July 1, 2022

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Putin’s Ukraine invasion will spur 30-year economic setback: experts

Russia’s Prime Minister Vladimir Putin addresses a rally at the Manezhnaya Square just outside the Kremlin in Moscow, late on March 4, 2012.

Dmitry Astakhov | AFP | Getty Images

WASHINGTON — Vladimir Putin’s unprovoked war on Ukraine and the resulting global response will set Russia’s economy back by at least 30 years — close to old Soviet Union times — and lower its standard of living for at least the next five years, according to economists, investors and diplomats.

The sweeping Western sanctions are designed to inflict maximum pain on the country’s economy by expelling it from global markets and freezing assets around the world. From the moment they took effect three weeks ago, the sanctions have opened a new chapter in Russia’s economic history.

Its financial system and currency are collapsing on multiple fronts, forcing the Kremlin to close the stock market and artificially prop up the ruble inside its borders.

Practically overnight, the country’s 40-year effort to build a prosperous market-based economy that began under former leader Mikhail Gorbachev has failed — one more casualty in President Putin’s brutal invasion of Ukraine.

Landmark economic and social reforms originating in the 1980s gave the Soviet Union its first taste of American products. But decades of work to integrate the economy into Europe ended in the past few weeks, as blue chip companies quit the Russian market and the United States and European Union moved to wind down trade and tourism with Russia.

Pedestrians pass a LVMH Moet Hennessy Louis Vuitton SE window display outside the luxury GUM department store on Red Square in Moscow, Russia.

Andrey Rudakov | Bloomberg | Getty Images

Two sanctions in particular have wreaked considerable havoc. The first one expelled Russia’s largest banks from the global payments network known as SWIFT, making it very difficult for them to process overseas transactions.

The second measure froze hundreds of billions of euros held in reserve by Russia’s central bank. Without reserve funds to shore up the ruble, there is very little the Kremlin can do to prevent its value from collapsing.

Meanwhile, the United States and Britain are also halting imports of Russian oil and gas, the U.S. has imposed export controls on high tech equipment and luxury goods, and a growing list of countries have barred Russian ships from their ports.

“The problem you have now is we’re basically in a spiral where we don’t know how many unrealized losses there are left to realize,” said Maximillian Hess, a Central Asia fellow in the Eurasia program at the nonprofit Foreign Policy Research Institute.

“So we still can’t rule out that the ruble could collapse, collapse,” he stressed.

Unwinding decades of growth

Already, the snowballing economic crisis in Russia threatens to wipe out decades of economic gains made by ordinary citizens. 

In the past month, the ruble has lost 40% of its value against the dollar, rendering the currency effectively useless outside of Russia.

Desperate to maintain the ruble’s value inside the country, on March 8 the Kremlin issued a new order barring the exchange of rubles for hard currencies like the U.S. dollar or euro. 

This effectively turned the ruble into play money, a currency that only has value in an essentially fictional economy inside Russia, where people aren’t allowed to buy the products to which they’ve become accustomed. Policies like these are erasing credibility built over decades of integrating the Russian economy into the rest of Europe. 

People stand in line to use an ATM money machine in Saint Petersburg, Russia February 27, 2022.

Anton Vaganov | Reuters

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Russia’s finance minister recently said the country will pay its sovereign foreign debt in rubles as long as Western sanctions keep almost half of its central bank reserves frozen.

But Hess said the contracts governing these debts prohibit Russia from paying them in rubles, meaning an attempt to do so would constitute a technical default.

Taken together, the plummeting ruble and the looming defaults make the economy look very risky to lenders. 

“Russia destroyed any credibility that it has as a borrower for the foreseeable future,” said Hess, an expert on sovereign debt. “It’s never again going to be able to borrow at the rates that it was able to borrow at in recent years.”

The exodus of global brands

A Soviet policeman stands by a queue of people waiting to enter a newly opened McDonald’s on Gorky Street in Moscow in 1990.

Peter Turnley | Corbis Historical | Getty Images

Several of the companies that have halted operations in Russia insist they’ll be back as soon as the fighting in Ukraine is over. But global investment experts say U.S. sanctions and a depreciating ruble make it difficult to envision any of these companies returning this year, or the next.

“Not next year, not five years from now. It’s going to be a long time before investors go back to Russia,” said Smart of Barings.

A drop in the standard of living

Unlike their neighbors in Ukraine, who have been living under missile bombardment, average Russians aren’t fleeing for their lives. They’re not even feeling the full effect of the NATO sanctions yet.

“Very soon, the real impact will hit Russia,” said Smart. “They can’t import medicines. They won’t import spare parts for their airplanes. They won’t have access to any kind of investment to develop their oil fields.”

