Tag: Sanctions

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.

Navigating Market Exits: Companies’ Responses to the Russian Invasion of Ukraine

Posted on May 20, 2024 | Policy Brief

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Russia’s invasion of Ukraine on 24 February 2022 led to widespread international condemnation. As governments imposed sanctions on Russian businesses and individuals tied to the war, international companies doing business in Russia came under increasing pressure to withdraw from Russia voluntarily. In the first part of this policy brief, we show what kind of companies decided to leave the Russian market using data collected by the LeaveRussia project. In the second part, we focus on prominent Swedish businesses which announced a withdrawal from Russia, but whose products were later found available in the country by investigative journalists from Dagens Nyheter (DN). We collect the stock prices for these companies when available and show how investors respond to these news.

Business Withdrawal from Russia

The global economy is highly interconnected, and Russia forms an important part. Prior to the invasion, Russia ranked 13th in the world in terms of global goods exports value and 22nd in terms of imports (Schwarzenberg, 2023). In the months following the full-scale invasion of Ukraine, Russia’s imports dropped sharply (about 50 percent according to Sonnenfeld et al., 2022). Before February 24th, Russia’s main trading partners were China, the European Union (in particular, Germany and the Netherlands) and Belarus (as illustrated in Figure 1). While there is some evidence of Russia shifting away from Western countries and towards China following the annexation of Crimea in 2014 and the resulting sanctions, Western democracies still made up about 60 percent of Russia’s trade  in 2020 (Schwarzenberg, 2023). In the same year, Sweden’s exports to Russia accounted for 1.4 percent of Sweden’s total goods exports, of which 59 percent were in the machinery, transportation and telecommunications sectors. 1.3 percent of Swedish imports were from Russia (Stockholms Handelskammare, 2022).

Figure 1. Changes in trade with Russia, 2013-2020.

Source: IMF Direction of Trade Statistics, data until 2020. From Lehne (2022).

In response to Russia’s invasion of Ukraine in February 2024, Western governments imposed strict trade and financial sanctions on Russian businesses and individuals involved in the war (see S&P Global, 2024). These sanctions are designed to hamper Russia’s war effort by reducing its ability to fight and finance the war. The sanctions make it illegal for, e.g., European companies to sell certain products to Russia as well as to import select Russian goods (Council of the European Union, 2024). Even though sanctions do not cover all trade with Russia, many foreign businesses have been pressured to pull out of Russia in an act of solidarity. The decision by these businesses to leave is voluntary and could reflect their concerns over possible consumer backlash. It is not uncommon for consumers to put pressure on businesses in times of geopolitical conflict. For instance, Pandya and Venkatesan (2016) find that U.S. consumers were less likely to buy French-sounding products when the relationship between both countries deteriorated.

The LeaveRussia Project

The LeaveRussia project, from the Kyiv School of Economics Institute (KSE Institute), systematically tracks foreign companies’ responses to the Russian invasion. The database covers a selection of companies that have either made statements regarding their operations in Russia, and/or are a large global player (“major companies and world-famous brands”), and/or have been mentioned in relation to leaving/waiting/withdrawing from Russia in major media outlets such as Reuters, Bloomberg, Financial times etc. (LeaveRussia, 2024). As of April 5th, 2024, the list contains 3342 firms, the companies’ decision to leave, exit or remain in the Russian market, the date of their announced action, and company details such as revenue, industry etc. The following chart uses publicly available data from the LeaveRussia project to illustrate patterns in business withdrawals from Russia following the invasion of Ukraine.

Figure 2a shows the number of foreign companies in Russia in the LeaveRussia dataset by their country of headquarters. Figure 2b shows the share of these companies that have announced a withdrawal from Russia by April 2024, by their country of headquarters.

Figure 2a. Total number of companies by country.

Figure 2b. Share of withdrawals, by country.

Source: Authors’ compilation based on data from the LeaveRussia project and global administrative zone boundaries from Runfola et al. (2020).

Some countries (e.g. Canada, the US and the UK) that had a large presence in Russia prior to the war have also seen a large number of withdrawals following the invasion. Other European countries, however, have seen only a modest share of withdrawals (for instance, Italy, Austria, the Netherlands and Slovakia). Companies headquartered in countries that have not imposed any sanctions on Russia following the invasion, such as Belarus, China, India, Iran etc., show no signs of withdrawing from the Russian market. In fact, the share of companies considered by the KSE to be “digging in” (i.e., companies that either declared they’d remain in Russia or who did not announce a withdrawal or downscaling as of 31st of March 2024) is 75 percent for more than 25 countries, including not only the aforementioned, but also countries such as Argentina, Moldova, Serbia and Turkey.

Withdrawal Determinants

The decision for companies to exit the market may range from consumer pressure to act in solidarity with Ukraine, to companies’ perceived risk from operating on the Russian market (Kiesel and Kolaric, 2023). Out of the 3342 companies in the LeaveRussia project’s database, about 42 percent have, as of April 5th, 2024, exited or stated an intention to exit the Russian market. This number increases only slightly to 49 percent when considering only companies headquartered in democratic (an Economist Intelligence Unit Democracy Index score of 7 or higher) countries within the EU. Figure 3 shows the number of companies that announced their exit from the Russian market, by month. A clear majority of companies announce their withdrawal in the first 6 months following the invasion.

Figure 3. Number of foreign companies announcing an exit from the Russian market, 2022-2024.

Source: Authors’ compilation based on data from the LeaveRussia project.

Similarly to the location of companies’ headquarters, the decision to exit the Russian market varies by industry. Figure 4 a depicts the top 15 industries with the highest share of announced withdrawals from the Russian market among industries with at least 10 companies. Most companies with high levels of withdrawals are found in consumer-sensitive industries such as the entertainment sector, tourism and hospitality, advertising etc.

Figure 4a. Top 15 industries in terms of withdrawal shares.

Figure 4b. Bottom 15 industries in terms of withdrawal shares.

Source: Authors’ compilation based on data from the LeaveRussia project.

In contrast, Figure 4b details the industries with the lowest share of companies opting to withdraw from the Russian market. Only around 10 percent of firms in the “Defense” and “Marine Transportation” industries chose to withdraw. Two-thirds of firms within the “Energy, oil and gas” and “Metals and Mining” sectors have chosen to remain in business in Russia following the war in Ukraine.

Several sectors have been identified as crucial in supplying the Russian military with necessary components to sustain their military aggression against Ukraine, mainly electronics, communications, automotives and related categories. We find that many of these sectors are among those with the lowest share of companies withdrawing from Russia. Companies for which Russia constitute a large market share have more to lose from exiting than others. Another reason for not exiting the market relates to the current legal hurdles of corporate withdrawal from Russia (Doherty, 2023). Others may simply not have made public announcements or operate within an industry dominated by smaller companies that are not on the radar of the LeaveRussia project. Nonetheless, Bilousova et al. (2024) detail that products from companies within the sanction’s coalition continue to be found in Russian military equipment destroyed in Ukraine. This is due to insufficient due diligence by companies as well as loopholes in the sanctions regime such as re-exporting via neighboring countries, tampering with declaration forms or challenges in jurisdictional enforcement due to lengthy supply chains, among others. (Olofsgård and Smitt Meyer, 2023).

And Those Who Didn’t Leave After All

The data from the LeaveRussia project details if and when foreign businesses announce that they will leave Russia. However, products from companies that have announced a departure from the Russian market continue to be found in the country, including in military components (Bilousova, 2024). In autumn 2023, investigative journalists from the Swedish newspaper Dagens Nyheter exposed 14 Swedish companies whose goods were found entering Russia, in most cases contrary to the companies’ public claims (Dagens Nyheter, 2023; Tidningen Näringslivet, 2023). For this series of articles, the journalists used data from Russian customs and verified it with information from numerous Swedish companies, covering the time period up until December 2022. This entailed reviewing thousands of export records from Swedish companies either directly to Russia or via neighboring countries such as Armenia, Kazakhstan, and Uzbekistan. All transactions mentioned in the article series have been confirmed with the respective companies, who were also contacted by DN prior to publication (Dagens Nyheter, 2023b). DNs journalists also acted as businessmen, interacting with intermediaries in Kazakhstan and Uzbekistan, exposing re-routing of Swedish goods from a company stated to have cut all exports to Russia in the wake of the invasion (Dagens Nyheter, 2023d).

For Sweden headquartered companies exposed in DN and that are traded on the Swedish Stock Exchange, we collect their stock prices and trading volume. Our data includes information on each stock’s average price, turnover, number of trades by date from around the date of the DN publications as well as the date of each company’s prior public announcement of exiting Russia. Table 1 details the companies who were exposed of doing direct or indirect business with Russia by DN and who had announced an exit from the Russian market previously. In their article series, DN also shows that goods from the following companies entered Russia; AriVislanda, Assa Abloy, Atlas Copco, Getinge, Scania, Securitas Tetra Pak, and Väderstad. Most of the companies exposed by DN operate within industries displaying low withdrawal shares.

Table 1. Select Swedish companies’, time of exit announcement and exposure in Dagens Nyheter and stock names.


