Location: Russia

Russia’s Counter Sanctions: Forward to the Past!

Posted on May 12, 2025 | Policy Brief

Since February 2022, Russia has introduced a series of counter sanctions in response to the international sanctions introduced following the country’s full-scale invasion of Ukraine. These measures aimed to counteract external economic pressure while shielding the domestic economy from further destabilization. However, their broad implementation has led to mixed effects across various sectors while simultaneously increasing the administrative burden. This policy brief argues that Russia’s countersanctions reinforced state control over key industries, worsened market competition and fiscal sustainability, which contributed to a systematic move towards a planned economy.

Russia’s Counter Sanctions and the Expansion of State Control

Since February 2022, Russia has introduced a series of countersanctions in response to the international sanctions imposed following its invasion of Ukraine. A broad range of economic, financial, and trade restrictions have been implemented, including nationalization of foreign assets, price control, capital flow restrictions, export bans, and state-directed subsidies – all aimed at mitigating external economic pressure while reinforcing state control over key industries (Garant, 2025).

While it is widely accepted that, in times of crisis, governments may intervene in the economy to provide necessary support, such intervention should remain limited in scope and duration. Prolonged state involvement, particularly through subsidies and market controls, can distort price signals, crowd out private investment, and erode the foundations of competitive market dynamics (Friedman, 2020).

In the case of Russia, intensive government economic interventions, specifically after 2022, have led to mounting inefficiencies, increased inflationary pressures, and weakening long-term growth prospects (SITE, 2024; SITE, 2025). This policy brief discusses how the recent surge in presidential decrees, the sharp expansion of targeted subsidies across nearly all sectors, and the tightening of price regulations reflect the Kremlin’s strategic use of counter sanctions as a means of consolidating economic power and reinforcing centralized control.

An Expansion of Presidential Control

Since 2022, presidential decrees account for 25 percent of all anti-sanctions legislative measures, indicating a significant consolidation of executive control over economic policymaking.  The trend of expanding presidential control through issued decrees is illustrated in Figure 1. As shown in the figure, the total number of presidential decrees has nearly doubled since 2019, amounting to 1131 in 2024. The largest share of this decree increase, however, occurred post February 2022.

Figure 1. Number of Presidential Decrees in Russia

Source: ConsultantPlus, 2025.

Beyond the expansion in the number of decrees, what is particularly noteworthy is the breadth of topics they cover. They range from significant interventions on nationalization and economic control to quite detailed low-impact orders.

Among the highly impactful presidential decrees, Decree No. 79 (February 28, 2022) should be mentioned. The decree introduced a mandate that Russian residents engaged in foreign economic activities sell 80 percent of their foreign currency earnings. Further, Decree No. 302 (April 25, 2023), allowed the Russian state to seize foreign assets from “unfriendly states” if necessary for national security or in retaliation for asset confiscations abroad. Global companies from Germany (Uniper), Finland (Fortum), France (Danone), and Denmark (Carlsberg) are among those affected by these expropriations (Garant, 2025). Seized foreign assets were transferred to state-controlled entities, which drastically reduced competition and increased inefficiencies within key Russian industries.

Similarly, Decree No. 416 (June 30, 2022) on the Nationalization of Sakhalin-2, transferred oil and gas projects from foreign operators (Shell, Mitsubishi and Mitsui) to a Russian-controlled legal entity. Moreover, foreign companies from “unfriendly” countries were required to sell their Russian assets at a minimum 50 percent discount when exiting the market. Additionally, they were obliged to pay a “voluntary contribution” to the Russian federal budget at 15 percent of asset value (Garant, 2025).

At the same time, numerous presidential decrees have been adopted to address very specific low-level administrative issues. While their economic impact has been quite limited, they have largely contributed to a growing micromanagement and regulatory complexity (for instance, Decree No. 982 (December 22, 2023) on Temporary State Control Over a Car Dealership, Decree No. 1096 (June 17, 2022) on Transport Credit Holidays etc.).

Apart from the potential negative effects of direct government intervention in the economy, there are several issues with Presidential Decrees. Most importantly, presidential decrees, unlike statutes or other forms of legislation, are not subject to parliamentary approval. Thus, they are bypassing legislative debate and accountability, which makes them less transparent and balanced. Presidential decrees serve as tools to avoid legislative resistance since the Russian judiciary rarely challenges presidential authority, meaning decrees are difficult to contest or reverse through legal means. Further, they often overlap with other legislation, thus duplicating the functions of other legislative (and executive) authorities, leading to regulatory uncertainty. This, in turn, undermines implementation and expands bureaucratic oversight, further increasing inefficiencies and costs (see for instance, Remington, 2014; Pertsev, 2025).

Altogether, the surge in presidential decrees in Russia contributes to increasing institutional instability, an increasing administrative burden and a centralization of power. However, the full impact of these measures on the macro level is yet to unfold.

Targeted Subsidies and Industry Dependence

A key tool in Russia’s counter sanctions strategy is the expansion of state subsidies. Since 2022, substantial subsidies have been directed toward the energy sector; industrial and technological development – including aviation, pharmaceuticals, electronics, and shipbuilding; agriculture and food security; transportation and infrastructure; the banking sector; housing; and consumer lending. The scale of these subsidies indicates growing imbalances and escalating fiscal risks in the Russian economy (Garant, 2025).

However, estimating the total resources going to subsidies is quite challenging. Precise subsidy figures are only explicitly stated in few legislative acts. Most legislative documents mention the form of subsidy without specifying the amount or the source of financing. Nevertheless, some estimates have been made by both Russian and Western experts.

For instance, Russia spent approximately 12 RUB trillion (126 USD billion) on fossil fuel subsidies in 2023 (Gerasimchuk et al., 2024). Subsidies to the agricultural sector were estimated at 1 trillion RUB between 2022 and 2024 (Statista, 2025). Since 2022, Russia has allocated approximately 1.09 trillion RUB (12 billion USD) in subsidies to the aviation sector to maintain operations (Stolyarov, 2023; Garant, 2025). Around 100 billion RUB were allocated to support the tourism industry during 2023–2024 (Ministry of Economic Development of the Russian Federation, 2024; Garant, 2025).

To understand the order of magnitude, it’s worth noting that, for instance, budget revenues from oil and gas amounted to 8.8 trillion RUB in 2023 and 11.1 trillion RUB in 2024 (Figure 2).

Figure 2. Budget revenues and expenditures

Source: SITE, 2025.

In addition, state subsidies for mortgages nearly doubled since 2022, with the total amount reaching 1.7 trillion RUB between 2022 and 2024 (CBR, 2024). Thus, the Russian mortgage market has become heavily dependent on state support, with subsidized mortgage programs accounting for nearly 70 percent of the growth in mortgage lending in early 2024 (CBR, 2024). Although the so-called standard preferential mortgage program was terminated on July 1, 2024, its discontinuation does not remove the substantial fiscal burden created by earlier subsidy schemes.

Moreover, the Russian government has expanded subsidized lending programs to support both businesses and individuals. For instance, preferential loans and credit holidays have been granted to small, medium and large enterprises (see for instance, Presidential Decree: No. 121, March 2022, Federal Law 08.03.2022 No. 46-FZ, and others (Garant, 2025)), further straining the government’s finances.

In many cases, subsidies allocated to state-owned enterprises double as a mechanism for off-budget military financing. For instance, defense-industrial conglomerates like Rostec not only receive targeted support but play also a pivotal role in facilitating military acquisitions and production activities outside of the formal federal budget framework (Kennedy, 2025). This not only obscures the true scale of budget expenditures but again increases the long-term fiscal burden.

As such, these measures have fostered a heavy reliance on state funding, resulting in the accelerated depletion of financial reserves and contributing to increased fiscal risks.

Price Controls, State Regulation and Planned Procurement

As mentioned earlier, the set of countermeasures recently implemented by Russia also indicates a shift toward a planned economy, with hallmark features such as price controls gradually re-emerging as policy tools. As in Belarus, where state-led economic management has long been the norm, the Russian government’s direct intervention in price-setting mechanisms, particularly for essential goods, erodes market signals.

Since 2022, a series of decrees have introduced price controls on essential goods and services to cushion households against rising costs amid inflation. These measures include caps on fare increases for public transportation, limits on tariffs for heating, water supply, and wastewater services; price limits on essential medicines, and staple agricultural products (Garant, 2025).

By limiting the price growth of necessities, these interventions aim to support households in the short term. However, prolonged price controls may entail distorted market signals, increased subsidies dependency for producers, and higher administrative costs for control enforcement.

The deviation from market mechanisms has been even more amplified in procurement, through Federal Law No. 272-FZ (July 14, 2022), which compels businesses to accept government contracts if they receive state subsidies or operate in strategic sectors. In practice, companies cannot refuse government contracts if their products or services are required for so-called counterterrorism and military operations abroad. Refusal to comply with procurement orders may result in criminal liability, as non-performance can be interpreted as economic sabotage under this law.

In addition, the Russian government provides up to 90 percent of procurement contracts in advance (Government Decree No. 505, March 29, 2022). This arrangement weakens the role of contracts, prices, and competition, while increasing the fiscal risks. In effect, it reinforces a central planning logic and undermines competitive procurement, where outcomes should be driven by performance and value rather than access to state funding.

With Russian companies cut off from foreign investment and other external financing due to sanctions, large-scale government support has become even more critical – intensifying dependence on state subsidies and, by extension, state control. The legal changes outlined above have turned procurement into a key instrument of political control over businesses. The scale of these subsidies is contributing to a damaging shift toward a centrally planned system, restricting competition and undermining long-term growth potential.

Fiscal Sustainability at Risk

The extensive use of subsidies, preferential loans, and government-backed financial interventions has placed an increasing burden on Russia’s fiscal system. While these measures were introduced to mitigate the effects of international sanctions, stabilize key industries and support households, they have led to significant structural imbalances, growing budget deficits, and rising financial risks.

State-subsidized loans have surged across multiple sectors, including construction, IT, housing, energy, infrastructure, and agriculture. The result has been a sharp increase in corporate and consumer debt, with unsecured consumer loans growing at an annual rate of 17 percent as of April 2024. Overdue debt on loans to individuals reached 1.34 trillion RUB by February 2025, signaling mounting financial distress for households despite the support measures (CBR, 2025).