Smart predicted Russia will have a lot of “knockoffs and lookalike cars and cellphones” imported from China.

Barring a major change in regime that puts Putin out of power, Hess of the Foreign Policy Research Institute predicted that in five years Russians “will be living in some version of the ’90s and potentially even something worse,” if Putin decides to further manipulate the currency or to weaponize commodities.

Even as the Russian economy reels from sanctions that are a direct result of Putin’s war, the increasingly isolated president himself remains very firmly in control of the country. Still, that doesn’t mean he’s invincible.

“Putin has premised his rule on making sure that people don’t have to live in the living standards and the ways they lived in the 90s again,” said Hess. And for most of his time in power, Putin has lived up to his end of that bargain.

When he was first elected president in 2000, he took the helm of a country where 38% of the population lived on less than $5.50 per day, according to World Bank data using 2011 price values. By 2018, that figure had fallen by more than 90%, to just 3.7% of the population.

During that time, millions of Russians bought foreign cars and microwaves and TVs. They dressed in brands like Diesel and Mango and Benetton, and they began to take holidays abroad.

Russian President Vladimir Putin chats with the first President of Russia, Boris Yeltsin, during the State reception in Kremlin, devoted to the Day of Declaration of Sovereignty in Moscow, 12 June 2001.

– | Afp | Getty Images

But if average Russians start to see their standard of living fall as a result of the Ukraine invasion, experts say Putin could have a real problem, given the unwritten social contract he has with voters.

“The deal was that [Putin] would end the chaos of the 1990s and allow people to be domestically and financially successful,” said Barry Ickes, head of the economics department at Penn State University. “In exchange, the people would agree not to challenge Putin’s political power. And that’s been his deal ever since.”

This contract helps to explain how Putin has retained power for two decades, and why so many levels of Russian society have tolerated his evolution into a full-blown autocrat. But it’s also the key to understanding his vulnerability, experts said.

For years, the Kremlin has argued that for Russians the freedom to travel and spend money is more important than less tangible freedoms like the freedom to protest against the government.

“In the early 1990s our people were paupers — and it’s ridiculous to say they were free,” Vladislav Surkov, a leading Kremlin ideologist, said in a 2006 Financial Times interview. “When you have a car to ride in and things to buy, that’s freedom.”

If Putin cannot provide “stability and a good level of economic support” to average Russians, said Ickes, then he risks looking as though he’s not honoring the social contract.

As the war in Ukraine carries into its third week, both stability and economic support are becoming harder for Putin to provide over.

The coming decade of isolation

Again and again, investors and policy experts said it’s nearly impossible to envision a realistic scenario in which American companies would resume operations in Russia within the next five years.

Russian President Vladimir Putin meets with members of the Delovaya Rossiya (Business Russia) All-Russian Public Organization at the Kremlin, in Moscow, Russia February 3, 2022.

Aleksey Nikolskyi | Sputnik | Kremlin | via Reuters

“Once companies leave [Russia] they take some costs and book them on their accounts. And then there’s an environment where you’ve already taken these losses, so it’s a lot harder to convince your risk committee to go back in,” said Hess.

Given the direct impact that sanctions are having on the business climate in Russia, securing a full or partial lifting of them is key to making American companies want to come back. 

But none of the experts who spoke to CNBC for this story believe that any of the current sanctions against Russia or Belarus are going to be eased or lifted for at least the next three years.

“Until you have a new leader in Russia, one who apologizes for invading Ukraine and who writes a check for reparations, these sanctions are going to remain in place,” said Smart, of Barings. “And I don’t see any of the three things I just described happening.”

Underscoring this is the fact that the current sanctions do not even contain any language about what Russia could do to convince Washington to lift them.

For Smart, the best way to understand the Western effort to isolate the Kremlin is to view it as a long-term strategic move, within a 10- to 20-year window.

Russia “is the 11th largest economy in the world, and we’re about to seal it up in a container and not do business with it for the foreseeable future,” he said.

For everyday consumers, the coming months will test how much of the modern world they are willing to give up to further Putin’s ambitions of control over Eastern Europe. 

“Until recently, [Putin’s] whole program was relatively popular,” said Ickes, of Penn State. “It’s the last two weeks where there’s been a major shift.”

“Now the loss of international travel is painful. And the loss of the internet is painful. And your debit card doesn’t work anymore. That’s a big, big, big, deal,” he said.

https://www.cnbc.com/2022/03/14/putins-invasion-of-ukraine-will-knock-the-russian-economy-back-by-30-years.html