Source: The LeaveRussia project, 2023; Dagens Nyheter, 2023b, 2023c, 2023d. Note: The exit statements have been verified through companies’ press statements and/or reports when available. For Epiroc, the claim has been verified via a previous Dagens Nyheter article (Dagens Nyheter, 2023a).

In Figure 5, we show the average stock price and trades-weighted average stock price of the Swedish companies in Table 1 around the time when the companies announced that they are leaving Russia.

Figure 5. Average stock price of companies in Table 1 around Russian exit announcements.

Source: Author’s compilation based on data from Nasdaq Nordic.

There appears to be an immediate increase in stock prices after firms announced their exit from the Russian market. Stock prices, however, reverse their gains over the next couple of days. In general, stock prices are volatile, and we also see similar-sized movements immediately before the announcement. Due to this volatility and the fact that we cannot rule out other shocks impacting these stock prices at the same time, it is difficult to attribute any movements in the stock prices to the firms’ decisions to leave Russia.

The academic evidence on investors’ reactions to firms divesting from Russia is mixed. Using a sample of less than 300 high-profile firms with operations in Russia compiled by researchers at the Yale Chief Executive Leadership Institute, Glambosky and Peterburgsky (2022) find that firms that divest within 10 days after the invasion experience negative returns, but then recover within a two-week period. Companies announcing divesting at a later stage do not experience initial stock price declines. In contrast, Kiesel and Kolaric (2023) use data from the LeaveRussia project to find positive stock price returns to firms’ announcements of leaving Russia, while there appears to be no significant investor reaction to firms’ decisions to stay in Russia.

When considering the effect from DN’s publications, the picture is almost mirrored, with the simple and trades-weighted average stock prices dipping in the days following the negative media exposure before not only recovering, but actually increasing. Similar caveats apply to the interpretation of this chart. In addition, the DN publication occurred shortly after the Hamas attacks on Israel on October 7 and Israel’s subsequent war on Gaza. While conflict and uncertainty typically dampen the stock market, the events in the Middle East initially caused little reaction on the stock market (Sharma, 2023).

Figure 6. Average stock price for companies listed in Table 1 around the time of DN exposure.

Source: Author’s compilation based on data from Nasdaq Nordic.

Discussion

As discussed in Becker et al. (2024), creating incentives and ensuring companies follow suit with the current sanctions’ regime should be a priority if we want to end Russia’s war on Ukraine and undermine its wider geopolitical ambitions. Nevertheless, Bilousova et al. (2024), and Olofsgård and Smitt Meyer (2023), highlight that there is ample evidence of sanctions evasions, including for products that are directly contributing to Russia’s military capacity. Even in countries that have a strong political commitment to the sanctions’ regime, enforcement is weak. For instance, in Sweden, it is not illegal to try and evade sanctions according to the Swedish Chamber of Commerce (2024). There is little coordination between the numerous law enforcement agencies that are responsible for sanction enforcement and there have been very few investigations into sanctions violations.

Absent effective sanctions enforcement and for the many industries not covered by sanctions, can we rely on businesses to put profits second and voluntarily withdraw from Russia? Immediately after the start of Russia’s invasion of Ukraine, as news stories about the brutality of the war proliferated, many international companies did announce that they will be leaving Russia. However, a more systematic look at data collected by the LeaveRussia project and KSE Institute reveals that more than two years into the war, less than half of companies based in Western democracies intend to distance themselves from the Russian market. A closer look at companies who are continuing operations in Russia reveals that they tend to be in sectors that are crucial for the Russian economy and war effort, such as energy, mining, electronics and industrial equipment. Many of these companies are probably seeing the war as a business opportunity and are reluctant to put human lives before their bottom line (Sonnenfeld and Tian, 2022).

Whether companies who announce that they are leaving Russia actually do leave is difficult to independently verify. A series of articles published in a prominent Swedish newspaper (Dagens Nyheter) last autumn revealed that goods from 14 major Swedish firms continue to be available in Russia, despite most of these firms publicly announcing their withdrawal from the country. The companies’ reactions to the exposé were mixed. A few companies, such as Scania and SSAB, have decided to cut all exports to the intermediaries exposed by the undercover journalists (for instance, in Kazakhstan, Uzbekistan and Kyrgyzstan). Other companies stated that they are currently investigating DN’s claims or that the exports exposed in the DN articles were final or delayed orders that were accepted before the company decided to withdraw from Russia. Another company, Trelleborg – a leading company within polymer solutions for a variety of industry purposes – reacted to the DN exposure by backtracking from its earlier commitment to exit the Russian market (Dagens Nyheter 2023b, 2023d). Wider reaction to these revelations was muted. Looking at changes in stock prices for the exposed companies, we find little evidence that investors are punishing companies for not honoring their public commitment to withdraw from Russia.

In an environment, where businesses themselves withdraw at low rates and investors do not shy away from companies contradicting their own claims, the need for stronger enforcement of sanctions seems more pressing than ever.

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.

Sanctions on Russia: Getting the Facts Right

Posted on March 14, 2024 | Policy Brief

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The important strategic role that sanctions play in the efforts to constrain Russia’s geopolitical ambitions and end its brutal war on Ukraine is often questioned and diminished in the public debate. This policy brief, authored by a collective of experts from various countries, shares insights on the complexities surrounding the use of sanctions against Russia, in light of its illegal aggression towards Ukraine. The aim is to facilitate a public discussion based on facts and reduce the risk that the debate falls prey to the information war.

Sanctions are a pivotal component in the array of strategies deployed to address the threat posed by Russia to the rule-based international order. Contrary to views minimizing their impact, evidence and research suggest that sanctions, particularly those targeting Russian energy exports, have significantly affected Russia’s macroeconomic stability [1,2,3]. Between 2022 and 2023:

  • merchandise exports fell by 28 percent,
  • the trade surplus decreased by 62 percent,
  • and the current account surplus dropped by 79 percent (see the Bank of Russia’s external sector statistics here).

Although 2022 represents an extraordinarily high baseline due to the delayed impacts of energy sanctions, the $190 billion decrease in foreign currency inflows during this time has already made a significant difference for Russia. This amount is equivalent to about two years of Russia’s current military spending, or around 10 percent of Russia’s yearly GDP, depending on the figures. Our estimates suggest that Russia’s losses due to the oil price cap and import embargo alone amount to several percent of its GDP [3,4]. These losses have contributed to the ruble’s continued weakness and have forced Russian authorities to sharply increase interest rates, which will have painful ripple effects throughout the economy in the coming months and years. Furthermore, the international sanctions coalition’s freezing of about $300 billion of the Bank of Russia’s reserves has significantly curtailed the central bank’s ability to manage the Russian economy in this era of war and sanctions.

Sanctions Enforcement

Addressing the enforcement of sanctions, it is crucial to acknowledge the extensive and continuous work undertaken by governments, think tanks, and the private sector to identify and close loopholes that facilitate sanctions evasion. Suggesting that such efforts are futile, often with arguments that lack solid evidence, potentially undermines these contributions, and furthermore provides (perhaps unintended) support to those advocating for a dismantling of the sanctions regime. We do not deny that several key aspects are facing challenges, from the oil price cap to export controls on military and dual-use goods. However, the path forward is to step up efforts and strengthen the implementation and enforcement – not to abandon the strategy altogether. Yes, Russia’s shadow fleet threatens the fundamental mechanism of the oil sanctions and, namely its reliance on Western services [4,5,6]. However, recent actions by the U.S. Treasury Department have shown that the sanctioning coalition can in fact weaken Russia’s ability to work around the energy sanctions. Specifically, the approach to designate (i.e., sanction) individual tankers has effectively removed them from the Russian oil trade. More vessels could be targeted in a similar way to gradually step-up the pressure on Russia [7]. While Russia continues to have access to many products identified as critical for the military industry (for instance semiconductors) [8], it has been shown that Russia pays significant mark-ups for these goods to compensate for the many layers of intermediaries involved in circumvention schemes. Sanctions, even when imperfect, thus still work as trade barriers. In addition to existing efforts and undertakings, companies which help Russia evade export controls can be sanctioned, even when registered in countries outside of the sanctioning coalition. Furthermore, compliance efforts within, and against, western companies, who remain extremely important for Russia, can be stepped up.

The Russian Economy

Many recent newspaper articles have been centered around the theme of Russia’s surprisingly resilient economy. We find these articles to generally be superficial and missing a key point: Russia is transitioning to a war economy, driven by massive and unsustainable public spending. In 2024, military spending is projected to boost Russia’s GDP growth by at least 2.5 percentage points, driven by a planned $100 billion in defense expenditures [9]. However, seeing this for what it is, namely war-spending, raises significant concerns about the sustainability of this growth, as it eats into existing reserves and crowds out investments in areas with a larger long-term growth potential. The massive spending also feeds inflation in consumer prices and wages, in particular as private investment levels are low and the labor market is short on competent labor. This puts pressure on monetary policy causing the central bank to increase interest rates even further, to compensate for the overly stimulating fiscal policy.