The high concentration of corporate debt has further destabilized the financial system. By early 2024, the debt of the five largest companies accounted for 56 percent of the banking sector’s capital, indicating systemic vulnerabilities (CBR, 2025). In addition, the government has implemented new policies that exacerbate the risks connected to state interventions in banking operations. For instance, in March 2022, it introduced a moratorium on bankruptcy proceedings, effectively delaying the official declaration of businesses as insolvent or financially distressed. At the same time, the Central Bank required commercial banks to restructure loans rather than classify them as defaults – masking financial distress and exacerbating long-term risks to the banking sector (Garant, 2025).

Moreover, a growing share of Russia’s war-related spending now flows through off-budget channels – such as state-owned enterprises and regional programs – rather than the federal budget. According to a recent analysis, as much as one-third of military and strategic expenditures bypass formal budget reporting altogether (Kennedy, 2025).

These hidden expenditures distort the actual fiscal position, reduce transparency, and increase the long-term burden on the public sector by masking the true scale of liabilities – raising further questions about the sustainability and accountability of Russia’s fiscal policy.

Conclusions

Since February 2022, Russia’s counter-sanctions measures have markedly shifted its economic governance toward greater state control and elements reminiscent of Soviet-era central planning. Large-scale subsidies, administrative pricing, and deep state involvement in production and procurement have suppressed market competition and efficiency. These interventions have distorted incentives and curtailed the role of market signals, contributing to growing inefficiency across key sectors.

Looking ahead, the long-term economic outlook for Russia is increasingly negative. While the counter-sanctions measures may have softened the initial blow of international sanctions, they have entrenched structural vulnerabilities, reduced fiscal flexibility, and amplified systemic risks, particularly in the financial and real estate sectors. Moreover, by undermining innovation and productivity, Russia’s counter sanctions are accelerating its trajectory toward deeper economic isolation and a centrally managed model, with severe implications for sustainable growth.

References

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

Russia’s Car Fleet Dynamics – and Why They Matter

Posted on May 5, 2025 | Policy Brief

Traffic moves along the Kremlin walls in Moscow during winter, illustrating Russia car fleet dynamics amid economic shifts.

Russia’s car imports have evolved dramatically since its full-scale invasion of Ukraine in February 2022. The invasion and subsequent sanctions have led to a shift away from mainly Western car imports to domestically produced cars, and especially Chinese cars, both entailing quality concerns. Despite state sponsored loans reliefs, the heightened inflation pressures in Russia and increased financial burden on households is catching up to the car market – in the first quarter of 2025, the sales of new cars decreased by 25 percent compared to 2024. This policy brief uses the developments in the Russian primary car market as a lens to examine the spending power of Russian households and highlight the limitations of state interventions under sanctions and inflationary pressure. 

From Western Dominance to Domestic Car Sales

Prior to February 2022, imports of American, European, South Korean and Japanese (hereafter called western) cars stood for about 60 percent of all new car sales in Russia. Domestic production took up most of the remaining 40 percent market share (SITE, 2024). In 2023, the number of western car sales was almost zero as most of these automotive firms exited the Russian market following the country’s war on Ukraine. Collaborations between European and Russian automotive companies, such as between  Renault and Autovaz, as well as production of western cars in Russia, were also largely abolished. The mass exodus severely impacted the production levels in the Russian automotive industry; in 2021 around 1 350 000 cars were produced in Russia, dropping to around 450 000 in 2022, and increasing to only about 750 000 cars in 2024. However, the sales of new Russian cars fell in the immediate months following the invasion and subsequent sanctions but managed to bounce back to initial levels in 2023 (Figure 1).

Figure 1. New car sales in Russia

Source: Association of European Businesses. Note: Detailed data for 2024 and 2025 is unavailable.

The Chinese Import Surge

While the sale of Russian cars rebounded following the invasion, the key market player post-2022 is China. As illustrated in Figure 1, in 2023, the sales of newly produced Chinese cars in Russia were eight times the 2020 figures.

Although the imports of Chinese cars made up for a large part of the massive withdrawals of western cars post-invasion, new issues have arisen. Chinese cars are considered unfit for Russian weather conditions, and spare parts are also considered to be of low quality. Additionally, Chinese cars are reported to survive shorter total mileages (about half, compared to many western brands), and to have poor electronic and ergonomic systems. Still, prices for a Chinese car are generally higher than for a Russian car, mostly due to taxes and import tariffs. To dampen the recent Chinese expansion on the car market (in 2025 accounting for 63 percent of the market), Russia in March 2025, hiked the import tax on Chinese cars from nearly $6000 to $7500. Furthermore, the price of Chinese cars is expected to increase in 2025, following a depreciation of the ruble against the yuan.

High Prices, Large Loans

Not only Chinese cars have met criticism when it comes to quality and price. In summer 2022, Autovaz declared that the 22 model of the classic Lada Granta would be void of air bags, an ABS braking system and a brake assist system, due to a scarcity of imported components. A subset of the model has since been equipped with a driver-seat air bag. Despite such major shortcomings, prices for new Russian-made cars have increased by 67 percent since the onset of the war. These price increases are mirrored on the secondary market where the price for a used foreign car have increased by 60 percent since 2022.

Another feature of the Russia automotive market concerns the large increase in automobile loans granted to businesses and entrepreneurs over the last four years (Figure 2).

Figure 2. Volume of companies’ automobile loans

Source: Rosstat.

While the near doubling in the loan value for companies’ car loans seems large, its growth is small compared to that for individuals. Since the onset of the war, the volume of private car loans has grown more than fivefold. This increase is arguably spurred by the preferential loans scheme for the purchase of new cars, introduced mid-July 2022 and granted to Russians with at least one child under 18, new car owners, people employed within health and education, military personnel and their close relatives, and disabled people. The so-called loan (projected to be in place up until 2027) applies to car purchases in Russia of a maximum 2 million ruble and discounts the price by 20 percent (25 percent for cars sold in the Far East Region). Under this scheme, car loans constituted almost 6 percent of all consumer loans in mid-2024, a sixfold increase in just a year (see Figure 3). This trend has not waned off since 2024. In December 2023, 70 percent of all cars bought in Russia were financed by borrowed funds. The size of an average car loan also grew substantially, around 20 percent, between 2022 and 2023. At the same time, the share of risky borrowers increased. In October 2024, 60 percent of the borrowers had a Debt Service-To-Income (DSTI) Ratio of over 50 percent, indicating that a large segment of car buyers will potentially be unable to repay the debt (CBR, 2024).

Figure 3. Private Automobile Loans

Source: CBR (2024). Note: Figure based on approximation from CBR figure.

Household Strains and Financial Risks

Over the last five years gasoline prices have gone up by about 17 percent (standard petrol), alongside substantial price increases for nearly all major consumption goods in Russia – driven by the rampant inflation. In fact, the price of the Russian consumer basket nearly doubled between February 2022 and August 2024. Progressive income taxes have been introduced for about 3.2 percent of the working population – increasing taxation from 13 percent up to 22 percent. Furthermore, in July 2024, the subsidized mortgages for newly built apartments were scrapped such that all buyers now face a 16-20 percent rate (SITE, 2025). While real wages did increase by 8 to 9 percent in 2023 and 2024, real pensions did not. Furthermore, reported inflation figures are likely severely understated, with actual inflation being around 20, rather than the reported 9.5 percent. If so, the actual real wage growth would be about 0 percent (SITE, 2025).

This undermines the spending power of Russian households, which is now being reflected on the primary car market. There has been a sharp drop in car sales – 25 percent in the first quarter in 2025, and car prices are also on the decline. This, combined with the growing reliance on credit, signals that many consumers are no longer able to make large purchases despite the state driven support scheme – pointing to major affordability issues. Given that the preferential loans scheme will be in place only up until 2027 and that Chinese cars will likely become more expensive, demand may dwindle even further in the years to come. In such situation, the government could be forced to expand their preferential scheme to artificially keep up demand levels, taking on greater financial risks and associated costs. They may also increasingly close off the inflow of Chinese cars, which leave consumers with no options outside of domestically produced cars.

The falling demand for cars may also be considered an indicator of household’s beliefs about the economic conditions to come. That is, the demand for cars could be a signal of consumers understanding that the economy is, or will shortly be in a recession (Attanasio, Larkin, Ravn and Padula, 2022). While the Russian war time economy is not currently displaying recession signs, its persistent issues with rampant inflation, rapidly growing household mortgages and changes in the credit to GDP ratio signals its financial stability is at risk. As discussed in the report “Financing the Russian War Economy”, these are key indicators correlated with banking crises (SITE, 2025). If declining demand for cars is a sign of consumers perceiving the economy as increasingly fragile, this perception could amplify existing vulnerabilities.

Conclusion

The automotive sector offers comparatively timely data, making it a useful window for assessing the financial situation of Russian households. In the current automotive landscape in Russia, buying a new car is becoming increasingly expensive. This has forced not only private buyers but also businesses to increasingly take up loans to cover the payment of a new car – often despite reduced quality and limited choice. The demand for new cars is partly driven by state intervention, particularly the preferential loan scheme. This not only places a growing financial burden on the state but also carries rising risks of borrowers defaulting. At the same time, the current trends in the sector illustrate the growing limitations of both import substitution and state-backed credit schemes as tools for maintaining consumer demand. The recent drop in new car sales, despite state support, may reflect a growing reluctance among households to make large purchases, exposing how Russian households’ purchasing power are eroding in the Russian wartime economy. Importantly, this drop may point not only to affordability issues but also to a broader perception that the financial system is increasingly unstable.

Overall, the dynamics in the automotive sector suggest that the Russian economy is not doing as well as officially claimed, adding support for the effectiveness of sanctions and company withdrawals from the Russian market.

References

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

Financing the Russian War Economy: SITE Presents New Report on Russia’s Wartime Economy

Posted on April 17, 2025 | News

Kremlin complex at night symbolizing state control and off-budget military spending in the context of financing the Russian war.

The Stockholm Institute of Transition Economics (SITE) has released a new policy report analyzing how the Kremlin finances its war efforts under growing economic pressure. The report, titled “Financing the Russian War Economy”, was presented to Sweden’s Minister of Finance, Elisabeth Svantesson, on April 17, 2025.

