JIIA Strategic Comments (2022-10)

Papers in the "JIIA Strategic Commentary Series" are prepared mainly by JIIA research fellows to provide commentary and policy-oriented analyses on significant international affairs issues in a readily comprehensible and timely manner.

Introduction

On February 24, 2022, Russian President Vladimir Putin announced the start of a "special military operation" against Ukraine in response to a "request" for military assistance from the Donetsk People's Republic and the Lugansk People's Republic (pro-Russian controlled areas in the Donetsk and Luhansk provinces of Ukrainian territory) and launched all-out attacks in Ukraine. The G7, EU and NATO immediately called for the withdrawal of Russian troops and announced an unprecedented level of economic sanctions against Russia. The Japanese government has also labeled Russia's military actions an "invasion" and has imposed a series of economic sanctions on Russia in coordination with the United States and other Western countries.

This article examines the impact of Western economic sanctions on Russia's economy and society as of August, six months after the start of the war in Ukraine, and considers the state of the Russian economy and society as a backdrop to the protracted war.

1. Russia's invasion of Ukraine and Western countries' imposition of economic sanctions against Russia

On February 22, 2022, President Putin recognized the independence of the pro-Russian areas in Ukrainian territory (the Donbas region comprising the Donetsk and Luhansk provinces) and, on the 24th, under the guise of a "special military operation," he launched attacks on the entire country, including the capital Kyiv (Kiev). Soon after the start of the war, Russian troops invaded the Donbas region and areas around Kyiv, the northern Ukrainian province of Kharkiv (Kharkov), and the southern regions of Kherson and Zaporizhzhia (Zaporozhe), seizing the Chernobyl and Zaporizhzhia nuclear power plants. However, stubborn resistance by the Ukrainian army and poor maneuvering by the Russian army itself led to the withdrawal of Russian troops from the area around the capital Kyiv by the end of March. At that time, the world was shocked to learn of atrocities such as the massacre of civilians in Bucha, near Kyiv, and other areas from which the Russians had withdrawn. Even after the withdrawal from Kyiv, Russian forces have continued missile attacks in Odesa (Odessa) and elsewhere in the country, causing heavy civilian casualties.

Having failed to capture Kyiv, the Russian army then concentrated its forces in the eastern Donbas region and declared control of all of Luhansk Province on July 3. In Kherson and other occupied territories, Russia has established military-civilian administrations and distributed Russian passports to residents while preparing referendums to incorporate these territories into Russia. Despite President Putin's statement at the start of the war that the "special military operation" was not aimed at the occupation of Ukraine, the circulation of the Russian ruble and Russian television and radio broadcasts in the occupied territories of Kherson and Zaporizhzhia have begun, effectively Russianizing these regions. [*]¹

As soon as Russia launched its military operation, Western countries, including Japan, immediately labeled the attack an act of aggression and, coordinating through the G7, the EU and other frameworks, imposed multiple economic sanctions on Russia on an unprecedented scale to stop its invasion of Ukraine. The main sanctions are as follows: ① financial sanctions such as the freezing of the foreign assets of the Central Bank of Russia (CBR) and the exclusion of major Russian banks from the SWIFT (Society for Worldwide Interbank Financial Telecommunication) international settlement network, (2) a ban on the export of high-tech products such as semiconductors, industrial machinery and equipment, and luxury goods, (3) the revocation or withdrawal of most-favored-nation status (i.e., the imposition of higher tariffs), (4) the gradual curtailment or prohibition of imports of energy resources such as crude oil, petroleum, natural gas, and coal, and (5) the freezing of assets of senior members of the Russian government and their close associates, called the oligarchs. In addition to these sanctions by Western governments, a number of foreign companies that had been operating in Russia, including McDonald's, Ikea and Renault, announced that they were shutting down operations there and exiting the Russian market. The multinationals' quick reaction to the reputational risk of continuing to operate in Russia is a phenomenon not seen in previous wars.

2. Impact of Economic Sanctions on the Russian Economy and Society

At the time of writing (early August 2022), economic sanctions imposed by Western countries have not been decisive in stopping Russia's war of aggression. If the goal of the sanctions is to stir up political discontent among the Russian people by throwing the economy into disarray and impoverishing their lives and thereby get them to urge the Putin government to change course, that goal has not been well served. On the face of it, at least, there has been no "economic turmoil in Russia" as expected at the beginning of the sanctions.