Further, it is important to bear in mind that, beyond this stimulus, the Russian economy is characterised by fundamental weaknesses. Russia has for many years dealt with anaemic growth due to low productivity gains and unfavourable demographics. Since the first round of sanctions was imposed on Russia, following its illegal annexation of Crimea in 2014, growth has hovered at around 1 percent per year on average – abysmal for an emerging market with catch-up potential. More recently, current sanctions and war expenditures have made Russia dramatically underperform compared to other oil-exporting countries [10]. Moreover, none of the normal (non-war related) growth fundamentals is likely to improve. Rather, the military aggression and the ensuing sanctions have made things worse. Hundreds of thousands of Russians have been killed or wounded in the war; many more have left the country to either escape the Putin regime or mobilization. Those leaving are often the younger and better educated, worsening the already dire demographic situation, and reinforcing the labor market inefficiencies. Additionally, with the country largely cut off from the world’s most important financial markets, investments in the Russian economy are completely insufficient [11].

As a result, Russia will be increasingly dependent on fossil fuel extraction and exports, a strategy that holds limited promise as considerations related to climate change continue to gain importance. With the loss of the European market, either due to sanctions or Putin’s failed attempt to weaponize gas flows to Europe, Russia finds itself dependent on a limited number of buyers for its oil and gas. Such dependency compels Russia to accept painful discounts and increases its exposure to market risks and price fluctuations [12].

The Cost of Sanctions

Sanctions have not been without costs for the countries imposing them. Nonetheless, the sanctioning countries are in a much better position than Russia. Any sanction strategy is necessarily a tradeoff between maximizing the sanctioned country’s economic loss while minimizing the loss to the sanctioning countries [9], but there are at least two qualifications to bear in mind. The first is that some sanctions imply very low losses – if any – while others may carry limited short term losses but longer term gains. This includes the oil-price cap that allows many importing countries to buy Russian oil at a discount [3], and policies to reduce energy demand, which squeezes Russia’s oil-income [13]. These policies may also initially hurt sanctioning countries, but in the long term facilitate an investment in energy self-sufficiency. Similarly, trade sanctions also imply some protection of one’s own industry, meaning that such sanctions may in fact bring benefits to the sanctioning countries – at least in the short run. The second qualification is that, in cases where sanctions do imply a cost to the sanctioning countries, the question is what cost is reasonable. Russia’s economy is many times smaller than, for instance, the EU’s economy. This gives the EU a strategic advantage akin to that in Texas hold’em poker: going dollar for dollar and euro for euro, Russia is bound to go bankrupt. Currently, Russia allocates a significantly larger portion of its GDP to its war machine than most sanctioning countries spend on their defense. That alone suggests sanctioning countries may want to go beyond dollar for dollar as it is cheaper to stop Russia economically today than on a future battlefield. This points to the bigger question: what would be the future cost of not sanctioning Russia today? Many accredit the weak response from the West to the annexation of Crimea in 2014 as part of the explanation behind Putin’s decision to pursue the current full-scale invasion of Ukraine. Similarly, an unwillingness to bear limited costs today may entail much more substantial costs tomorrow.

When discussing the cost of sanctions, one must also take into account Russia’s counter moves and whether they are credible [14]. Often, they are not [3, 15]. Fear-inducing platitudes, such that China and Russia will reshape the global financial system to insulate themselves from the West’s economic statecraft tools, circulate broadly. We do not deny that these countries are undertaking measures in this direction, but it is much harder to do so in practice than in political speeches. For instance, moving away from the U.S. dollar (and the Euro) in international trade (aside from in bilateral trade relations that are roughly balanced) is highly challenging. In such a trade, conducted without the U.S. dollar, one side of the bargain will end up with a large amount of currency that it does not need and cannot exchange, at scale, for hard currency. As long as a transaction is conducted in U.S. dollar, the U.S. financial system is involved via corresponding accounts, and the threat of secondary sanctions remains powerful. We have seen examples of this in recent months, following President Biden’s executive order on December 22, 2023.

One of Many Tools

Finally, we and other proponents of sanctions do not view them as a panacea, or an alternative to the essential military and financial support that Ukraine requires. Rather, we maintain that sanctions are a critical component of a multi-pronged strategy aimed at halting Putin’s unlawful and aggressive war against Ukraine, a war that threatens not only Ukraine, but peace, liberty, and prosperity across Europe. The necessity for sanctions becomes clear when considering the alternative: a Russian regime with access to $300 billion in the central bank’s reserves, the ability to earn billions more from fossil fuel exports, and to freely acquire advanced Western technology for its military operations against Ukrainian civilians. In fact, the less successful the economic statecraft measures are, the greater the need for military and financial aid to Ukraine becomes, alongside broader indirect costs such as increased defense spending, higher interest rates, and inflation in sanctioning countries. A case in point is the West’s provision of vital – yet expensive – air defense systems to Ukraine, required to counteract Russian missiles and drones, which in turn are enabled by access to Western technology. Abandoning sanctions would only exacerbate this type of challenges.

Conclusion

The discourse on sanctions against Russia necessitates a nuanced understanding of their role within the context of the broader strategy against Russia. It is critical to understand that shallow statements and misinformed opinions become part of the information war, and that the effectiveness of sanctions also depends on all stakeholders’ perceptions about the sanctioning regime’s effectiveness and long run sustainability. Supporting Ukraine in its struggle against the Russian aggression is not a matter of choosing between material support and sanctions; rather, Ukraine’s allies must employ all available tools to ensure Ukraine’s victory. While sanctions alone are not a cure-all, they are indispensable in the concerted effort to support Ukraine and restore peace and stability in the region. The way forward is thus to make the sanctions even more effective and to strengthen the enforcement, not to abandon them.

References

[1] “Russia Chartbook”. KSE Institute, February 2024

[2] “One year of sanctions: Russia’s oil export revenues cut by EUR 34 bn”. Center for Research on Energy and Clean Air, December 2023

[3] “The Price Cap on Russian Oil: A Quantitative Analysis”. Wachtmeister, H., Gars, J. and Spiro, D, July 2023

[4] Spiro, D. Gars, J, and Wachtmeister, H. (2023). “The effects of an EU import and shipping embargo on Russian oil income,” mimeo

[5] “Energy Sanctions: Four Key Steps to Constrain Russia in 2024 and Beyond”. International Working Group on Russian Sanctions & KSE Institute, February 2024

[6] “Tracking the impacts of G7 & EU’s sanctions on Russian oil”. Center for Research on Energy and Clean Air

[7] “Russia Oil Tracker”. KSE Institute, February 2024

[8] “Challenges of Export Controls Enforcement: How Russia Continues to Import Components for Its Military Production”. International Working Group on Russian Sanctions & KSE Institute, January 2024

[9] “Russia Plans Huge Defense Spending Hike in 2024 as War Drags”. Bloomberg, September 2023

[10] “Sanctions and Russia’s War: Limiting Putin’s Capabilities”. U.S. Department of the Treasury, December 2023

[11] “World Investment Report 2023”. UNCTAD

[12] “Russia-China energy relations since 24 February: Consequences and options for Europe”. Swedish Institute of International Affairs, June 2023

[13] Gars, J., Spiro, D. and Wachtmeister, H. (2022). “The effect of European fuel-tax cuts on the oil income of Russia”. Nature Energy, 7(10), pp.989-997

[14] Spiro, D. (2023). “Economic Warfare”. Available at SSRN 4445359

[15] Gars, J., Spiro, D. and Wachtmeister, H., (2023). “Were Russia’s threats of reduced oil exports credible?”. 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.

Monetary Policy in Belarus Since Mid-2020: From Rules to Discretion

Posted on February 12, 2024 | Policy Brief

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The most important “safeguard” against negative consequences from government’s economic policy mistakes is an independent monetary policy aimed at maintaining inflation near a pre-announced target and smoothing out short-term fluctuations. In Belarus, various monetary policy regimes have been employed and, for most of history, the ability of the National Bank of Belarus to set goals and deploy monetary policy instruments without government intervention has been limited. As a result, monetary policy in Belarus tend to exacerbate negative shocks to the Belarusian economy rather than play a stabilizing role. Since mid-2020, the National Bank has de facto lost operational and institutional independence, and monetary policy has become discretionary – focused on stimulating economic activity. As of 2024 this discretionary and expansionary monetary policy has increasingly come into conflict with the need to ensure macroeconomic stability.

Monetary Policy Design in Belarus: Developments in the Last Decade

Since 2015, the National Bank of Belarus (henceforth the National Bank) has declared its monetary policy regime to be monetary targeting. The primary goal of such policy is price stability, while the intermediate target is broad money supply growth. However, research results show that monetary targeting was employed only until mid-2016. From mid-2016 to mid-2020, the National Bank implicitly employed flexible inflation targeting (Kharitonchik, 2023b).

In mid-2020 the National Bank de facto lost its operational independence as the bank was no longer in control of the rules concerning monetary policy (Kharitonchik, 2023a). In 2022-2024, among other things, targets were set for inflation, the growth of the ruble monetary base, broad money supply, the banks’ claims on the economy, and the refinancing rate level. Thus, the National Bank seeks to simultaneously control both the volume of money in the economy and the prices. This is, in practice, expressed in the implementation of discretionary and situational monetary policy.

