could not be developed yet.
Since February 2022, sanctions against military and dual-use products have been significantly tightened. The Russian defense industry remains heavily dependent on parts and components imported from the West. For example, this affected the production of the T-72 tank, several modern anti-aircraft weapons (9K37 Buk, 9K22 Tunguzka) and the production of Kh-101 cruise missiles, since Taiwanese, Dutch, US and Swiss components are no longer available.
Russia’s most advanced 300mm satellite-guided Tornado missiles use a US-made gyroscope. Vehicle production, including military vehicle production, has suffered greatly. Renowned truck manufacturer KAMAZ has had to stop production of all of its modern military platforms because German-made Bosch injectors are no longer available.
However, as the war dragged on, Russia has strengthened its wartime economy and adapted to the sanctions. Adaptation measures in the defense sector have included import substitution with domestically manufactured goods, the re-equipment of old war material and the use of shell companies to import high-tech goods via third countries such as Turkey and Kazakhstan.
Recent work by researchers at RUSI shows how Russian high-tech imports via third countries increased throughout 2022. And a Wall Street Journal study documents that Russia is increasingly sourcing military components from China.
The United Arab Emirates are also cited as a country allowing Russia to circumvent some of the sanctions’ effects. Russia has also managed to import arms from Iran and North Korea. Iranian drones have been shown to contain chips that cannot be exported to Russia. These adjustments have allowed Russia to continue its war, albeit with diminished effectiveness.
If the West wants Ukraine to win the war, it must not only keep up arms supplies and financial and humanitarian aid to Ukraine. He will also have to further tighten his sanctions system against Russia to respond to Russian accommodation.
Loopholes must be closed. Additional sanctions against Iran, such as reducing its drone-making capacity, and severe prosecution of shell companies and pressure on third countries may slow Russia’s military capabilities. Ukraine continues to need firm and consistent support from the West.
This post is an abridged version of a DGAP Policy Brief that will be published shortly.
“Everything on shares” is the daily stock exchange shot from the WELT business editorial team. Every morning from 7 a.m. with our financial journalists. For stock market experts and beginners. Subscribe to the podcast on Spotify, Apple Podcast, Amazon Music and Deezer. Or directly via RSS feed.