Immediately after the imposition of the sanctions, the exchange rate of the ruble collapsed, hitting a low of 120 rubles to the US dollar and 132 rubles to the euro on March 12 (CBR official rate), but defensive actions by the CBR (temporarily doubling the key interest rate to 20% and forcing Russian companies to convert 80% of their foreign exchange earnings from exports into rubles, measures that were relaxed on April 8) proved successful in restoring the ruble to autumn 2014 levels by the latter half of June. In addition, Western countries have imposed sanctions on the energy sector, the main source of revenue for the Russian government, and have announced plans to reduce or ban imports of Russian energy resources. However, these measures have so far failed to completely cut Russia off from its sources of revenue because of, for example, by exempting oil imports through pipelines from the ban as concessions to Hungary, which is heavily dependent on Russian oil (Germany and Poland, which also used to import oil from Russia via pipelines, have announced import suspensions and, by the end of the year, the EU as a whole is expected to have imposed embargoes on about 90% of Russian oil imports). According to media reports in early July, Russian energy export earnings are actually higher than they were before the war due to high prices and a strong ruble as well as buy-ins from China and India, especially as India imports large amounts of cheap Russian oil. Oil exports to the EU fell 33% between February and June, while those to China and India rose 6% and 88%, respectively.[*]² As a result, Russia's oil and gas revenues for the first half of 2022 amounted to 6.37 trillion rubles, which is more than its revenues for all of 2020 and more than 70% of its revenues for all of 2021. [*]³

The Federal State Statistics Service (Rosstat) regularly publishes a report titled "Socioeconomic Situation in Russia". According to its latest version (January-June 2022) released on July 27, 2022, the basic sector output (the combined production of the agricultural, mining, manufacturing, electricity, gas and steam supply, water, construction, transportation, wholesale and retail industries) in March, April, and May 2022 after the outbreak of the war was 101.9%, 97.6%, and 96.8% year on year, and 112.4%, 92.9%, and 97.5% month on month, respectively, showing a decline in output since April. [*]⁴ However, even after the imposition of the sanctions, Russia has been maintaining production near pre-war levels, with basic sector output recovering to 104.6% in June from the previous month (but remaining at 95.5% from the previous year), so at this point (early August 2022) it is difficult to see the full effect of the sanctions. On the other hand, there has been a marked decline in production in the automobile industry, which recorded 54.5% year-on-year and 62.5% month-on-month in March when Western manufacturers announced that they would suspend or withdraw production in Russia. Since then, the decline has continued, with auto production in May at 34.0% year over year and 70.7% month over month. In June, auto output rose to 129.1% compared with the previous month, but represented only 37.8% compared with a year earlier, a far cry from pre-war levels.

Inflation and unemployment figures also show that Russia's economy is surprisingly strong. According to the aforementioned statistics from Rosstat, the inflation rate of 7.6% in March 2022 fell to 1.6% in April and dropped to 0.1% in May and to -0.35% in June (however, real wages and real pension levels have declined to around 90% year on year, partly due to persistent inflation since last year). In the immediate aftermath of the start of sanctions, there were reports of citizens hoarding goods, goods disappearing from supermarket shelves, and huge price increases, all of which could be said to have been temporary.[*]⁵ As for the unemployment rate, it was 4.4% in January 2022, 4.1% in March after the war began, 4.0% in April and 3.9% in May. At first, there were predictions that the unemployment rate would rise significantly due to a series of withdrawals of foreign-owned companies and economic turmoil caused by sanctions, but official statistics indicate that such a situation has not yet occurred. [*]⁶

Thus, at this point, it is difficult to see major impacts of sanctions on the lives of citizens other than the withdrawal of Western foreign-owned companies from the Russian market. It would appear that the measures taken by the Russian government to counter these sanctions have been effective to some extent. Since the start of the war, the Russian government has been actively increasing pensions, providing lump-sum payments to military personnel, and increasing financial support for families raising children, and these various pork-barrel policies seem to have supported the livelihoods of Russian citizens. [*]⁷

At the same time, however, reports of the gradual effects of sanctions on industry have become more prominent. For example, the government has encouraged the "parallel importation" of Western products that have been banned by sanctions against Russia, and the auto industry is reportedly forced to produce "new models" with lowered environmental and safety standards because of the difficulty in obtaining Western parts. [*]⁸ It is quite possible that the disruption of flow of materials, parts and other goods as well as production technology from the West will lead to a slowdown in corporate production activities in the future. Indeed, at a press conference on June 10, 2022, Elvira Nabiullina, the head of the Central Bank of Russia, noted that many Russian companies today are having difficulties in relation to foreign trade, and that she was particularly concerned about the slowdown in the production activities of Russian companies that rely on imported components. [*]⁹ President Putin also acknowledged at a July 18 ministerial meeting that foreign high-tech goods were becoming harder to obtain. So far, Russia has done a good job of dealing with Western sanctions, but the outlook for the Russian economy is far from rosy.

