- Written by Faisal Islam
- economics editor
That was in March 2022. The Russian ruble collapsed, and the London value of major companies Gazprom and Sberbank fell by 97%. Lines began to form at automated teller machines in Moscow. The oligarch's yacht, soccer team, mansion, and even credit cards were seized.
Russia fell into a great depression.
This was a direct result of the most extraordinary attempt by the West to financially contain Russia after the invasion of Ukraine.
At the heart of this was the seizure of the Russian state's official foreign currency assets, in particular the unprecedented freezing of $300bn (£238bn) of the central bank's foreign exchange reserves.
Although Western governments overtly avoided using phrases like “economic war,” it seemed certain that there was a stage for a financial war with the Kremlin. It was better than the option of direct confrontation between nuclear powers.
Almost two years have passed since then, and there are significant changes in this economic context.
In a long, rambling interview this week, Putin gleefully exclaimed that Russia is Europe's fastest-growing economy.
The International Monetary Fund (IMF) last week raised its growth forecast for this year to 2.6% from 1.1%, underscoring the resilience of the Russian economy.
Russia's economy grew faster than the entire G7 last year and is expected to grow again in 2024, according to IMF statistics.
These are more than just numbers. The impasse in Ukraine last year, and growing expectations that the conflict on the ground will freeze through this year, has prompted Russia to remobilize its economy toward military efforts, particularly building a defensive line in eastern and southern Ukraine. It is supported by
Western leaders argue that this model is completely unsustainable in the medium term. But the question is, how long can it last?
Russia has transformed its economy into a mobilized war economy. The Russian state is spending record amounts in the post-Soviet era.
Military and security spending has reached up to 40% of the budget, returning to late Soviet-era levels. Other areas of state aid to the population are also being squeezed to supplement the funding for the production of tanks, missile systems and defense equipment in occupied Ukraine.
Moreover, despite Western restrictions on Russian oil and gas, hydrocarbon revenues continue to enter the state treasury.
Tankers are currently heading to India and China, with many payments being made in Chinese yuan rather than US dollars.
Russia's oil production remains at 9.5 million barrels per day, barely below pre-war levels. The country has avoided sanctions by purchasing and deploying a “shadow fleet” of hundreds of tankers.
The country's finance ministry reported last week that hydrocarbon taxes in January exceeded levels in January 2022, just before the invasion.
Continued foreign currency inflows into Russian oil, gas and diamonds are also helping to reduce stress on the ruble's value.
Western leaders are adamant that this situation cannot continue, but recognize the implications.
One world leader recently said, “2024 will be a much more positive year for President Putin than we expected. He has succeeded in restructuring his country's industry more efficiently than we expected.'' “I did,” he said informally.
However, this form of economic growth greatly increased Russia's dependence on oil revenues, China, and unproductive war spending.
Russia will be at risk as demand for oil and gas peaks and competitors ramp up production in the Arabian Gulf next year.
The statistical increase in gross domestic product (GDP) resulting from the production of tanks and shells being blown up in Donbass, eastern Ukraine, is also far from productive.
Meanwhile, Russia is experiencing a brain drain of some of its most talented citizens.
The Western strategy was not to encircle the Russian economy, but to engage in a cat-and-mouse game that limited access to technology, raised costs, limited revenues, and made the conflict unsustainable in the long term.
“I hope Russia uses that money to buy tankers.” [for oil] The goal of oil market policy is not, for example, to prevent India from buying Russian oil, but rather to limit the flow of profits from that trade back into the Kremlin's war machine.
But this resilience and stalemate could last at least through the rest of this year. This affects the Kremlin's clear strategy of waiting for a possible change in the US president and a reduction in Western funding for Ukraine's defense.
That's why attention is now returning to the central role of hundreds of billions of dollars in frozen Russian financial assets.
British Prime Minister Jeremy Hunt and Foreign Secretary David Cameron support the move.
Lord Cameron said to me: “We have frozen these assets. The question is whether we will use them or not.”
He said, “If you want to pay it forward, spend some of this money now.” [Russian] “Reparations for illegal aggression against Ukraine” and could be used “to support Ukraine and at the same time save Western taxpayers money.”
The G7 called on central banks to conduct a technical and legal analysis. Central bankers are understood to be worried. One top financier told me that there are risks in what he calls the “weaponization of the dollar.” Traditionally, central banks enjoy sovereign immunity for this type of action.
Plans being developed would use that money, or profits from investments, to raise tens of billions of dollars for Ukraine.
But it's a balancing act. If Russian assets were seized in this way, what message would that send to other countries, perhaps in the Gulf, Central Asia, or Africa, about the safety of Western central banks' safe reserves? Or?
These relationships are part of the central arteries of global finance, recycling hundreds of billions of dollars used to pay for energy around the world. Putin certainly wanted to convey that China is emerging as an alternative for emerging economies, if not for the West.
Russia has also indicated it intends to sue the seizures and seize similar assets from Western companies frozen in Russian banks.
The shadow battle over Russia's economy is therefore essential to understanding this conflict and the fate of the global economy.
Although Russia's war economy is unsustainable in the long run, it has bought the country some time. In response to Russia's unexpected show of resilience, the West is poised to step up the challenge.
The precise form of this financial escalation will have implications far beyond Russia and Ukraine.