Under pressure from the government, the National Bank’s monetary policy has since mid-2020 focused on stimulating economic activity, with a high degree of tolerance to inflationary risks. After the US, EU, UK, and several other countries imposed strict sanctions on Belarus in the beginning of 2022, the government’s pressure on the National bank to support economic activity increased even further.

Since October 2022, the only inflation regulator has been strict price controls, exercised by the government in the form of a system of price regulations for approximately 85 percent of the items in the consumer basket. According to the system, manufacturers are obliged to coordinate wholesale prices with government authorities and retailers were in Q4 2022 forced to adjust prices. The system has been modified several times, but as of 2024, it continues to operate in an extremely rigorous version.

Besides the erosion of operational independence, the recent years have been characterized by a marked decline in the institutional framework for executing monetary policy. Aspirations to enhance transparency and accountability of the National Bank to the public seem to be history, at least for the time being. The frequency of the bank’s communication has decreased significantly and its content, as well as the bank’s published data and analytical materials have deteriorated. There are no longer any National Bank briefings on the outcomes of its board meetings, nor are there clear explanations of the decisions made or meetings with the expert community.

The National Bank also introduces uncertainty and undermines confidence in its policies with its strange approach to setting and announcing inflation targets. The increased inflation target, from the previous 5, to 7-8 percent for 2023 is unexplained, the explicit inflation target for 2024 was not presented until the end of August 2023, and the medium-term inflation target is nonexistent. Under such conditions, investment planning and forecasting becomes challenging, necessitating substantial efforts to rebuild trust in monetary authorities for the future.

Figure 1. Inflation and inflation targets in Belarus, 2015–2023.

Source: Author’s estimates based on data from Belstat and the National Bank of Belarus.

Between 2020 and 2023, the National Bank was unable to effectively implement monetary policy in a coordinated manner, falling short in achieving de jure primary and intermediate targets. Thus, inflation in 2020–2022 was significantly higher than targeted levels, while the money supply growth was close to the lower bound of its target range (see Figure 1 and 2).

Figure 2. Broad money growth and its target in Belarus, 2015–2023.

Source: Author’s estimates based on data from the National Bank of Belarus.

In 2023, the inflation was below its target due to total price controls, while money supply growth was twice its target (see Figure 2). Such targeted monetary policy dynamics indicate the instability of the economy’s demand for money and the money multiplier, the instability and poor predictability of money velocity in the face of shocks to the Belarusian economy, as well as the lack (or inability) of a strict commitment by the National Bank to achieve the primary goal of monetary policy.

Monetary Conditions Between 2020 and 2023

Monetary conditions are calculated as a weighted combination of deviations of real interest rates on assets in Belarusian rubles and the real effective exchange rate of the Belarusian ruble from their equilibrium levels. As detailed in Figure 3, the monetary conditions for 2020–2023 are considered stimulative for economic activity and pro-inflationary.

Figure 3. Monetary conditions in Belarus,2015–2023.

Source: Author’s estimates based on QPM BEROC (Kharitonchik, 2023b).
Note: Monetary conditions are estimated as a combination of deviations of real interest rates on the Belarusian ruble assets and of the real effective Belarusian ruble exchange rate from their equilibrium (or inflation-neutral) levels (assessed within the model). Positive monetary condition values indicate their restraining-economic-activity and disinflationary stance, and negative monetary condition values indicate their stimulating and pro-inflationary stance.

In 2020, the soft monetary conditions (the combined effect of interest rates and the exchange rate on the economy) were determined by the behavior of the exchange rate. The Belarusian ruble weakened significantly and became undervalued in 2020 due to a sharp increase in demand for foreign currency at the onset of the Covid-19 pandemic in Belarus and following the presidential elections in August 2020.

As a result of the National Bank’s discretionary monetary policy, interest rates’ volatility significantly increased. A deterioration of the liquidity situation in the banking system and increased risks to the economy during the acute phase of the socio-political crisis in 2020 resulted in interest rates restraining economic activity in September-December 2020.

In 2021, there was a notable improvement in the economic situation in Belarus compared to the crisis experienced in 2020. External demand for Belarusian goods and services rose, and export prices increased significantly which contributed to an increase in foreign currency earnings. As a result, the undervaluation of the Belarusian ruble neutralized during 2021, the banking system moved to a liquidity surplus, and interest rates decreased noticeably, creating soft monetary conditions (see Figure 3).

In 2022–2023, monetary conditions became even softer against the backdrop of increasing priority for the National Bank to support economic activity over inflation containment. The Belarusian ruble again became undervalued which increased foreign trade and allowed for the banking system’s liquidity surplus to expand significantly (see Figure 4).

The realization of a substantial liquidity surplus in 2022 resulted from the National Bank’s active emission policy, likely associated with considerable government pressure. The National Bank injected at least 1.7 billion Belarusian rubles (0.9 percent of GDP) into the financial system through lending to non-deposit financial organizations in 2022, and more than 1.9 billion Belarusian rubles (1 percent of GDP) in 2022 and 1.1 billion Belarusian rubles (0.5 percent of GDP) in 2023, through the purchase of government bonds on the secondary market.

Figure 4. Banking system liquidity in Belarus, 2017–2023.

Source: Author’s estimates based on data from Belstat and the National Bank of Belarus.

Under a colossal and stable liquidity surplus – not withdrawn by the National Bank – interest rates in the money and credit-deposit markets, in 2022-2023, repeatedly reached historically low levels in nominal terms, and in real terms remained  significantly below their equilibrium levels (see Figure 3).

The Monetary Conditions’ Impact on Economic Activity and Inflation in Belarus, 2022–2024

Under loose monetary conditions there was a significant strengthening of the credit impulse (share of new loans in GDP) from Q3 2022 and onwards (BEROC, 2023). In this environment of increased credit activity, the money supply grew at a rapid pace in the second half of 2022–2023 (see Figure 2). The money supply growth significantly exceeded an inflation-neutral pace and by the end of 2023, the volume of real money supply exceeded the inflation-neutral level by almost 10 percent.

Expansionary monetary policy was one of the drivers of the rapid economic recovery in the second half of 2022–2023. The negative output gap, which widened in Q2 2022, following increased sanctions against Belarus, was offset in Q1 2023. Moreover, in Q2–Q4 2023, GDP surpassed its equilibrium level (see Figure 5).

Figure 5. Output gap decomposition in Belarus, 2015–2023.

Source: Author’s estimates based on QPM BEROC (Kharitonchik, 2023b).
Note: The output gap is the deviation of real GDP from its potential (or equilibrium) level, where potential is understood as such a volume of GDP that does not exert any additional pro-inflationary or disinflationary pressure.

By 2024, the Belarusian economy reached a state of moderate overheating (see Figure 5). Currently, loose monetary policy fuels demand but the ability to adjust supply to increased demand levels is limited under sanctions and labor shortages. This mismatch between supply and demand would normally lead to a significant acceleration of inflation. However, due to the strict price controls, this is yet to realize. In fact, inflation reached a historically low value of 2.0 percent Year over Year (YoY), in September 2023. Nonetheless, inflation in Belarus began to accelerate in Q4 in 2023 and amounted to 5.8 percent YoY at the end of the year. In an environment of excess demand and a shortage of workers, firms’ costs rise and translate into higher selling prices, albeit on a limited scale and with a time lag due to the price controls (see Figure 6).

Figure 6. CPI inflation in Belarus, 2015–2023.

Source: Author’s estimates based on data from Belstat. Calculations based on QPM BEROC (Kharitonchik, 2023b).

A prolonged combination of total price controls and loose monetary policy leads to an inflationary overhang – the potential for delayed accelerated price growth. Inflation overhang is a highly undesirable phenomenon since it increases the risk of a price surge in the future and the need for a sharp and aggressive tightening of monetary policy. The inflationary overhang in Belarus is estimated at 5–9 percent (for the end of 2023).  This means that there is a risk of a sharp increase in prices by 5-9 percent if price controls are removed or significantly relaxed.

Conclusion

Since mid-2020, the National Bank has de facto lost its operational independence, and monetary policy has become discretionary, focused on stimulating economic activity. By the beginning of 2024, this discretionary and overly loose monetary policy has increasing come into conflict with the task of ensuring macroeconomic stability.

The Belarusian economy enters 2024 in a state of low economic growth potential (about 1 percent per year) and an imbalance of supply and demand, which creates threats of intensified inflation and a decline in foreign trade.

Attempts by the authorities to artificially maintain high rates of GDP growth and low inflation through excessively stimulating economic policies and archaic price controls may lead to an economic overheating by the end of 2024 similar to the situations leading up to the currency crises in 2009, 2011 and 2015. Under such developments, the fragility of the economy and the likelihood of an economic crisis in Belarus will increase.

To prevent such negative development, it is critical to gradually normalize the monetary policy design in coordination with fiscal policy. Key recommendations from experts for a strengthening of the stabilizing role of monetary policy include ensuring the National Bank’s independence, eliminating discretionary and subjective policymaking, and outlining a clear hierarchy of monetary policy goals (Kruk, 2023).