3. "Donbass Consensus" maintained

That Russians are not feeling strongly impacted by the economic sanctions has led to high support for Putin and his war in Ukraine. [*]¹⁰ According to opinion polls, Putin's approval rating, which used to be around 60%, has increased by 20 percentage points since the invasion of Ukraine to around 80%. [*]¹¹ Support for the war in Ukraine hovers around 74-77%, showing no significant change. [*]¹² Since the start of the war at the end of February, the Russian government has been keeping an eye on and thoroughly pressuring anti-war activities among its citizens and, while some have pointed out that there has been an increase in the number of cases in which people do not answer opinion polls honestly, the results of opinion polls conducted by all the companies indicate that Putin's approval rating is on the rise. [*]¹³

Valery Fyodorov, director of the Russian Public Opinion Research Center (VCIOM), a government-affiliated polling agency, has dubbed the broad swath of public support for the president and his policies the "Donbass Consensus," noting that the consensus may hold for years to come. [*]¹⁴ He suggested that the reasons behind this might be (1) that the Russian people have accepted the "new normal" of continuing Western sanctions on Russia since its annexation of Crimea in 2014 and are "used to sanctions," (2) that the people have "confidence" they will be able to overcome this latest crisis because the sanctions have not had such a significant impact on civilian life at the moment, and (3) that the Russian people are buying into Putin's "track record" in foreign policy thus far and think with regard to the current war that "it must be a profoundly correct decision by Putin that we cannot possibly understand." [*]¹⁵

On the other hand, Lev Gudkov, director of the analytical Levada Center, an independent pollster, believes that people are so preoccupied with their daily lives that they are not interested in politics or war, and that their "apathy" results in support for the Putin government and its policies. However, once the effects of sanctions are more tangibly felt, he said, people will not remain "apathetic," leading eventually to criticism of the regime. [*]¹⁶ Similarly, Andrei Kolesnikov, a senior fellow at the Carnegie Moscow Center, said that, if the war in Ukraine and the confrontation with the West become more intense and seriously impact Russian society and its economy in future, political discontent will grow among the people and could turn into political protests in unexpected ways. [*]¹⁷ [*]¹⁸

Views among Russian intellectuals thus vary but, if one were to dare to find the greatest common denominator, one could say that the "apathy" of Russian society has contributed to prolonging the war. [*]¹⁹ The "apathy" mentioned here may refer to the "apathy" that Gudkov points out in which people are so busy with their daily lives that they have no energy left to get involved in politics, or the "apathy" that Fyodorov describes in which people leave thinking to others - ""Putin has made the right decisions so far, so he must be right about this war as well" - and do not actively get involved in politics themselves. All of this "apathy" is underpinned by the relatively minor impact of the sanctions on civilian life at the moment, creating a picture of continued, if not active, support for the Putin regime and the war. In this sense, the "Donbass Consensus" can be seen as maintained, and there is little momentum in Russia at present to stop the war of aggression.

Conclusion

Nearly six months have passed since the start of Russia's war of aggression against Ukraine that shocked the world. As often pointed out by media reports during this period, the lack of a clear vision on the way out of the war on both the Russian and Ukrainian sides is certainly protracting the war, but the state of Russian society as seen in this article is also a factor that prolongs the war.

Following the outbreak of war on February 24, Western countries imposed unprecedented economic sanctions on Russia in an effort to exert maximum pressure while avoiding a full-scale armed confrontation with Moscow. However, apart from the immediate aftermath of the imposition of the sanctions, on the surface there has been no "economic havoc" in Russia, and to the extent that official statistics suggest, the country seems to have managed to cope with the sanctions for now. Therefore, the Russian people are not fully aware of the gravity of the situation, they seem to regard the war in Ukraine as the issue for someone else, and there is no momentum among the people to demand an immediate ceasefire. Russian society's "apathy" toward the situation in Ukraine and the war is one of the reasons the war has been prolonged.

It is strongly hoped that the Russian people face up to the reality of the Ukraine war and correct their own country's mistakes. If we wait patiently for changes in Russian society, though, we will unfortunately not be able to stop the horrific killings that are taking place in Ukraine right now. It goes without saying that an early end to the war is necessary. It is natural for the international community to resolutely protest against injustices by Russia, which started the Ukraine war, and at the same time, it is necessary to seriously consider what can be done to achieve an early ceasefire and a peaceful resolution of the various issues between Russia and Ukraine.

(The original Japanese version of this paper is dated August 12, 2022.)