This new publication builds on SITE’s 2024 report, The Russian Economy in the Fog of War. It offers updated insights into the financial structure behind Russia’s wartime economy. Notably, it highlights the sharp rise in off-budget military spending. Consequently, SITE argues that the real cost of financing the Russian war far exceeds official data.

Key Insights: How Russia Is Financing the War

The report identifies four major developments in Russia’s war financing strategy:

  • Off-budget expenditures: A significant share of military spending flows through state-owned enterprises and regional programs, bypassing the federal budget.

  • Depleting fiscal reserves: While oil prices continue to fall, Russia’s financial buffers are shrinking at a rapid pace.

  • Hidden liabilities: SITE stresses that true financial obligations—especially future costs—remain largely unaccounted for in government figures.

  • Economic instability: Sustained military spending, without major adjustments, may soon trigger painful policy trade-offs.

As a result, SITE warns of growing risks. These include deeper financial imbalances, limited fiscal flexibility, and long-term damage to Russia’s economic stability. Moreover, the report reveals how Russia’s financing model has become increasingly opaque, masking the true scale of war-related expenses.

Read More

About SITE

SITE was set up as a research institute at the Stockholm School of Economics (SSE) in 1989 with the mandate of studying developments in the Soviet Union and Eastern Europe. Today, SITE is a leading research-based policy institute on these issues. SITE has also built a network of research institutes in the region (FREE Network) that includes the Kyiv School of Economics (KSE). KSE not only provides a premier economics education to future leaders in Ukraine but is also involved in the analysis of the Ukrainian as well as Russian economy, including analysis of the role of sanctions in limiting Russia’s destructive capacity. KSE has been an important contributor of data and analysis that underlie this report.

Should the $60 Price Cap on Russian Oil Exports be Lowered?

Posted on March 24, 2025 | Policy Brief

Oil tanker at sea representing the impact of price cap on Russian oil exports.

Western governments have imposed a $60 price cap on Russian seaborne oil exports using Western services. To evade the policy, Russia has developed a “shadow fleet” which uses no such services. In this policy brief, we claim that the resulting segmentation of Russian oil exports dramatically modifies the conventional analysis of a price cap. Our research shows that lowering the cap would not hurt Russia as intended unless a robust expansion in non-Russian oil supply was to limit the induced increase in the world oil price. If this price increase is not limited, lowering the cap could even moderately increase Russian profits because shadow fleet sales would be more profitable. By contrast, policies that reduce some shadow fleet capacity would reduce Russian profits if undertaken while Russia still relies on some Western services.

In response to Russia’s invasion of Ukraine in February 2022, the EU, the U.S., and other G7 countries (hereafter the West) ceased their imports of Russian oil, leading Russia to export more to India, Turkey, and China instead. In addition, the West imposed sanctions on oil exports from Russia, whose profits are instrumental in supporting its war.

Since more than 80 percent of Russia’s seaborne oil exports relied on the provision of Western services (CREA, 2023) (financial, operational, and commercial) the EU suggested banning the use of these Western services for all Russian seaborne exports. However, governments feared that this would cause a spike in the world oil price. As an alternative, the U.S. suggested a price cap, which the West ultimately imposed in December 2022, limiting Russian revenues from oil shipped using Western services to $60 per barrel.

Oil transported without Western services is exempt from the cap. Therefore, Russia has gradually assembled a “shadow fleet” that uses non-Western services in order to sell oil at prices above the cap.

The price cap on Russian oil is a new, insofar untested economic sanction, currently a subject of active public discussion, with experts recommending potential adjustments and application to more countries, and policymakers currently considering to tighten the price cap – see for example the January 2025 call by Sweden, Denmark, Finland, Latvia, Lithuania and Estonia to lower the price cap below $60. The policy quickly piqued the interest of economists – see for example Spiro, Wachtmeister, and Gars’ (2024) comprehensive review of policy options to limit Russia’s ability to finance the war.

In their pioneering contribution to the literature, Johnson, Rachel, and Wolfram (2025) provide a rich analysis of the effects of the price cap, albeit under the assumption that the shadow fleet has a fixed capacity. In a recent working paper (Cardoso, Salant, and Daubanes, 2025), we present a new dynamic economic model that accounts for the expansion of the Russian shadow fleet. The model is calibrated to reproduce observed facts and used to simulate the effects of (1) various levels of the price cap, including the extreme case of a complete ban, (2) enforcement stringency, and (3) policies targeting the shadow fleet.

Perhaps surprisingly, our analysis shows that, in the absence of any increase in non-Russian oil supply, lowering the level of the price cap below $60 would benefit Russia. This includes lowering the cap to levels so low (below $34) that the policy amounts to a ban as Russia would prefer not to use Western services at all at these cap levels. More generally, the model reveals that a lower cap would have two opposite effects on Russia: On the one hand, it would reduce Russia’s profit (i.e., revenues net of production costs) from sales at the cap. On the other hand, since a lower cap would reduce Russia’s oil exports, it would increase the oil price and, therefore, Russia’s profit from sales through its shadow fleet. Our analysis yields a testable and intuitive condition under which the latter effect dominates the former, making a lower cap counterproductive. This condition depends on the shadow fleet capacity relative to Russian sales at the ceiling price.

Application of this condition shows that when sanctions were imposed, Russia’s shadow fleet capacity was already sufficiently high for Russia to benefit from a reduction in the price ceiling. Russia would even have benefited from a reduction in the cap if the West had prevented any expansion in Russia’s shadow fleet beyond its initial level. With no such limitation, Russia would continue to expand its fleet size regardless of the size of the cap reduction. This leads us to conclude that Russia would also benefit if an unanticipated reduction in the cap (or a complete ban) occurred subsequently.

It should be noted that in the absence of a non-Russian supply response, caps at different levels quantitatively impact Russian total profits in a similar way. For example, the $60 cap reduces Russian profits by about 25 percent compared to a scenario without sanctions, and a complete ban would have impacted Russia only slightly less.

The following figure shows a comparison of prices, shadow fleet capacity, and profits under a price cap sanction (solid lines), a service ban (dotted lines), and the absence of sanctions (grey dashed lines). The simulations assume no supply response from non-Russian producers (none occurred when the cap was first implemented). A lower cap cuts Russian exports and raises the global oil price, increasing Russian profits from its fleet sales. A non-Russian supply response would dampen this oil price spike and would, therefore, diminish the resulting revenue increase from Russian fleet sales.

Figure 1. Outcomes under different sanction scenarios

Source: Authors’ calculations.

Russia sometimes uses Western services to ship oil at a price above the cap, taking the risk that its shipments get sanctioned. Increasing the probability that cheating is punished lowers the price Russia expects to receive, with consequences identical to a reduction in the cap level.

By contrast, policies that reduce some capacity of the shadow fleet (“sidelining” some of its tankers) may harm Russia, even though they prompt Russia to rebuild its fleet rapidly. This happens, for example, if sidelining part of the fleet occurs while oil is also being sold at the ceiling, so that ceiling sales replace the lost fleet sales and there is no increase in the world oil price.

Conclusion

To conclude, we consider a variety of oil-market sanctions that have been have imposed on Russia to reduce the total export profits it uses to finance the war in Ukraine. As seen, tightening these sanctions is more effective if the induced increase in the world price can be significantly mitigated (if not entirely eliminated); otherwise, increased revenues from shadow fleet sales will weaken or undermine the intended effect of the tighter sanctions.

In one case we considered, no supplementary intervention is required for the sanction to be effective. Reducing Russia’s shadow fleet capacity when Russia is still selling at the ceiling price will induce an equal and offsetting increase in Russian sales at the ceiling, resulting in no increase in the world price.

However, other sanctions – lowering the ceiling, increasing its enforcement, or even reducing the shadow fleet capacity after Russian sales at the ceiling have ceased – will induce an increase in the world price sufficient to undermine the sanctions’ intended effect unless accompanied by a simultaneous expansion of non-Russian supply (presumably from the U.S. or OPEC) to dampen the increase in the world price. Supplemented in this way, the potency of each of these sanctions would be restored.

Overall, our results call attention to the need for complementary energy policies that would facilitate the response of non-Russian oil production to higher global prices.

References

  • Cardoso, D. S., S. W. Salant, and J. Daubanes. (2025). The Dynamics of Evasion: The Price Cap on Russian Oil Exports and the Amassing of the Shadow Fleet. MIT CEEPR Working Paper 2025-05.
  • Centre for Research on Energy and Clean Air. (2023). December 2023 Monthly Analysis on Russian Fossil Fuel Exports and Sanctions.
  • Johnson, S., L. Rachel, and C. Wolfram. (2025). A Theory of Price Caps on Non-Renewable Resources. NBER Working Paper No. 31347.
  • Spiro, D., H. Wachtmeister, and J. Gars. (2024). Assessing the Impact of Oil Sanctions on Russia. SSRN Working Paper.

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

Energy Security at a Cost: The Ripple Effects of the Baltics’ Desynchronization from the BRELL Network

Posted on March 3, 2025 | Policy Brief

High-voltage power lines in a foggy landscape representing the desynchronization of the BRELL network.

The Baltic States’ desynchronization from the BRELL network on February 7, 2025, cut ties with Russia and Belarus, ending electricity trade. Though the transition was smooth with no outages, recent underwater cable disruptions have highlighted vulnerabilities, raising energy security concerns. These events underscore the importance of both diversifying and decentralizing power systems, drawing lessons from Ukraine’s electricity market, which has remained operational despite sustained Russian attacks.

The Baltics’ power system was part of a large Russian-operated synchronous electricity system known as BRELL, which connected the electricity transmission systems of Belarus, Russia, Estonia, Latvia, and Lithuania (Figure 1). The desynchronization from BRELL and the integration into the European grid have been discussed since 2007, when the Prime Ministers of the Baltic States declared desynchronization as the region’s strategic priority. In 2018, a decision was made to join the Continental European Synchronous Area through a connection with Poland, leading to significant investments – financially supported by the European Commission – to ensure adequate infrastructure. Fully committing to their priority, the Baltic’s desynchronized completely from BRELL on February 7th, 2025.

Figure 1. The BRELL power ring

Source: Karčiauskas (2023)

A Successful Physical (De)synchronization

The desynchronization process proceeded smoothly, with no blackouts. This success was anticipated, given the project’s meticulous planning over several years. A comparable example is Ukraine, which disconnected from the Russian and Belarusian power systems less than a month after Russia’s full-scale invasion in 2022. Ukraine then synchronized with the Continental European power grid ENTSO-E, an event that had been in preparation since 2017.