Simulation results indicate that the use of flexible inflation targeting is the most preferable monetary policy strategy for Belarus under existing sanctions and internal and external capital control measures (as discussed in Kharitonchik, 2023a).

Lastly, as monetary policy is about managing expectations for which trust (i.e. credibility) plays a key role, restoring the public’s trust in the National Bank is essential. To achieve this, the National Bank needs to reestablish communication with the public and resume the publication of analytical and statistical reports, at a minimum matching the extent seen in early 2021.

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.

How to Undermine Russia’s War Capacity: Insights from Development Day 2023

Posted on January 15, 2024 | Policy Brief

Image from SITE Development Day conference

As Russia’s full-scale invasion of Ukraine continues, the future of the country is challenged by wavering Western financial and military support and weak implementation of the sanction’s regime. At the same time, Russia fights an information war, affecting sentiments for Western powers and values across the world. With these challenges in mind, the Stockholm Institute for Transition Economics (SITE) invited researchers and stakeholders to the 2023 Development Day Conference to discuss how to undermine Russia’s capacity to wage war. This policy brief shortly summarizes the featured presentations and discussions.

Holes in the Net of Sanctions

In one of the conference’s initial presentations Aage Borchgrevink (see list at the end of the brief for all presenters’ titles and affiliations) painted a rather dark picture of the current sanctions’ situation. According to Borchgrevink, Europe continuously exports war-critical goods to Russia either via neighboring countries (through re-rerouting), or by tampering with goods’ declaration forms. This claim was supported by Benjamin Hilgenstock who not only showed that technology from multinational companies is found in Russian military equipment but also illustrated (Figure 1) the challenges to export control that come from lengthy production and logistics chains and the various jurisdictions this entails.

Figure 1. Trade flows of war-critical goods, Q1-Q3, 2023.

Source: Benjamin Hilgenstock, Kyiv School of Economics Institute.

Offering a central Asian perspective, Eric Livny highlighted how several of the region’s economies have been booming since the enforcement of sanctions against Russia. According to Livny, European exports to Central Asian countries have in many cases skyrocketed (German exports to the Kyrgyzs Republic have for instance increased by 1000 percent since the invasion), just like exports from Central Asian countries to Russia. Further, most of the export increase from central Asian countries to Russia consists of manufactured goods (such as telephones and computers), machinery and transport equipment – some of which are critical for Russia’s war efforts. Russia has evidently made a major pivot towards Asia, Livny concluded.

This narrative was seconded by Michael Koch, Director at the Swedish National Board of Trade, who pointed to data indicating that several European countries have increased their trade with Russia’s neighboring countries in the wake of the decreased direct exports to Russia. It should be noted, though, that data presented by Borchgrevink showed that the increase in trade from neighboring countries to Russia was substantially smaller than the drop in direct trade with Russia from Europe. This suggests that sanctions still have a substantial impact, albeit smaller than its potential.

According to Koch, a key question is how to make companies more responsible for their business? This was a key theme in the discussion that followed. Offering a Swedish government perspective, Håkan Jevrell emphasized the upcoming adoption of a twelfth sanctions package in the EU, and the importance of previous adopted sanctions’ packages. Jevrell also continued by highlighting the urgency of deferring sanctions circumvention – including analyzing the effect of current sanctions. In the subsequent panel Jevrell, alongside Adrian Sadikovic, Anders Leissner, and Nataliia Shapoval keyed in on sanctions circumvention. The panel discussion brought up the challenges associated with typically complicated sanctions legislation and company ownership structures, urging for more streamlined regulation. Another aspect discussed related to the importance of enforcement of sanctions regulation and the fact that we are yet to see any rulings in relation to sanctions jurisdiction. The panelists agreed that the latter is crucial to deter sanctions violations and to legitimize sanctions and reduce Russian government revenues. Although sanctions have not yet worked as well as hoped for, they still have a bite, (for instance, oil sanctions have decreased Russian oil revenues by 30 percent).

Reducing Russia’s Government Revenues

As was emphasized throughout the conference, fossil fuel export revenues form the backbone of the Russian economy, ultimately allowing for the continuation of the war. Accounting for 40 percent of the federal budget, Russian fossil fuels are currently mainly exported to China and India. However, as presented by Petras Katinas, the EU has since the invasion on the 24th of February, paid 182 billion EUR to Russia for oil and gas imports despite the sanctions. In his presentation, Katinas also highlighted the fact that Liquified Natural Gas (LNG) imports for EU have in fact increased since the invasion – due to sanctions not being in place. The EU/G7 imposed price cap on Russian oil at $60 per barrel was initially effective in reducing Russian export revenues, but its effectiveness has over time being eroded through the emergence of a Russia controlled shadow fleet of tankers and sales documentation fraud. In order to further reduce the Russian government’s income from fossil fuels, Katinas concluded that the whitewashing of Russian oil (i.e., third countries import crude oil, refine it and sell it to sanctioning countries) must be halted, and the price cap on Russian oil needs to be lowered from the current $60 to $30 per barrel.

In his research presentation, Daniel Spiro also focused on oil sanctions targeted towards Russia – what he referred to as the “Energy-economic warfare”. According to Spiro, the sanctions regime should aim at minimizing Russia’s revenues, while at the same time minimizing sanctioning countries’ own costs, keeping in mind that the enemy (i.e. Russia) will act in the exact same way. The sanctions on Russian oil pushes Russia to sell oil to China and India and the effects from this are two-fold: firstly, selling to China and India rather than to the EU implies longer shipping routes and secondly, China and India both get a stronger bargaining position for the price they pay for the Russian oil. As such, the profit margins for Russia have decreased due to the price cap and the longer routes, while India and China are winners – buying at low prices. Considering the potential countermoves, Spiro – much like Katinas – emphasized the need to take control of the tanker market, including insurance, sales and repairs. While the oil price cap has proven potential to be an effective sanction, it has to be coupled with an embargo on LNG and preferrable halted access for Russian ships into European ports – potentially shutting down the Danish strait – Spiro concluded.

Chloé Le Coq presented work on Russian nuclear energy, another energy market where Russia is a dominant player. Russia is currently supplying 12 percent of the United States’ uranium, and accounting for as much as 70 percent on the European market. On top of this, several European countries have Russian-built reactors. While the nuclear-related revenues for Russia today are quite small, the associated political and economic influence is much more prominent. The Russian nuclear energy agency, Rosatom, is building reactors in several countries, locking in technology and offering loans (e.g., Bangladesh has a 20-year commitment in which Rosatom lends 70 percent of the production cost). In this way Russia exerts political influence on the rest of the world. Le Coq argued that energy sanctions should not only be about reducing today’s revenues but also about reducing Russian political and economic influence in the long run.

The notion of choke points for Russian vessels, for instance in the Danish strait, was discussed also in the following panel comprising of Yuliia Pavytska, Iikka Korhonen, Aage Borchgrevink, and Lars Schmidt. The panelists largely agreed that while choke points are potentially a good idea, the focus should be on ensuring that existing sanctions are enforced – noting that sanctions don’t work overnight and the need to avoid sanctions fatigue. Further, the panel discussed the fact that although fossil fuels account for a large chunk of federal revenues, a substantial part of the Russian budget come from profit taxes as well as windfall taxes on select companies, and that Russian state-owned companies should in some form be targeted by sanctions in the future. In line with the previous discussion, the panelists also emphasized the importance of getting banks and companies to cooperate when it comes to sanctions and stay out of the Russian market. Aage Borchgrevink highlighted that for companies to adhere to sanctions legislation they could potentially be criminally charged if they are found violating the sanctions, as it can accrue to human rights violations. For instance, if companies’ parts are used for war crimes, these companies may also be part of such war crimes. As such, sanctions can be regarded as a human rights instrument and companies committing sanctions violations can be prosecuted under criminal law.

Frozen Assets and Disinformation

The topic of Russian influence was discussed also in the conference’s last panel, composed of Anders Ahnlid, Kata Fredheim, Torbjörn Becker, Martin Kragh, and Andrii Plakhotniuk. The panelists discussed Russia’s strong presence on social media platforms and how Russia is posting propaganda at a speed unmet by legislators and left unchecked by tech companies. The strategic narrative televised by Russia claims that Ukraine is not a democracy, and that corruption is rampant – despite the major anti-corruption reforms undertaken since 2014. If the facts are not set straight, the propaganda risks undermining popular support for Ukraine, playing into the hands of Russia. Further, the panelists also discussed the aspect of frozen assets and how the these can be used for rebuilding Ukraine. Thinking long-term, the aim is to modify international law, allowing for confiscation, as there are currently about 200 billion EUR in Russian state-owned assets and about 20 billion EUR worth of private-owned assets, currently frozen.

The panel discussion resonated also in the presentation by Vladyslav Vlasiuk who gave an account of the Ukrainian government’s perspective of the situation. Vlasiuk, much like other speakers, pointed out sanctions as one of the main avenues to stop Russia’s continued war, while also emphasizing the need for research to ensure the implications from sanctions are analyzed and subsequently presented to the public and policy makers alike. Understanding the effects of the sanctions on both Russia’s and the sanctioning countries’ economies is crucial to ensure sustained support for the sanction’s regime, Vlasiuk emphasized.

