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A board shows currency exchange rates of the U.S. dollar and euro against the Russian ruble, in Moscow, on Aug. 7.EVGENIA NOVOZHENINA/Reuters

In the dreams of Ukraine and the West, Russia would be a failed state by now. The sanctions imposed for the war in Ukraine, ranging from the price cap on Russian oil exports to cutting the country’s banks out of the SWIFT global messaging network, plus the horrific cost of the war itself, were designed to cripple the Russian economy, forcing Vladimir Putin to sue for peace.

Shortly after the start of the invasion 18 months ago, it looked like the West’s fantasy would be fulfilled. The Russian ruble plunged against the dollar, and the stock market cratered. The West froze more than US$300-billion of Russian financial assets held outside the country. Sanctions piled up, and the budget deficit soared as it became apparent that Moscow, denied a quick victory, would have to finance a long, ugly war that it had chosen to launch.

But the Russian economy, and the ruble, would prove remarkably resilient. The ruble would recover, then soar, as capital controls worked their magic. Climbing prices for oil and natural gas helped double the 2022 current account surplus (the surplus of exports over imports). Lost oil sales to Europe were somewhat recouped by sales to China and India, though at a substantial discount to world prices. Gross domestic product fell 2.1 per cent last year, but that was far less than the early forecasts from the World Bank and other institutions. Russia’s Ministry of Economic Development is calling for 1.2-per-cent growth this year.

Mr. Putin, who had turned the ruble’s recovery last year into an anti-Western propaganda weapon, a symbol of defiance as NATO countries flooded Ukraine with weapons, is not smiling today. Russia is under more pressure than the headline GDP figures suggest. It has taken a while, but the Kremlin must be in a low-grade panic as revenue shrinks and the bills pile up for what may turn into an unwinnable war.

Early this week, the currency fell off a cliff again, hitting 100 rubles to the U.S. dollar; a year ago, 60 rubles bought a buck. One ruble is now worth a mere cent – a level that must embarrass Mr. Putin, all the more so since, earlier this week, Maxim Oreshkin, his economic adviser, wrote an article carried by TASS that said “a weak ruble complicates the economy’s structural transformation and negatively influences real household earnings. A strong ruble is in the interests of the Russian economy.”

In a rare example of public infighting, he blamed the Russian central bank for the currency’s fall, not the Kremlin for starting a war with the potential to wreck the Russian economy. The bank tried to rescue the sinking ruble by jacking up interest rates to 12 per cent from 8.5 per cent. The currency rose a bit, not much. The weak ruble doesn’t just suggest that the Russian economy is in trouble – it shouts it.

The economy has, so far, managed to survive the West’s ever-tightening sanctions, to the point that, bolstered by a surge in military spending, it is overheating as capacity constraints intensify. Inflation is now running at about 7 per cent, well ahead of the central bank’s 4-per-cent official target.

At the same time, the oil price cap imposed by the European Union and G7 countries seems to be working, depriving the Kremlin of the revenues it needs to finance the war. In other words, Russia is running the economy hot with money it doesn’t have. It is running a budget deficit of about 2 per cent of GDP; declining hydrocarbon sales could see that shortfall rise.

Oil and gas revenues are Russia’s life blood, and it is here that the time bomb is hidden, under the floorboards of the Finance Ministry. The cap, in place since early this year, means buyers of Russian seaborne oil can pay no more than US$60 a barrel (Brent crude, the effective international benchmark, currently sells for about US$83). Vessels that carry Russian oil above the price cap are prohibited from buying insurance from European companies, which dominate the seaborne liability coverage industry.

Combine the price cap with the lost energy sales to the EU – only small amounts of Russian oil and gas are finding their way into that market, which Moscow dominated before the war – and the Kremlin is staring at an ever-widening hole in its finances. According to the Centre for Research on Energy and Clean Air, Russian fossil fuel exports were about €500-million a day in early August, down from a peak of €1.2-billion shortly after the war began (the EU continues to buy large amounts of Russian liquefied natural gas, which is not on the sanctions list). The Kremlin’s hydrocarbon revenues were down by almost half year-over-year in the first six months of 2023, according to the Finance Ministry.

The Russian central bank is reportedly considering capital controls to prop up the ruble. But this would amount to window dressing. The economic pain has set in, and rising interest rates and inflation will hurt Russian families as the Kremlin spends heavily to keep its war machine alive. The question is whether the Russian people will turn angry and demand an end to the war. There is no sign of that happening now, but the scenario cannot be ruled out. Long wars are typically ruinous to economies.

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