After the desynchronization, the Baltic states temporarily operated in island mode, relying entirely on domestic generation for all grid operations. To maintain system stability, the commercial capacity of interconnectors with the Nordics (whose regional group is not part of the Continental European Synchronous Area) was reduced, ensuring they could serve as reserves in case of major generator outages. The NordBalt cable is one such connector linking Sweden’s SE4 region and Lithuania.

However, conditions are gradually returning to normal. As of February 17, 2025, 700 MW is now available for commercial trading, as shown in Figure 2. Despite this progress, the commercial trading capacity of the interconnector with Poland (the LitPol line) remains heavily restricted and is primarily used to maintain system stability.

Figure 2. Day-ahead commercial transfer capacities on the Nordic interconnectors around the desynchronization

Source: Nord Pool

The Baltic region’s synchronization with the European grid is currently achieved through a 400 kV overhead power line connecting Lithuania and Poland. A second link, the Harmony Link, an underground cable, is planned to become operational by 2030. This makes the existing interconnection an essential part of regional infrastructure and a potential security risk, particularly given the recent sabotage of cables in the Baltic Sea. In response to these threats, Lithuania has increased surveillance of the NordBalt cable. The country’s prime minister has estimated the cost of securing the Baltic cables at €32-34 million,  seeking EU support for its funding. The government has also strengthened the protection measures. Initially, security was outsourced to a private security company, but plans are in place for the country’s Public Security Service (Viešojo saugumo tarnyba) to take over in spring 2025. Further, in preparation for the Baltics’ full desynchronization, the Polish Transmission System Operator deployed helicopters to patrol the interconnection, to enhance the security of the infrastructure.

From Trade Interruption to Infrastructure Sabotage

The most significant short-term impact of the desynchronization from the BRELL is the limitation of electricity trade for the Baltic states. The desynchronization has affected reserve balancing in the Baltic region, forcing the three states to rely more on their internal generation for system stability. This has resulted in reduced generation capacity for commercial trade, as the states must be prepared to again operate in island mode in case of an outage on the LitPol cable. Until February 19, 2025, the LitPol line remained unused for commercial trading. However, gradual increases are expected to eventually allow for 150 MW commercial trade between the Polish area and the Baltics, a significant reduction from the 500 MW previously available. This limited trading capacity could lead to higher prices in the Baltics, as the region is a net importer of electricity.

This is not the first time the Baltics have faced trade disruptions. In November 2020, after the construction of a Belarusian nuclear power plant near the Lithuanian border, Lithuania, followed by Latvia and Estonia, limited commercial electricity exchanges with Russia and Belarus. Furthermore, on May 15, 2022, electricity trade between Russia and Finland was halted, followed by the closure of the Kaliningrad-Lithuania connection the next day. While this event led to no blackouts, it clearly impacted the region’s price volatility (Lazarczyk & Le Coq, 2023).

Recently, the region has experienced sabotage to underwater interconnectors, significantly impacting electricity trade between the Nordics and the Baltics. On December 25, 2024, the Estlink 2 cable, one of two connections between Finland and Estonia, was cut, reducing transmission capacity between the two regions. Repair costs are expected to reach several million Euros. As disclosed via Nord Pool’s Urgent Market Message, repairs are expected to last until August 2025 – stressing the system. As Estlink 2 is offline, the Baltic system is not fully operating. If another major component fails, there may be insufficient capacity to maintain grid stability, increasing the risk of outages or the need for emergency interventions.

With the complete disconnection from the Russian and Belarusian power grids, Russia no longer has direct control over the Baltic electricity trade, effectively eliminating the risk of trade disruptions from Russia. However, a new energy threat has emerged: infrastructure sabotage. Although the perpetrators of recent sabotage incidents have not been clearly identified, both Lazarczyk & Le Coq (2023) and Fang et al. (2024) emphasize Russia’s strategic incentives to engage in such actions to maintain its geopolitical influence and discourage neighboring countries from reducing their energy dependence. Sabotaging critical infrastructure presents another efficient method of weaponizing electricity, particularly in the current context of limited Nord Pool imports and the Baltic States’ insufficient integration with the broader European grid.

From Diversification to Decentralization: Responses to Electricity Infrastructure Threats

The Baltic States have diversified their domestic energy supply sources to address the electricity infrastructure threat. In 2024, Estonia’s parliament approved the development of nuclear energy, with Fermi Energia planning to build two 300 MW light-water reactors. Other projects include a hydrogen-ready gas plant in Narva, which is expected to be completed by 2029, as well as an expansion of wind power capacity. While there was some support for extending the use of oil-fired plants in Estonia, their competitiveness has been undermined by high carbon prices and the closure of domestic oil fields. Elering, the Estonian Transmission system operator, has also begun long-term procurement to acquire 500 MW of new generation and storage for frequency management to ensure reserve capacity.

However, diversification alone will not be sufficient to address the challenges currently faced by the Baltic States. Incidents like the cutting of underwater cables underscore the growing need to decentralize the power system. Large, centralized power plants are more vulnerable to targeted attacks compared to decentralized energy systems. As a result, connected microgrids seem to be a viable solution for future energy resilience, as they can maintain functionality even when localized damage occurs. Again, Ukraine’s experience demonstrates the benefits of decentralization. Since the onset of the war, Ukraine has faced both physical and cyberattacks but has strengthened its energy resilience by decentralizing its system and expanding wind and solar power (Eurelectric, 2025). This approach has proven effective: while a single missile could destroy a nearly gigawatt-scale power plant, it would only damage an individual wind turbine or a small section of solar panels, significantly limiting the overall impact.

The desynchronization of the Baltic States from the BRELL network marked a complete break with Russia and Belarus, effectively ending any possibility of electricity trade between these countries and the Baltic region. This transition was successfully completed without any power outages. While the primary goal was to enhance energy security in the Baltics, several challenges remain, as highlighted in this policy brief. Recent disruptions to underwater cables, as well as Russia’s attacks on Ukraine’s electricity market, underscore the urgent need for both diversification and decentralization to strengthen the region’s energy security. While energy supply diversification reduces supply chain dependencies, decentralization enhances resilience against targeted attacks, creating a more robust and flexible energy system.

References

  • Eurelectric, 2025, Redefining Energy Security In the age of electricity, Lexicon.
  • Fang, S., Jaffe, A. M., Loch-Temzelides, T., and C.L. Prete. (2024). Electricity grids and geopolitics: A game-theoretic analysis of the synchronization of the Baltic States’ electricity networks with Continental Europe. Energy Policy, 188, 114068.
  • Karčiauskas, J. (2023). Lithuania External Relations Briefing: Synchronization of the Baltic Electricity Network and Breaking Dependence on Russian Energy Market. China CEE Institude Weekly Briefing 2023 Eylül, 4, 3.
  • Lazarczyk, E. and Le Coq, C. (2023). Power coming for Russia and Baltic Sea region’s energy security, Energiforsk report.
  • Lazarczyk, E. and Le Coq, C. (2022). Can the Baltic States Do Without Russian Electricity?, FREE Policy Brief.

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

Ukraine’s Fight Is Our Fight: The Need for Sustained International Commitment

Posted on February 24, 2025 | Policy Brief

A large Ukrainian flag being carried by a crowd of demonstrators in Lithuania, symbolizing Ukraine International Commitment and global solidarity against aggression.

We are at a critical juncture in the defense of Ukraine and the liberal world order. The war against Ukraine is not only a test of Europe’s resilience but also a critical moment for democratic nations to reaffirm their values through concrete action. This brief examines Western support to Ukraine in the broader context of international efforts, putting the order of magnitudes in perspective, and emphasizing the west’s superior capacity if the political will is there. Supporting Ukraine to victory is not just the morally right thing to do, but economically rational from a European perspective.

As the U.S. support to the long-term survival of Ukraine is becoming increasingly uncertain, European countries need to step up. This is a moral obligation, to help save lives in a democratic neighbor under attack from an autocratic regime. But it is also in the self-interest of European countries as the Russian regime is threatening the whole European security order. A Russian victory will embolden the Russian regime to push further, forcing European countries to dramatically increase defense spending, cause disruptions to global trade flows, and generate another wave of mass-migration. This brief builds on a recent report (Becker et al., 2025) in which we analyze current spending to support Ukraine, put that support in perspective to other recent political initiatives, and discuss alternative scenarios for the war outcome and their fiscal consequences. We argue that making sure that Ukraine wins the war is not only the morally right thing to do, but also the economically rational alternative.

The International Support to Ukraine

The total support provided to Ukraine by its coalition of Western democratic allies since the start of the full-scale invasion exceeded by October 2024 €200 billion. This assistance, that includes both financial, humanitarian and military support, can be categorized in various ways, and its development over time can be analyzed using data compiled by the Kiel Institute for the World Economy. A summary table of their estimates of aggregate support is provided below.

A particularly relevant aspect in light of recent news is that approximately one-third of total disbursed aid has come from the United States. The U.S. has primarily contributed military assistance, accounting for roughly half of all military aid provided to Ukraine. In contrast, the European Union—comprising both EU institutions and bilateral contributions from member states—stands as the largest provider of financial support. This financial assistance is crucial for sustaining Ukraine’s societal functions and maintaining the state budget.

Table 1. International support to Ukraine, Feb 2022 – Oct 2024

Source: Trebesch et al. (2024).

Moreover, the EU has signaled a long-term commitment to provide, in the coming years, an amount comparable to what has already been given. This EU strategy ensures greater long-term stability and predictability, guaranteeing that Ukraine has reliable financial resources to sustain state operations in the years ahead. Consequently, while a potential shift in U.S. policy regarding future support could pose challenges, it would not necessarily be insurmountable.

What is crucial is that Ukraine’s allies remain adaptable, and that the broader coalition demonstrates the ability to adjust its commitments, as this will be essential for sustaining the necessary level of assistance moving forward.