Joining on video-link from Kyiv, Tymofiy Mylovanov, rounded off the conference by again emphasizing the need for continued pressure on Russia in forms of sanctions and sanctions compliance. According to Mylovanov, the Russian narrative off Ukraine struggling must be countered as the truth is rather that Ukraine is holding up with well-trained troops and high morale. However, Mylovanov continued, future funding of Ukraine’s efforts against Russia must be ensured – reminding the audience how Russia poses a threat not only to Ukraine, but to Europe and the world.

Concluding Remarks

The Russian attack on Ukraine is military and deadly, but the wider attack on the liberal world order, through cyber-attacks, migration flows, propaganda, and disinformation, must also be combatted. As discussed throughout the conference, sanctions have the potential for success, but it hinges on the beliefs and the compliance of citizens, companies, and governments around the world. To have sanctions deliver on their long-term potential it is key to include not only more countries but also the banking sector, and to instill a principled behavior among companies – having them refrain from trading with Russia. Varying degrees of enforcement undermine sanctions compliant countries and companies, ultimately making sanctions less effective. Thus, prosecuting those who breach or purposedly evade sanctions should be a top priority, as well as imposing control over the global tanker market, to regain the initial bite of the oil price cap. Lastly, it is crucial that the global community does not forget about Ukraine in the presence of other conflicts and competing agendas. And to ensure success for Ukraine we need to restrain the Russian war effort through stronger enforcement of sanctions, and by winning the information war.

List of Participants

Anders Ahnlid, Director General at the National Board of Trade
Aage Borchgrevink, Senior Advisor at The Norwegian Helsinki Committee
Torbjörn Becker, Director at the Stockholm Institute of Transition Economics
Chloé Le Coq, Professor of Economics, University of Paris-Panthéon-Assas, Economics and Law Research Center (CRED)
Benjamin Hilgenstock, Senior Economist at Kyiv School of Economics Institute
Håkan Jevrell, State Secretary to the Minister for International Development Cooperation and Foreign Trade
Michael Koch, Director at Swedish National Board of Trade
Iikka Korhonen, Head of the Bank of Finland Institute for Emerging Economies (BOFIT)
Martin Kragh, Deputy Centre Director at Stockholm Centre for Eastern European Studies (SCEEUS)
Eric Livny, Lead Regional Economist for Central Asia at European Bank for Reconstruction and Development (EBRD)
Anders Leissner, Lawyer and Expert on sanctions at Advokatfirman Vinge
Tymofiy Mylovanov, President of the Kyiv School of Economics
Vladyslav Vlasiuk, Sanctions Advisor to the Office of the President of Ukraine
Nataliia Shapoval, Chairman of the Kyiv School of Economics Institute
Yuliia Pavytska, Manager of the Sanctions Programme at KSE Institute
Andrii Plakhotniuk, Ambassador Extraordinary and Plenipotentiary of Ukraine to the Kingdom of Sweden
Daniel Spiro, Associate Professor, Uppsala University
Adrian Sadikovic, Journalist at Dagens Nyheter
Kata Fredheim, Executive Vice President of Partnership and Strategy and Associate Professor at SSE Riga
Lars Schmidt, Director and Sanctions Coordinator at the Ministry for Foreign Affairs, Sweden

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.

Cognitive Dissonance on Belarus: Recovery and Adaptation or Stalemate?

Posted on January 8, 2024 | Policy Brief

20240107 Cognitive Dissonance on Belarus Image 02

A closer look at the Belarusian economy over the recent year, produces two initially competing narratives. The first one emphasizes that tough sanctions have led to a deadlock for the Belarusian economy. The second one stresses that output losses have turned out to be much lower than expected, and that the economy has displayed a rather high degree of adaptability – securing an early and rapid recovery. This policy brief shows that these narratives are not mutually exclusive but rather elements of the same bigger picture. A short-term focus gives the impression that the current stance is ‘more good than bad’. This reflects the fact that output has recovered and almost reached historically high levels, made possible due to a combination of exports protection mechanisms and compensatory effects on output. However, this does not eliminate the disappointing medium- and long-term prospects for the country. On the flip side of the immediate survival of the Belarusian economy is the country’s economic and political stalemate. This includes the lack of opportunities for future sustainable growth and Belarus’ enormous and continuously growing dependence on Russia. Within this stalemate, stagnation is the best plausible scenario. At the same time, much worse scenarios, both economically and politically, are also highly likely. Ultimately, breaking the deadlock is the only way to a better future for Belarus.

The Belarusian Economy and the Changing Narratives

About 1.5 years ago, Western countries introduced tough sanctions against Belarus, punishing the Lukashenka regime for its role in Russia’s invasion of Ukraine. This gave rise to a huge uncertainty regarding Belarus’ economic prospects. A FREE policy brief published about a year ago (Kruk & Lvovskiy, 2022) presented a model-based estimate of a potential rock-bottom for the Belarusian economy in the new environment, which amounted to 20 percent of output losses. The authors however argued that actual output losses might be significantly lower given Russia’s support and policy responses, which were unaccounted for in the model. At the same time, downside risks and a lack of output consistency seem to have become permanent traits of the Belarusian economy.

Expectations of a large and prolonged recession in Belarus prevailed into mid-2023. International institutions (IMF, World Bank) and rating agencies (S&P, Fitch Ratings) mainly expected a recession in Belarus up to 10 percent 2022-2023.  The reality has however turned out to be quite different with the recession being relatively contained and short-lived. The output losses between the peak (Q2-2021) trough Q3-2022 amounted to 6.8 percent. In Q4-2022 a recovery began, and in Q3-2023 the economy had almost fully recovered, reaching nearly the same levels as in Q2-2021 (see Figure 1). Further, in terms of average real wages and household consumption, the situation appears to be even more positive. The real average wage reached its pre-war level in Q1-2023 and has since displayed record high levels, and household consumption follow a similar trend (see Figure 1).

These dynamics have given rise to a new narrative. As of lately, the Belarusian economic situation is at times treated as ‘more good than bad’. Further, most international financial institutions currently forecast a continued weak recovery growth in the coming years (EBRD, 2023; IMF, 2023; Izvorski et al., 2023).

Figure 1. Real GDP, Average Real Wages, and Real Household Consumption (index, seasonally adjusted, 2018=100).

Source: Author’s estimations based on Belstat data.

Factors Behind the Recent Recovery Growth

The underlying reasons for the recovery growth can be divided into two groups: (i) export protection mechanisms under sanctions and (ii) positive shocks and compensatory effects on output.

Export protection mechanisms under sanctions are twofold. Firstly, the Belarusian regime turned out to be somewhat successful in adjusting to the new sanctions-environment. This partly due to a somewhat geographical U-turn of Belarusian exports, underpinned by new logistics and payment schemes. The best example of this turn is the re-orientation of oil product exports from the EU and Ukraine to Russia (Kharitonchik, 2023). Moreover, some exports to traditional markets, which were challenged by logistics and payment barriers rather than sanctions, were secured by crossing these barriers. The best such example is the recovery of potash fertilizer exports to China, Brazil and India. Since early 2023 these displayed a rapid recovery due to Belarus finding logistic solutions through Russian sea ports instead of EU ports, and by using railway transportation.

Secondly, the practices of sanctions evasion may also have played a significant role. The scope of sanctions evasion is however difficult to assess due to its secretive nature. Moreover, the difference between avoiding and evading sanctions is not always clear.

Export protection mechanisms allowed Belarus to cushion actual export losses, making them transitory (see Figure 2). Actual losses in exports were close to the rock-bottom scenario estimates for only a couple of months. Instead of an expected level shift in exports by roughly 40 percent (from the pre-war level), exports displayed a recovery trajectory. Hence, what was modelled as a permanent shock in Kruk & Lvovskiy (2022), turned out to be transitory.

Figure 2. Physical Volume of Exports (index, seasonally adjusted, 2018=100).

Source: Author’s estimations based on Belstat data.

One important aspect to mention is that part of this recovery is due to oil-product exports taking place already in 2022 (Kharitonchik, 2023). In Kruk & Panasevich (2023) the authors show that the oil-refinery industry is of extreme importance for the entire Belarusian economy. Due to inter-industrial linkages, the oil-refinery industry indirectly accounts for about 11 percent of Belarus’ output, despite its modest direct contribution to the GDP (slightly more than 1 percent). Hence, due to protecting these exports (and the corresponding production of oil products), a large amount of output losses was avoided. A similar situation unfolded also for potash fertilizer exports and the chemical industry producing them (although inter-industrial linkages and effects on output are much weaker for that industry).

Besides export protection mechanisms, the recovery of exports and output stem largely from various positive and compensatory effects on output Some of them arose from Belarus’ and Russia’s respective regimes responses to sanctions, and from Russia’s readiness to support Belarus. Others are classical external positive shocks (to no degree related to sanctions) while some are a combination of both. They include: (i) increasing energy (gas) subsidies from Russia, (ii) a prolonged period of extra-high price competitiveness, especially in the Russian market, (iii) expanded access to the Russian market, (iv) other forms of Russian support (debt restructuring, budget transfers, new loans), (v) favorable trade conditions and export prices (apart from on the Russian market), (vi) a (macro)economic environment that allow for more  room for domestic economic policy interventions.