Putting the Support in Perspective

To assess whether the support provided to Ukraine is truly substantial, it is essential to place it in context through meaningful comparisons. One approach is to examine it in historical terms, particularly in relation to past instances of large-scale military and financial assistance. A key historical benchmark is the Second World War, when military aid among the Allied powers played a decisive role in shaping the outcome of the conflict. Extensive resources were allocated to major military operations spanning multiple continents, with the United States and the United Kingdom, in particular, dedicating a significant share of their GDP to support their allies, including the Soviet Union, France, and other nations.  As seen in Figure 1, by comparison, the current level of aid to Ukraine, while substantial and essential to its defense, remains considerably smaller in relation to GDP.

Figure 1. Historical comparisons

Source: Trebesch et al. (2024).

Another way to assess the scale of support to Ukraine is by comparing it to other major financial commitments made by governments in response to crises. While the aid allocated to Ukraine is significant in absolute terms, it remains relatively modest when measured against the scale of other programs, see Figure 2.

A recent example is the extensive subsidies provided to households and businesses to mitigate the impact of surging energy prices since 2022.  Sgaravatti et al. (2021) concludes that most European countries implemented energy support measures amounting to between 3 and 6 percent of GDP. Specifically, Germany allocated €157 billion, France and Italy each committed €92 billion, the UK spent approximately €103 billion. These figures represent 5 to 10 times the amount of aid given to Ukraine so far, with some countries, such as Italy, allocating even greater relative sums. On average, EU countries have spent about five times more on energy subsidies than on Ukraine aid. Only the Nordic countries and Estonia have directed more resources toward Ukraine than toward energy-related support. Although not all allocated funds have been fully disbursed, the scale of these commitments underscores a clear political and financial willingness to address crises perceived as directly impacting domestic economies.

Figure 2. EU response to other shocks (billions of €)

Source: Trebesch et al. (2024).

Another relevant comparison is the Pandemic Recovery Fund, also known as Next Generation EU. With a commitment of over €800 billion, this fund represents the EU’s comprehensive response to the economic consequences of the Covid-19 pandemic. Again, the support to Ukraine appears comparatively small, about one seventh of the Pandemic Recovery Fund.

The support to Ukraine is also much smaller in comparison to the so-called “Eurozone bailout”, the financial assistance programs provided to several Eurozone member states (Greece, Ireland, Spain and Portugal) during the sovereign debt crisis between 2010 and 2012. The programs were designed to stabilize the economies hit hard by the crisis and to prevent the potential spread of instability throughout the Eurozone.

Overall, the scale of these commitments underscores a clear political and financial willingness and ability to address crises perceived as directly impacting domestic citizens. This raises the question of whether the relatively modest support for Ukraine reflects a lack of concern among European voters. However, this does not appear to be the case. In survey data from six countries – Belgium, Germany, Hungary, Italy, the Netherlands, and Poland – fielded in June 2024, most respondents express satisfaction with current aid levels, and a narrow majority in most countries even supports increasing aid (Eck and Michel, 2024).

A further illustration comes from the Eurobarometer survey conducted in the spring of 2024 which asked: “Which of the following [crises] has had the greatest influence on how you see the future?”. Respondents could choose between different crises, including those mentioned above, and the full-scale invasion of Ukraine.

Figure 3 illustrates the total commitments made by EU countries for Ukraine up until October 31, 2024, compared to other previously discussed support measures, represented by the blue bars. The yellow bars, on the other hand, show a counterfactual allocation of these funds, based on public priorities as indicated in the Eurobarometer survey. Longer yellow bars indicate that a higher proportion of respondents perceived this crisis as having a greater negative impact on their outlook for the future. By comparing the actual commitments (blue bars) with this hypothetical allocation (yellow bars)—which reflects how resources might have been distributed if they aligned with the population’s stated priorities—it becomes evident that there is substantial public backing for maintaining a high level of support for Ukraine. The results show that the population prioritizes the situation in Ukraine above several other economic issues, including those that directly affect their own personal finances.

Figure 3. Support to Ukraine compared to other EU initiatives – what do voters think?

Source: Trebesch et al. (2024); Niinistö (2024); authors’ calculations.

The Costs of Not Supporting Ukraine

When discussing the costs of support to Ukraine it is important to understand what the correct counterfactual is. The Russian aggression causes costs for Europe irrespective of what actions we take. Those costs are most immediately felt in Ukraine, with devastating human suffering, the loss of lives, and a dramatic deterioration in all areas of human wellbeing. Also in the rest of Europe, though, the aggression has immediate costs, in the economic sphere primarily in the form of dramatically increased needs for defense spending, migration flows, and disruptions to global trade relationships. These costs are difficult to determine exactly, but they are likely to be substantially higher in the case of a Russian victory. Binder and Schularik (2024) estimate increased costs for defense, increased refugee reception and lost investment opportunities for the German industry at between 1-2 percent of GDP in the coming years. As they put it, the costs of ending aid to Ukraine are 10-20 times greater than continuing aid at Germany’s current level.

Any scenario involving continued Russian aggression would demand substantial and sustained economic investments in defense and deterrence across Europe. Clear historical parallels can be drawn looking at the difference in countries’ military spending during different periods of threat intensity. Average military spending in a number of Western countries during the Cold War (1949-1990) was about 4.1 percent of GDP, much higher in the U.S. but also in Germany, France and the UK. In the period after 1989-1991 (the fall of the Berlin Wall, the dissolution of the Soviet Union), the amounts fell significantly. The average for the same group of countries in this period is about 2 percent of GDP and only 1.75 percent if the U.S. is excluded.

Also after 1991 there is evidence of how perceived threats affect military spending. Figure 4 plots the change in military spending over GDP between 2014-2024 against the distance between capital cities and Moscow. The change varies between 0 (Cyprus) and around 2.25 (Poland) and shows a very clear positive correlation between increases in spending and proximity to Moscow.  There has also in general been a substantial increase in military spending after 2022 in several European countries, but in a scenario where Russia wins the war, these will certainly have to be increased further and maintained at a high level for longer.  An increase in annual military expenditure in relation to GDP in the order of one to two percentage points would mean EUR 200-400 billion per year for the EU, while the total EU support to Ukraine from 2022 to today is just over €100 billion.

Figure 4. Increase in military expenditures in relation to distance to Moscow

Source: SIPRI data, authors’ calculations.

A Russian victory would also have profound consequences for migration flows, with the most severe effects likely in the event of Ukraine’s surrender. The Kiel Institute estimates the cost of hosting Ukrainian refugees at €26.5 billion (4.2 percent of GDP) for Poland, one of the countries that received the largest flows. Beyond migration, a Russian victory would also reshape the global geopolitical order. Putin has framed the war as a broader conflict with the U.S. and its democratic allies, while an emerging alliance of Russia, Iran, North Korea, and China is positioning itself as an alternative to the Western-led system. A Ukrainian defeat would weaken the authority of the U.S., NATO, and the rules-based international order, potentially driving more nations in the Global South toward authoritarian powers for military and economic support. This shift could disrupt global trade, affect access to food, metals, and energy. Estimating the full economic impact of such a shift is difficult, but comparisons can be drawn with other global shocks. The European Union’s GDP experienced a significant contraction due to the Covid-19 pandemic, 5.9 percent contraction in real GDP according to Eurostat, 6.6 percent according to the European Central Bank. While the economy rebounded relatively quickly from the pandemic, a permanent geopolitical realignment caused by a Russian victory would likely have far more severe and lasting economic consequences.

Given that Ukraine is at the forefront of Russia’s aggression, its resilience serves as a critical test of Europe’s ability to withstand potential future threats. Thus, strengthening our own security and economic stability in the long term is inseparable from strengthening Ukraine’s resilience now. The fundamental difference lies in the long-term trajectory of these investments. In a scenario where Ukraine is victorious, military and financial aid during the war would eventually transition into reconstruction efforts and preparations for the country’s integration into the EU. This outcome is undeniably more favorable—both economically and in humanitarian terms—not only for Ukraine but for Europe as a whole. Therefore, an even more relevant question is whether the level of support is enough for Ukraine to win the war.

Is Sufficient Support Feasible?

Is it even reasonable to think that we in the West could be able to support Ukraine in such a way that they can militarily defeat Russia? Russia is spending more on its war industry than it has since the Cold War. In 2023, it spent about $110 billion (about 6 percent of GDP). By 2024, this figure is expected to have increased to about $140 billion (about 7 percent of GDP). These amounts are huge and represent a significant part of Russia’s state budget, but they are not sustainable as long as sanctions against Russia remain in place (SITE, 2024). For the EU, on the other hand, the sacrifices needed to match this expenditure would not be as great. The EU’s GDP is about ten times larger than Russia’s, which means that in absolute terms the equivalent amount is only 0.6-0.7 percent of the EU’s GDP. If the U.S. continues to contribute, the share falls to below 0.3 percent of GDP.

Despite the economic advantage of Ukraine’s allies over Russia, several factors could still shift the balance of power in Russia’s favor. One key issue is military production capacity—Russia has consistently outproduced Ukraine’s allies in ammunition and equipment. While Western economies have the resources to manufacture superior weaponry, actual production remains insufficient, requiring both increased capacity and political will. Another challenge is cost efficiency. Military purchasing power parity estimates suggest that Russia can produce approximately 2.5 times more military equipment per dollar than the EU, giving it a cost advantage in volume production. However, this does not fully compensate for its overall economic disadvantage, particularly when factoring in quality differences.

Manpower is also a critical factor. Russia’s larger population allows for sustained mobilization, but at a steep financial cost. Soldiers are recruited at a minimum monthly salary of $2,500, with additional bonuses bringing the first-year cost per recruit to three times the average Russian annual salary. Compensation for injured and fallen soldiers further strains state finances, with estimated payouts reaching 1.5 percent of Russia’s GDP between mid-2023 and mid-2024. Over time, these costs limit Russia’s ability to fund its war effort, making mass mobilization financially unsustainable.

Overall, advanced Western weaponry and superior economic capacity can match Russia’s advantage in manpower if the political will is there. Additionally, Russia’s already fragile demographic situation is deteriorating due to battlefield losses and wartime emigration. Any measure that weakens Russia’s economic capacity—particularly through sanctions and embargoes—diminishes the strategic advantage of its larger population and serves as a crucial complement to military and financial support for Ukraine.

Conclusion

Ukraine’s western allies have provided the country with substantial military and financial support since the onset of the full-scale invasion. Yet, relative to the gravity of the risks involved, previous responses to economic shocks, and citizens’ concerns about the situation, the support is insufficient. The costs of a Russian victory will be higher for Europe, even disregarding the human suffering involved. With U.S. support potentially waning, EU needs to pick up leadership.