Taken together, these positive output drivers largely contributed to curbing the recession in 2022 and to the output recovery in 2023. A straightforward decomposition of the actual output growth path is unfeasible (due to the close interconnection of export protection mechanisms and output drivers, and the lack of available statistics). However, approximating the actual path in a model environment results in the following: between Q2-2021 and Q3-2022, about 12 percent of losses due to sanctions (taking into account the export protection mechanisms) and a deprivation of the Ukrainian market, and 5.2 percent of gains due to output shocks, resulted in actual output losses of 6.8 percent. Later in 2023, due to increasing effects from the export protection mechanisms, the sanctions-related output losses shrank to about 6.6 percent, while output shocks expanded output by roughly the same level. This allowed output losses to be zeroed out, i.e. the level of output in Q3-2023 was almost identical to Q3-2021.

An Economic Stalemate

Is the ‘more good than bad’ economic situation sustainable? Does the recent recovery mean that Belarus has overcome the major challenges to the economy? The short answer is no. Even with short-term thinking, there are still numerous downside risks. Sanctions still form a permanently challenging environment for the Belarusian economy, putting exports and output in jeopardy. The export protection mechanisms are not persistent, and they largely depend on Russia’s political will to support them. Moreover, the updated logistics and payment chains may also be vulnerable and sensitive to changes in the sanctions’ environment, and short-term trends in external prices. The aforementioned positive output effects are short-term by their nature and there are indications of them starting to fade already in 2023 (BEROC, 2023). Hence, even short-term projections for 2024 are challenging: the output growth is expected to weaken significantly or even fade away, while inflation spikes and financial destabilization risks are high (BEROC, 2023). Therefore, a return to a stagnant economic environment appears to be the most plausible short-term outlook.

The medium-term outlook seems even worse. According to Kruk (2023), the Belarusian macroeconomic balance (a) is very fragile, (b) is subject to numerous and huge downside risks, and (c) cannot be secured by macroeconomic policies because of the structural weaknesses in their design and the lack of room for maneuver. This means that even the existing weak long-term growth potential cannot be realized in the medium term, while the likelihood of recessions, inflation spikes and financial destabilization is high.

Re-shifting focus to a long-term and international perspective makes the viewpoint ‘more good than bad’ appear inconsistent. First, the long-term growth potential for Belarus, which was very weak even before the sanctions, keeps on worsening. This as adverse supply shocks and a deterioration of the productivity determinants continue eroding it (Kruk & Lvovskiy, 2022). Estimations of the growth potential (that rely on historical time series) are mainly within the range of 0-1 percent per annum. However, even such disappointing estimates might be optimistic bearing in mind the current political and sanctions-related risks and uncertainty (absent in the historical data). This makes stagnation the best possible long-term outlook, although it cannot be guaranteed.

Second, despite the milder recession and rapid recovery, the well-being gap between Belarus and its EU neighbors keeps on expanding (see Figure 3).

Figure 3. Well-being in Belarus vs the average among its EU neighbors (Latvia, Lithuania, Poland), 1990-2022, in percent.

Note: The GDP per capita PPP in 2017 constant international dollars is considered as well-being. The average well-being for EU Neighbors is the simple average in GDP in Latvia, Lithuania, and Poland.
Source: Author’s estimations based on World Bank data.

The average well-being in Belarus (measured in GDP per capita in constant international dollars) vs. that among its EU neighbors reached an (almost) historically low level in 2022. After attaining a level of well-being of roughly 75 percent of the average in Latvia, Lithuania, and Poland in the early 2010s, the well-being in Belarus has fall to about 52.5 percent, almost as low as in the mid-1990s. Given the economic stagnation as the most likely outlook, this means that the country will, in relative terms, keep on getting poorer in comparison to its EU neighbors.

A Political Stalemate

The hypothetical way out of the economic stalemate is more or less obvious. For instance, there is somewhat of a consensus among Belarusian economists about strengthening the long-term growth and securing macroeconomic stability (see Daneyko & Kruk, 2021; Kruk, 2023, for an overview of a collective view from a group of Belarusian economists). This vision, however, clashes with the views of the Lukashenka regime, which has inhibited its implementation throughout decades. Hence, democratic transition, or at least deprival of power of the Lukashenka regime has long appeared to be a highly likely precondition for moving away from the stalemate.

This, however, has changed in the last couple of years. The Belarusian economy’s dependence on Russia has moved from large to absolute. Prior to 2022, Russia was an important market for Belarusian exports (about 40 percent), the single energy supplier, and de facto the lender of last resort. To date, Russia’s role has expanded dramatically. The share of exports to Russia has increased up to about 65 percent. Moreover, the majority of the remaining 35 percent is exported with the assistance of or through Russia, using Russian infrastructure. Therefore, it would be fair to argue that Russia in some form “controls” roughly 90 percent of Belarusian exports. Further, being Belarus’ sole energy supplier, Russia has increased its significance for Belarus through expanded energy subsidies. The size of the energy subsidies reached a historical high in 2022, and the mechanism of the energy subsidies has become a cornerstone for macroeconomic stability in Belarus. Furthermore, Russia has turned out to be the only effective creditor for Belarus. Overall, Russia has accumulated a significant number of tools to undermine Belarus at any given moment.

A democratic transition or at least deprival of power of the Lukashenka regime might therefore not be sufficient preconditions for breaking the economic deadlock. Even if domestic political will to do so should emerge, the risk that Russia will successfully suppress it using the above outlined economic tools is very high. Hence, apart from a democratic transition, the way out of the economic stalemate requires a way out of the political stalemate. This seems to only be possible through either a politically weakened Russia, and/or an external political force, allied to the Belarusian democratic forces, and strong enough to suppress Russia.

Conclusions

Recently, the narrative on the Belarusian economy has changed. The prevailing expectations of a large and prolonged recession has been substituted by expectations of a gradual recovery. The narrative ‘the jig is up’ has somehow been crowded out by the ‘more good than bad’ viewpoint on the Belarusian economy. However, these narratives are not mutually exclusive. Behind the current ‘more good than bad’ viewpoint on the Belarusian economy, a severe economic and political deadlock prevails. Moreover, future economic and political deadlocks are the actual price being paid for the recent survival and recovery of the Belarusian economy.

From a positive perspective, the economic and political deadlock means that the country is likely to, at least, be bogged down in stagnation. Belarus’ total dependency on Russia makes the country hostage to Russia’s political preferences and country-specific risks. Should Russia decide to exert further economic and/or political influence over Belarus, it is likely to succeed. Consequently, any economic downturn faced by Russia would automatically impact Belarus.

From a normative perspective, breaking the economic and political deadlock might be the only solution, and for this, the order might matter. Prior to 2020 there was a widespread opinion that breaking the economic deadlock must be prioritized, and that it could – in turn – break the political deadlock. As of now, the tables have turned. The current order postulates the political deadlock comes first, as it seems to be the only way of breaking the economic stalemate. However, breaking the political deadlock appears to require external political will.

With these conclusions in mind, the recent Belarusian democratic forces’ manifest regarding Belarus’ EU membership aspiration, deserves attention (BDF, 2023). At first, such aspiration might appear schizophrenic given the actual political situation inside of the country. However, taking a Belarusian EU membership serious (within the EU and among Belarusians) might be the answer to Belarus’ political and economic deadlock. From this perspective, the task for the Belarusian society is thus to convince EU counterparts that this is not madness, but rather a feasible solution. It is rather evident why this solution is both desirable and feasible for the Belarusian society. The main question to be answered is therefore whether, and why it would be desirable and feasible for the EU.

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.

Risks of Russian Business Ownership in Georgia

Posted on November 27, 2023 | Policy Brief

Image of Tbilisi at night representing risks of Russian business ownership in Georgia

This policy brief addresses risks tied to Russian business ownership in Georgia. The concentration of this ownership in critical sectors such as electricity and communications makes Georgia vulnerable to risks of political influence, corruption, economic manipulation, espionage, sabotage, and sanctions evasion. To minimize these risks, it is recommended to establish a Foreign Direct Investment (FDI) screening mechanism for Russia-originating investments, acknowledge the risks in national security documents, and implement a critical infrastructure reform.

Russia exerts substantial influence over Georgia. First and foremost, Russia has annexed 20 percent of Georgia’s internationally recognized territories of Abkhazia and South Ossetia. Further, it employs a variety of hybrid methods to disrupt the Georgian society including disinformation, support for pro-Russian parties and media, trade restrictions, transportation blockades, sabotage incidents, and countless more. These tactics aim to hinder Georgia’s development, weaken the country’s statehood, and negatively affect pro-Western public sentiments (Seskuria, 2021 and Kavtaradze, 2023).

Factors that may also increase Georgia’s economic dependency on Russia concern trade relationships, remittances, increased economic activity driven by the most recent influx of Russian migrants, and private business ownership by Russian entities or citizens (Babych, 2023 and Transparency International Georgia, 2023). This policy brief assesses and systematizes the risks associated with Russian private business ownership in Georgia.