References

  • Becker, Torbjörn; and Anders Olofsgård; and Maria Perrotta Berlin; and Jesper Roine. (2025). “Svenskt Ukrainastöd i en internationell kontext: Offentligfinansiella effekter och framtidsscenarier”, Commissioned by the Swedish Fiscal Policy Council.
  • Binder, J. & Schularick, M. (2024). “Was kostet es, die Ukraine nicht zu unterstützen?” Kiel Policy Brief No. 179.
  • Eck, B & Michel, E. (2024). “Breaking the Stalemate: Europeans’ Preferences to Expand, Cut, or Sustain Support to Ukraine”, OSF Preprints, Center for Open Science.
  • Niinistö, S. (2024) .“Safer Together – Strengthening Europe’s Civilian and Military Preparedness and Readiness” European Commission Report.
  • Sgaravatti, G., S. Tagliapietra, C. Trasi and Zachmann, G. (2021). “National policies to shield consumers from rising energy prices”, Bruegel Datasets, first published 4 November 2021.
  • SITE. (2024). “The Russian Economy in the Fog of War”. Commissioned by the Swedish Government.
  • Trebesch, C., Antezza, A., Bushnell, K., Bomprezzi, P., Dyussimbinov, Y., Chambino, C., Ferrari, C., Frank, A., Frank, P., Franz, L., Gerland, C., Irto, G., Kharitonov, I., Kumar, B., Nishikawa, T., Rebinskaya, E., Schade, C., Schramm, S., & Weiser, L. (2024). “The Ukraine Support Tracker: Which countries help Ukraine and how?” Kiel Working Paper No. 2218. Kiel Institute for the World Economy.

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

The Dynamics of Evasion: The Price Cap on Russian Oil Exports and the Amassing of the Shadow Fleet

Posted on January 15, 2025 |

An oil tanker leaking oil into the sea, representing the impact of the price cap on Russian oil exports and the rise of the shadow fleet.

On January 21, 2025, Julien Daubanes, Associate Professor at the Technical University of Denmark (DTU), will present his co-authored working paper, “The Dynamics of Evasion: The Price Cap on Russian Oil Exports and the Amassing of the Shadow Fleet,” at SITE and online via Zoom.

Working Paper: The Dynamics of Evasion – The Price Cap on Russian Oil Exports and the Amassing of the Shadow Fleet

This paper examines how Russia bypasses Western-imposed price ceilings on seaborne oil exports by expanding a “shadow fleet” that avoids Western services. Using a calibrated model, the study analyzes different sanctions and their impact on Russia’s economic profits. Surprisingly, the results challenge conventional wisdom. Stricter enforcement and lower price ceilings do not necessarily impose greater financial harm on Russia.

About the Speaker

Julien Daubanes is an Associate Professor at the Technical University of Denmark (DTU) in the Department of Technology, Management, and Economics. He also works as an External Researcher at MIT’s Center for Energy and Environmental Policy Research (CEEPR) and a CESifo Research Fellow.

He earned a Master of Science in Economic Theory and Econometrics (2004) and a Ph.D. in Economics (2008) from the Toulouse School of Economics, where the French Economic Association awarded him the Thesis Prize.

His research focuses on environmental economics, particularly the impact of climate policies on energy markets and corporate voluntary initiatives like green finance. His work appears in top academic journals, including the American Economic Journal: Economic Policy, Journal of Public Economics, and Journal of the Association of Environmental and Resource Economists.

Interested in Attending the SITE Seminar at SSE or Online via Zoom?

Participation is by invitation only. To request access, please contact site@hhs.se and follow these instructions:

  • Email Subject: “SITE Seminar The Dynamics of Evasion”
  • Include your affiliation and field of interest
  • Specify if you will attend in person or online

Registered participants will receive a Zoom link and further details before the event.

Disclaimer: Opinions expressed during events and conferences are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

Breaking the Link: Costs and Benefits of Shutting Down Europe’s Last Gas Pipeline from Russia

Posted on January 13, 2025 | Policy Brief

A pressure gauge showing zero pressure in a Russian pipeline gas system, symbolizing the halt of gas transit to Europe.

Ukraine’s decision to halt Russian gas transit from January 1st, 2025, marks the end of decades of direct gas links between Europe and Russia. The EU is unlikely to face significant short-to-mid-term impacts, as Russian pipeline gas imports have already dropped sixfold since Russia’s full-scale invasion of Ukraine. However, uneven exposure to this shock has already created internal tensions within the EU. Further, increased reliance on liquefied natural gas may also slow the green transition. In the region, Moldova faces severe supply challenges and Ukraine will lose transit revenues. Targeted support and stronger cooperation within the EU and with neighboring countries, especially EU candidates, will be essential. In turn, the halt will make Russia face not only financial but also geopolitical losses.

On January 1st, 2025, Ukraine halted the transit of Russian gas to Europe following the expiration of a five-year agreement between Russian Gazprom and Ukrainian Naftogaz, marking a major shift in Europe’s energy landscape. This decision ended decades of reliance on Ukrainian pipelines for Russian gas (see Figure 1). Despite Ukraine announcing its intent not to renew the agreement well in advance (Corbeau, 2023), uncertainty lingered until the contract’s final days. Similarly, the broader implications remain uncertain. This policy brief explores the short-, mid-, and long-term effects of this change on the region.

Figure 1. Russian pipeline network to Europe, 2022-2025

A “Political” Pipeline

The Ukrainian transit route has long been a key corridor for direct gas deliveries to Europe, playing a crucial role in shaping the EU energy security policy. However, this route has also been the site of major disruptions, particularly during the 2006 and 2009 gas disputes between Russia and Ukraine. These incidents exposed Europe’s reliance on transit routes and its vulnerability to geopolitical conflicts, prompting political responses despite the relatively localized impact. To address these vulnerabilities, the EU introduced measures aimed at diversifying energy sources and strengthening internal energy markets (see, e.g., Le Coq and Paltseva, 2012). Early efforts focused primarily on improving the internal energy market’s efficiency while diversification advanced slowly. This changed drastically during the gas crisis that began in mid-2021 and escalated with Russia’s full-scale invasion of Ukraine in February 2022. These events forced the EU to alter its gas import strategy, driving further investments in liquefied natural gas (LNG) infrastructure and new pipelines, such as the Southern Gas Corridor enabling gas imports from Azerbaijan (see e.g., Regulation (EU) 2022/1032 and Regulation (EU) 2024/1789).

As a result, despite the significant burden of soaring energy prices and investment costs, the EU has made remarkable progress in reducing its reliance on Russian piped gas. Indeed, the share of Russian natural gas (both pipeline and LNG) in total EU gas imports, which increased 35 percent in 2015 to 41 percent in 2020, dropped to just 9 percent by 2023. However, the progress was non-uniform among member states (see Figure 2). In turn, by 2024, Russian gas via Ukraine accounted for just 5 percent of EU’s gas supply, with significant reliance limited to Austria, Hungary, and Slovakia (where it still made up between 65 percent and 78 percent of imports, and, between 12 percent and 22 percent of total energy consumption).

Figure 2. Share of Russian pipeline and LNG gas in total gas imports across the EU

Source: Eurostat, 2024. The gas imports include data for both pipeline and LNG imports. The 2024 gas imports data was unavailable at the time of writing this brief. However, several EU member states further decreased their consumption of Russian gas in 2024. For example, while Sweden and Finland were importing Russian LNG both in 2020 and 2023, possibly for re-export, as shown in Figure 1, they both stopped this practice from June 2024.
Further, Austrian data on imports from Russia is not available from Eurostat, and is, instead, compiled from Eurogas, IMF, and Austrian government data.

The Immediate Impact of the Transit Stop

The EU’s reduced reliance on Russian gas has significantly softened the immediate impact of the transit halt. Gas prices showed only a slight reaction, with no clear evidence linking the transit stop to price changes. Even if one would attribute the cumulative gas price increase over 2024 to the expectations of the pipeline shutdown only, the effect was much smaller than during the 2021 gas crisis or the sharp price spikes of 2022, as illustrated in Figure 3. Ample storage levels – 71.8% as of January 01.2025, well within acceptable levels for this time of the year – have further limited the immediate impact.

Figure 3. EU gas prices, 2021-2025

Effectively, the only part of the region facing an immediate and significant impact due to the termination of the gas transit deal has been Moldova. The pro-Russian separatist region of Transnistria, previously fully reliant on subsidized Russian gas via Ukraine and representing 70 percent of Moldovan gas consumption, has been cut off since January 1, 2025, due to the lack of alternative routes. This has also significantly affected the right-bank-of-Dniester Moldova as 80 percent of its electricity supply was previously provided by the Russian gas-based MGRES plant in Transnistria (Anisimova, 2024). In response, Chisinau declared a state of emergency in the energy sector, introducing energy-saving measures and rationing. In turn, Transnistria halted most industrial production and faced widespread blackouts (Kieff, 2025).

The Mid-Term Costs and Benefits for Involved Parties

In the mid-term, the impact will likely broaden and take various forms. Moldova, Ukraine, and Europe are expected to face primarily financial consequences, while Russia will also bear significant geopolitical costs.

Moldova will continue to be the most affected country. Russia could attempt to reroute gas to Transnistria via Turkstream and reversed flow on the Trans-Balkan pipeline. However, since this route briefly passes through Ukraine before reaching Moldova, it would require a transit agreement, an unlikely scenario under current conditions.

Alternatively, the Trans-Balkan route could be used to import gas from Azerbaijan or LNG from Turkey and Greece (Halser and Skaug, 2024). However, this would require political will from both Moldova and Transnistria, and involve substantial costs, likely unaffordable singlehandedly for Moldova or Transnistria, especially as the latter has long received Russian gas for free. Financial, as well as infrastructural support from the EU could help address these challenges.

Ukraine faces an annual loss of transit fees due to the halted agreement amounting to approximately $450 million/year. Formally, the loss should have been around $1.2 billion annually but Russia payed only for 15 bcm/a of gas transit since 2022, instead of 40 bcm/a under the ship-or-pay transit agreement, citing Ukraine’s refusal to transit gas via the Russia-occupied Sokhranivka entry point. This dispute is in international arbitration but is unlikely to be resolved before the war ends (see  Reley, 2025). The absence of a transit gas flow could also undermine the competitiveness of Ukraine’s gas storage services for the EU (Ukraine’s Naftogaz has Europe’s largest underground facilities with a capacity of 30.9bcm, 10bcm of which is available to foreign traders.)

At the same time, the option of renewing the transit agreement could boost Ukraine’s leverage in future talks with Russia. However, this leverage weakens with the EU’s ability to cope with its remaining reliance on Russian gas – greater diversification in EU imports would reduce the importance of Russian pipelines and, consequently, Ukraine’s bargaining position.

Europe’s mid-term impact from the transit halt will be non-uniform, with Austria, Slovakia, and Hungary facing the highest energy bill increases. However, the effect is expected to be limited due to its well-connected internal energy market, which can absorb shocks and distribute shortages across member states. The shortage is likely to be compensated by increased LNG purchases, which would somewhat increase gas prices due to the current LNG market rigidity. However, with LNG supply capacity increasing already in 2025 and projected to grow by 40 percent by 2028 without a matching rise in demand (IEEFA, 2024), the price increase is not going to last long.

However, the EU may also face a political cost. Expectations of price increases and Slovakia’s loss of transit fees could strain the EU unity, as differing energy dependencies risk deepening intra-EU tensions and complicating policy coordination (see, e.g., here and here). This underscores the importance of Europe’s “one voice” energy policy, which has gained momentum in recent years.

Russia faces significant financial and geopolitical losses from the transit halt. Financially, it risks losing approximately $6.5 billion annually in revenue at current prices (Keliauskaitė and Zachmann, 2024) unless flows are redirected. While temporary price increases – for the sales of Russian gas via Turkstream, and Russian LNG exports to Europe, could offset some of these losses – these are not going to last.

The greater impact lies in Russia’s diminished geopolitical leverage. Historically, Russia has used gas as a political tool, leveraging its dominant position and access to multiple pipeline routes to exert influence over transit countries and dependent nations. This influence would now be lost. Further, with the loss of a Ukrainian transit, Russia’s pipeline connection to EU gas markets now relies solely on Turkey, increasing its dependency on Turkey and potentially altering its alliance dynamics due to higher transit costs. Additionally, as Azerbaijani gas emerges as a viable alternative for Europe, Russia’s bargaining power in its geopolitical relations with Azerbaijan is likely to weaken further. This erosion of influence marks a significant shift in Russia’s regional energy strategy.

Long-Term Effects: Increased Dependence on LNG and the Green Transition

The halt of the Russian gas transit is facilitating the implementation of the RePowerEU goal of fully eliminating EU Russian fossil fuels dependency by 2027. However, its long-term effects, particularly on the timing and success of the green transition, warrant attention. Natural gas is widely considered a transitional fuel, essential for maintaining energy reliability in an energy system relying heavily on intermittent renewables. For the green transition to succeed, it is critical to avoid infrastructure lock-ins, displacement of low-carbon technologies, and the creation of stranded assets.

The shift from Russian gas to the LNG market will likely require substantial infrastructure investments in the EU and LNG-producing countries, increasing the risk of long-term dependency. Geopolitical dynamics add further complexity – e.g., the U.S., which supplied 50 percent of Europe’s LNG in 2023, has advocated for long-term purchasing agreements that could delay green technology adoption and extend the EU’s reliance on fossil fuels. This is already a reality as some EU member states having signed long-term gas contracts with Qatar, lasting beyond 2050, which may hinder efforts to accelerate the green transition.

Conclusion

The impact of the gas transit halt varies depending on whether it is seen from a short-, medium-, or long-term perspective. While all parties involved face losses, the impact of the halt on the EU is drastically different from what it could have been a few years ago due to the dramatic efforts undertaken in the last few years. Further, there are also potential benefits to consider. Notably, the EU has the opportunity to play a crucial role in reducing the economic and political burdens on neighboring countries, particularly those seeking EU membership. By offering targeted financial support and promoting deeper cooperation, the EU can help these nations manage the challenges posed by the halt. In turn, the halt will imply not only financial but also geopolitical losses for Russia.

References

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

What decision did Ukraine make regarding Russian pipeline gas transit? How has the EU’s reliance on Russian pipeline gas changed since Russia’s invasion of Ukraine? What are the potential consequences of the EU’s increased reliance on liquefied natural gas (LNG) following the decline in Russian pipeline gas imports? Read the policy brief “Breaking the Link: Costs and Benefits of Halting Russian Pipeline Gas to Europe” to explore the impact of halting Russian pipeline gas transit on Europe, Ukraine, and energy security.

Nobel Laureate Simon Johnson Shares Insights on Strengthening Sanctions Against Russia

Posted on December 17, 2024 | News

Professor Simon Johnson, 2024 Nobel Laureate in Economic Sciences, discussing strategies for strengthening sanctions against Russia during a SITE seminar.

The Stockholm Institute of Transition Economics (SITE) recently hosted a seminar featuring Professor Simon Johnson, the 2024 Nobel Laureate in Economic Sciences. The event centered on strengthening sanctions against Russia and strategies to reduce its capacity to sustain the war in Ukraine. It highlighted the vital role of economic measures in addressing geopolitical conflicts.

During the seminar, Professor Simon Johnson provided actionable insights into improving the effectiveness of sanctions. Specifically, he discussed mechanisms like the oil price cap and their importance in limiting Russia’s economic resources. Furthermore, he emphasized how these measures could strengthen European security while remaining aligned with international law.

Prof. Simon Johnson

Professor Johnson received the 2024 Sveriges Riksbank Prize in Economic Sciences. He is renowned for his research on the influence of political and economic institutions on national prosperity. With expertise in macroeconomic policy, institutional economics, and technology’s role in economic growth, he offers valuable insights. His experience as Chief Economist at the International Monetary Fund informed his recommendations on strengthening sanctions against Russia to counter its aggressive actions effectively.

Maria Perrotta Berlin, SITE’s sanctions project lead, presented the institute’s latest research findings. Her presentation laid the foundation for an engaging Q&A session. Experts from Ukraine and Sweden contributed additional perspectives, sparking a well-rounded discussion on the global implications of strengthening sanctions against Russia.

The seminar attracted policymakers, academics, and industry stakeholders. Together, they examined how economic tools can help address pressing geopolitical challenges. Specifically, the discussions underscored the importance of strengthening sanctions against Russia as a tool for ensuring international stability and peace.

Professor Johnson’s remarks were rooted in years of groundbreaking research and his tenure as Chief Economist at the IMF. He highlighted the interplay between macroeconomic policies, institutional frameworks, and global stability. His analysis reinforced the value of strengthening sanctions against Russia to disrupt its ability to sustain prolonged conflict.

For updates on SITE’s research and future events, visit SITE’s official website.

Further Reading on the State of Russia’s Economy

Read the report on Russia’s economy: A new analysis reveals that Russia’s economy faces mounting financial imbalances due to the ongoing war against Ukraine. The Stockholm Institute of Transition Economics (SITE) found that strengthening sanctions against Russia has placed significant pressure on its fiscal resources. As a result, Russia’s economic stability is expected to deteriorate further in the coming years.

Belarus’s Progressing Economic Dependence on Russia and Its Implications

Posted on October 21, 2024 | Policy Brief

Image showing the border between Belarus and Russia, symbolizing Belarus' economic dependence on Russia.

This policy brief examines the complexities surrounding Belarus’s economy as it deepens its economic dependence on Russia. Recent growth, driven by increased domestic demand and a resurgence in exports to Russia, has surpassed expectations. This trajectory is largely due to Belarus’s mounting dependence on Russia across trade, energy, finance, logistics, and other domains, a dependency that poses significant long-term risks and uncertainties. The Belarusian regime has begun to see this relationship not only as a lifeline but also as a potential source of economic enhancement. However, this approach may blur the lines between sustainable growth and short-term gains, fostering uncertainties about the true nature of this economic uptick. Hence, questions on whether this growth is viable or merely cyclical persist. The uncertainty and progressing dependence on Russia, in turn, imply numerous challenges for the political domain.

New Issues on the Belarusian Economic Agenda

The Belarusian economy continues to surprise, displaying output growth substantially higher than previous forecasts (see e.g. BEROC, 2024). In 2024, the economy is projected to grow by around 4.0 percent. The growth is being driven by domestic demand, fueled by rising real wages and labor shortages. However, an underlying factor is the recent resurgence of exports to Russia. The unexpectedly high growth has allowed for the Belarusian economy to surpass pre-war output levels, at the moment defying earlier predictions of stagnation or decline.

Although the growth period has now extended beyond what could be considered a mere “recovery”, the overall picture – as suggested in Kruk (2024) – still appears relevant. Despite the upturn, the economy remains significantly behind the counterfactual ‘no sanctions, no war’ scenario (see Figure 1).

Figure 1. The Dynamics of Output (seasonally adjusted, index, 2018=100): Actual vs. Counterfactual

Line graph comparing the actual economic output of Belarus with a counterfactual scenario, illustrating the impact of war and sanctions on the country's economic dependence.

Source: Own estimations based on Belstat data. Note: The counterfactual scenario assumes that the Belarusian economy continued to grow uniformly from Q2 2021 to the present, at a sluggish growth rate of 1 percent per annum (a conservative estimate of the potential growth rate before the sanctions were implemented (Kruk & Lvovskiy, 2022)).

Moreover, all the risks to long-term growth associated with total dependence on Russia, potential contagion effects from Russia, etc. are still relevant (KAS, 2024; Bornukova, 2023).

At the same time, a prolonged period of growth gives grounds to think about recent trends also from the perspective of ongoing structural changes in the Belarusian economy. Can these changes, besides implying numerous risks, enhance Belarus’s growth potential and degree of sustainability? If so, to what extent, for how long, and under which conditions? With these questions in mind, it is important to gain a better understanding of what aspects of the Belarusian economy are being transformed due to the increased coupling with Russia and which effects, besides increased dependency and corresponding risks, this coupling generates. Are there any growth-enhancing effects? If so, how sustainable are they?

Belarus’s Growing Economic Dependence on Russia

Belarus’s economic dependence on Russia is reaching unprecedented levels, spanning various critical sectors, with new dimensions of reliance emerging in recent years. This dependence is deeply embedded in the trade, energy, financial, and technological sectors of the Belarusian economy, and recent geopolitical shifts have further intensified these connections.

One of the most evident signs of Belarus’s economic reliance on Russia is reflected in its foreign trade. Russian imports make up around 55-60 percent of all imports to Belarus, with a staggering 80 percent consisting of intermediate goods crucial for industrial production. Energy products, including crude oil and natural gas, form the largest part of these imports, with almost all of Belarus’s energy needs being met by Russia. Exports have also become increasingly concentrated to the Russian market. In 2022-2023 there were several periods when about 70 percent of Belarusian exports were directed to Russia, an increase from about 35-40 percent prior to 2022. This surge was driven by new opportunities for Belarusian firms on the Russian market following Western companies withdrawals. Although competition in the Russian market has since intensified, Russia still accounts for around 60-65 percent of Belarus’s total exports (see Figure 2).

Figure 2. The Evolution of Physical Volume of Exports (2018=100) and the Share of Exports to Russia (in percent)

Graph showing Belarus's exports to Russia and other countries, illustrating the country's growing economic dependence on Russia with a significant increase in the share of exports to Russia post-2022.

Source: Own estimations based on data from the National Bank of Belarus.

A major new development since 2022 is Belarus’s reliance on Russia for transportation and logistics. Sanctions and the war in Ukraine have forced Belarus to abandon its traditional export routes through European ports, leaving Russian seaports as the only viable option for further exports. In 2023, Belarus secured around 14 million tons of port capacity in Russia, primarily for potash fertilizers and oil products exports. Although it is still below the needed volumes, this logistics dependency significantly exacerbates Belarus’s external trade dependency. Taking into account direct exports and imports to and from Russia, as well as mechanisms of logistics and transport control, Russia essentially “controls” up to 90 percent of Belarusian exports and about 80 percent of its imports.

Energy dependency is another critical factor to consider. Belarus imports over 80 percent of its energy resources from Russia, making it vulnerable to any shifts in Russian energy policy. In fact, Russian energy subsidies have played a crucial role in keeping Belarusian industries competitive. In 2022, when global energy prices spiked, the low and fixed price that Belarus paid for Russian gas and the steep discount on oil supplies translated into record-high energy subsidies. These amounted to billions of US dollars and shielded Belarus from the economic fallout other countries experienced due to rising energy prices. Although the value of these subsidies has somewhat decreased in 2023-2024, they remain significant and vital for Belarus.

Belarus’s fiscal situation has also become increasingly tied to Russia. After years of running budget deficits, Belarus achieved a budget surplus in 2023, largely due to Russian financial assistance. For instance, the budgetary item ‘gratuitous revenues’, which mainly includes reverse excise tax and other transfers from Russia, reached a historical high in 2023, securing revenues of around 3.0 percent of GDP. Without this external support, Belarus would likely face a severe fiscal deficit, forcing cuts in social spending and other areas. The scale of Russian financial aid has become a key factor in maintaining budgetary stability, imposing a serious risk for Belarus. Were Russia to restrict such financing, Belarus would almost instantly lose its fiscal stability.

In the monetary sphere, Belarus’s dependence on Russia manifests through the informal peg of the Belarusian ruble to the Russian ruble. Given the deep trade ties and shared currency use in bilateral transactions, Belarusian monetary policy is effectively constrained by Russian economic conditions. The Belarusian National Bank has little room for maneuver, as any nominal devaluation or appreciation of the ruble tends to self-correct through inflation or price adjustments tied to Russian trade. This linkage limits Belarus’s monetary sovereignty and aligns its inflation trajectory closely with Russia’s.

Belarus’s debt structure underscores this dependency further. Of the country’s roughly 17.0 billion US dollars in external debt, about 65 percent is owed directly to Russia or Russia-controlled entities like the Eurasian Fund for Stabilization and Development. In 2022-2023, Russia granted Belarus a six-year deferment on debt repayments, providing crucial breathing room for the regime. This deferment, along with Belarus’s limited access to other international financial sources due to sanctions, has cemented Russia’s role as the primary creditor and financial lifeline for Belarus.

New dimensions of dependence have also emerged within infrastructure, technology, and cyberspace. As Belarus is cut off from Western technologies and financial systems, it increasingly relies on Russian alternatives. Belarus has adopted Russian software for critical functions such as tax administration, giving Moscow access to sensitive financial data. Similarly, with several Belarusian banks disconnected from SWIFT, the country has integrated into Russia’s financial messaging system, further entrenching its reliance on Russian infrastructure. Belarusian companies, particularly in sectors like accounting and logistics, have also shifted to using Russian business software, while consumers increasingly rely on Russian digital platforms for social networks, payments, and entertainment.

An Attempt to Spur Growth Through Coupling with Russia

From the perspective of macroeconomic stability and the traditional view on strengthening growth potential, Belarus’s progressing dependence on Russia is obviously an evil (Kruk, 2023; Kruk, 2024). However, the Belarusian regime sees it as a necessary trade-off, or a “lesser evil”. In 2021-2023, the coupling was done in exchange for economic survival. Firstly, production coupling allowed to counterweight the losses in output associated with sanctions (as niches were freed up in the Russian market) (Kruk & Lvovskiy, 2022). Secondly, the coupling was driven by pressure from Russia and a desire from Belarusian authorities to rapidly obtain some compensations if accepting Russia’s demands. For example, in 2022-2023, Belarusian enterprises were granted a credit line of 105 billion rubles within so-called import-substitution projects.

However, in 2024, coupling with Russia is beginning to look more like a purposeful strategy by the Belarusian economic authorities rather than just a survival strategy. The regime seems willing to sacrifice sustainability considerations in favor of strengthening the growth potential by ‘directive production coupling’, i.e. artificially shaping value-added chains between producers in Belarus (mainly state-owned enterprises) and Russia. For instance, the regime accepted the co-called Union programs for 2024-2026 (Turarbekova, 2024), which encompass numerous activities by the governments of Belarus and Russia aimed at securing ‘production coupling’ in sectors such as machine building, agricultural and automotive engineering, aviation industry, and elevator manufacturing. In some cases, the Belarusian party solely initiates such kind of sectoral activities. It seems that the authorities either accepted the dependency due to the lack of outside options, or they became more optimistic regarding the possibility to spur economic growth through coupling with Russia based on the experiences from the last couple of years. And to some extent, this logic might hold true.

As in the previous two years, the coupling with Russia may, in the short to medium term, more than compensate for certain institutional weaknesses and vulnerabilities in the Belarusian economy. The positive effects may even extend beyond mere cyclical impacts and, under certain conditions, contribute to a semblance of stability for a period of time. For example, economic growth in Belarus could reach some degree of stability under the following conditions:

  • (a) if the war in Ukraine becomes protracted and military demand from Russia remains steady;
  • (b) if the Russian economy continues to grow (albeit modestly) in an environment with limited competition in Russian commodity markets;
  • (c) if specific tools and forms of support for the Belarusian economy remain in place.

Growth driven by a combination of these preconditions could be sufficiently stable as long as they persist. However, the existence of such a status quo is not inherently sustainable and could vanish at any moment. Each of these preconditions is highly unreliable and comes with its own set of determining factors. Thus, one cannot count on the preservation of the entire “package” of preconditions in the long term.

Conclusions

Belarus and its economic prospects are currently in a highly complex situation. The Belarusian economy has been steadily increasing its degree of coupling with Russia, with the ties strengthening both in the range of economic sectors involved and the depth of their integration.

From a long-term growth perspective, the unprecedented level of dependence on Russia is undoubtedly detrimental. In this regard, Kruk’s (2024) conclusion about the economic and political deadlocks remains entirely relevant.

However, as the past two years have shown, this situation can achieve a certain semblance of stability in the medium term. The Belarusian regime is increasingly viewing its coupling with Russia not only as a mechanism for economic survival but also as a means to enhance economic potential. In this way, the growing dependence on Russia, which brings substantial macroeconomic risks, is seen as an unavoidable cost entailed to the only available mechanism to sustain economic growth in Belarus.

How then, should we interpret the related fluctuations in Belarus’s economy? As an increase in economic potential (equilibrium growth rate) or as cyclical acceleration? Traditional economic logic encounters a contradiction here, as the line between equilibrium growth and cyclical fluctuations becomes blurred. An increase in economic potential should inherently be sustainable, whereas cyclical acceleration is inherently transient. Yet, how should we treat a mechanism that might be somewhat sustainable under certain conditions?

This contradiction creates numerous uncertainties, both strictly within the economic domain and beyond it. Economically, it diminishes the effectiveness of conventional macro forecasting tools, making them more dependent on ad-hoc assumptions. For example, if there is indeed an increase in potential, then macroeconomic projections generated without accounting for this channel (e.g. BEROC, 2024) would likely underestimate output growth while overestimating the risks of overheating and destabilization. Conversely, if the model assumes higher equilibrium growth but it proves unsustainable, the forecast could significantly overestimate growth while underestimating macroeconomic imbalances. In other words, the seemingly favorable situation could ultimately be a harbinger of a macroeconomic storm.

These uncertainties are even more pronounced in the political domain. Up to what threshold can an increasing economic dependency on Russia yield macroeconomic gains for the regime? What political consequences can arise if the strategy of coupling with Russia for growth enhancement fails? Can the progressing dependency on Russia undermine the regime politically? If political barriers for democratization are eliminated, what should and can be done to get rid of the dependence on Russia? Are the estimations and prescriptions in Hartwell et al. (2022) – which considers the perspectives of economic reconstruction for a democratic Belarus and the costs of eliminating the dependency on Russia in pre-war reality – still relevant today?

Answering such questions meaningfully using formal research tools ex-ante is nearly impossible. The dependence of macroeconomic sustainability on non-economic factors and motivations leaves little room for an accurate ex-ante diagnosis of the current state of affairs. Only ex-post will we likely be able to reliably assess which diagnosis is closer to the truth. This, in turn, means that we must accept an additional degree of uncertainty in today’s forecasts and projections. Similar challenges are faced by decision-makers in Belarus. As a result, the likelihood of incorrect economic and political decisions due to misdiagnosing the current situation is relatively high, even in the (more optimistic) scenario where the authorities recognize and account for these uncertainties. Such decisions, if made, could not only be costly but might even trigger rapid and drastic economic and political changes.

References

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.