Sectoral Overview of Russian Business Ovnership

Russian business ownership is significant in Georgia. Recent research from the Institute for Development of Freedom of Information (IDFI) has addressed Russian capital accumulation across eight sectors of the Georgian economy: electricity, oil and gas, communications, banking, mining and mineral waters, construction, tourism, and transportation. Of the eight sectors considered by IDFI, Russian business ownership is most visible in Georgia’s electricity sector, followed by oil and natural gas, communications, and mining and mineral waters industries. In the remaining four sectors considered by IDFI, a low to non-existent level of influence was observed (IDFI, 2023).

Figure 1. Overview of Russian Ownership in the Georgian Economy as of June 2023.

Source: IDFI, 2023.

There are several reasons for concern regarding the concentration and distribution of Russian business ownership in the Georgian economy.

First, it is crucial to keep Russia’s history as a hostile state actor in mind. Foreign business ownership is not a threat in itself; However, it may pose a threat if businesses are under control or influence of a state that is hostile to the country in question (see Larson and Marchik, 2006). Business ownership has been a powerful tool for the Kremlin, allowing Russia to influence various countries and raising concerns that such type of foreign ownership might negatively affect national security of the host country (Conley et al., 2016). Similar concerns have become imperative amidst Russia’s full-scale war in Ukraine (as, for instance, reflected in Guidance of the European Commission to member states concerning Russian foreign acquisitions).

Further, Russian business ownership in Georgia is particularly threatening due to the ownership concentration within sectors of critical significance for the overall security and economic resilience of the country. While there is no definition of critical infrastructure or related sectors in Georgia, at least two sectors (energy and communications) correspond to critical sectors, according to international standards (see for instance the list of critical infrastructure sectors for the European Union, Germany, Canada and Australia). Such sectors are inherently susceptible to a range of internal and external threats (a description of threats related to critical infrastructure can be found here). Intentional disruptions to critical infrastructure operations might initiate a chain reaction and paralyze the supply of essential services. This can, in turn, trigger major threats to the social, economic, and ecological security and the defense capacity of a state.

Georgia’s Exposure to Risks

Identifying and assessing the specific dimensions of Georgia’s exposure to risks related to Russian business ownership provides a useful foundation for designing policy responses. This brief identifies six distinct threats in this regard.

Political Influence

Russia’s business and political interests are closely intertwined, making it challenging to differentiate their respective motives. This interconnectedness can act as a channel for exerting political influence in Georgia. Russians that have ownership stakes in Georgian industries (e.g. within electricity, communications, oil and gas, mining and mineral waters) have political ties with the Russian ruling elite facing Western sanctions, or are facing sanctions themselves. For instance, Mikhail Fridman, who owns up to 50 percent of the mineral water company IDS Borjomi, is sanctioned for supporting Russia’s war in Ukraine. Such interlacing raises concerns about indirect Russian influence in Georgia, potentially undermining Georgia’s Western aspirations.

Export of Corrupt Practices

The presence of notable Russian businesses in Georgia poses a significant threat in terms of it nurturing corrupt practices. Concerns include “revolving door” incidents (movement of upper-level public officials into high-level private-sector jobs, or vice versa), tax evasion, and exploitation of the public procurement system.  For instance, Transparency International Georgia (2023) identified a “revolving door” incident concerning the Russian company Inter RAO Georgia LLC, involved in electricity trading, and its regulator, the Georgian state-owned Electricity Market Operator JSC (ESCO). One day after Inter RAO Georgia LLC was registered, the director of ESCO took a managerial position within Inter RAO Georgia LLC. Furthermore, tax evasion inquiries involving Russian-owned companies have been documented in the region, particularly in Armenia, further highlighting corruption risks. We argue that such corrupt practices might harm the business environment and deter future international investments.

Economic Manipulation

A heavy concentration of foreign ownership in critical sectors like energy and telecommunications, also poses a risk of manipulation of economic instruments such as prices. The significant Russian ownership in Armenia’s gas distribution network exemplifies this threat. In fact, Russia utilized a price manipulation strategy for gas prices when Armenia declared its EU aspirations. Prices were then reduced after Armenia joined the Eurasian Economic Union (Terzyan, 2018).

Espionage

Russian-owned businesses within Georgia’s critical sectors also pose espionage risks, including economic and cyber espionage. Owners of such businesses may transfer sensitive information to Russian intelligence agencies, potentially undermining critical infrastructure operations. As an example, in 2022, a Swedish business owner in electronic trading and former Russian resident, was indicted with transferring secret economic information to Russia. Russian cyber-espionage is also known to be used for worldwide disinformation campaigns impacting public opinion and election results, compromising democratic processes.

Sabotage

The presence of Russian-owned businesses in Georgia raises the risk of sabotage and incapacitation of critical assets. Russia has a history of using sabotage to harm other countries, such as when they disrupted Georgia’s energy supply in 2006 and the recent Kakhovka Dam destruction in Ukraine (which had far-reaching consequences, incurring environmental damages, and posing a threat to nuclear plants). These incidents demonstrate the risk of cascading effects, potentially affecting power supply, businesses, and locations strategically important to Georgia’s security.

Sanctions and Sanction Evasion

Russian-owned businesses in Georgia face risks due to Western sanctions as they could be targeted by sanctions or used to evade them. Recent cases, like with IDS Borjomi (as previously outlined) and VTB Bank Georgia – companies affected by Western sanctions given their Russian connections – highlight Georgia’s economic vulnerability in this regard. Industries where these businesses operate play a significant role in Georgia’s economy and job market, and instabilities within such sectors could entail social and political concerns. There’s also a risk that these businesses could help Russia bypass sanctions and gain access to sensitive goods and technologies, going against Georgia’s support for international sanctions against Russia. It is crucial to prevent such sanctions-associated risks for the Georgian economy.

Assessing the Risks

To operationalize the above detailed risks, we conducted interviews with Georgian field experts within security, economics, and energy. The risk assessment highlights political influence through Russian ownership in Georgian businesses as the foremost concern, followed by risks of corruption, risks related to sanctions, espionage, economic manipulation, and sabotage. We asked the experts to assess the severity level for each identified risk and notably, all identified risks carry a high severity level.

Recommendations

Considering the concerns detailed in the previous sections, we argue that Russia poses a threat in the Georgian context. Given the scale and concentration of Russian ownership within critical sectors and infrastructure, a dedicated policy regime might be required to improve regulation and minimize the associated risks. Three recommendations could be efficient in this regard, as outlined below.

Study the Impact of Adopting a Foreign Direct Investment Screening Mechanism

To effectively address ownership-related threats, it’s essential to modify existing investment policies. One approach is to introduce a FDI screening mechanism with specific functionalities. Several jurisdictions implement mechanisms with similar features (see a recent report by UNCTAD for further details). Usually, such mechanisms target FDI’s that have security implications. A dedicated screening authority overviews investment that might be of concern for national security and after assessment, an investment might be approved or suspended. In Georgia, a key consideration for designing such tool includes whether it should selectively target investments from countries like Russia or apply to all incoming FDI. Additionally, there’s a choice between screening all investments or focusing on those concerning critical sectors and infrastructure. Evaluating the investment volume, possibly screening only FDI’s exceeding a predefined monetary value, is also a vital aspect to consider. However, it’s important to acknowledge that FDI screening mechanisms are costly. Therefore, this brief suggests a thorough cost and benefit analysis prior to implementing a FDI screening regime in Georgia.

Consider Russian Ownership-related Threats in the National Security Documents

Several national-level documents address security policy in Georgia, with the National Security Concept – outlining security directions – being a foundational one. Currently, these concepts do not specifically address Russian business ownership-related threats. When designing an FDI screening mechanism, however, acknowledging various risks related to Russian business ownership must be aligned with fundamental national security documents.

Foster the Adoption of a Critical Infrastructural Reform

To successfully implement a FDI screening mechanism unified, nationwide agreement on the legal foundations for identifying and safeguarding critical infrastructure is needed. The current concept for critical infrastructure reform in Georgia envisages a definition of critical infrastructure and an implementation of an FDI screening mechanism. We therefore recommend implementing this reform in the country.

Conclusion

This policy brief has identified six distinct risks related to Russian business ownership in several sectors of the Georgian economy, such as energy, communications, oil and natural gas, and mining and mineral waters. Even though Georgia does not have a unified definition of critical infrastructure, assets concentrated in these sectors are regarded as critical according to international standards. Considering Russia’s track record of hostility and bearing in mind threats related to foreign business ownership by malign states, this brief suggests regulating Russian business ownership in Georgia by introducing a FDI screening instrument. To operationalize this recommendation, it is further recommended to consider Russian business ownership-related threats in Georgia’s fundamental security documents and to foster critical infrastructural reform in the country.

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 Data Warfare

Posted on April 18, 2023 | Policy Brief

20230417 Russian Data Warfare Image 01

After Russia’s invasion of Ukraine in February 2022, a broad spectrum of previously publicly available statistics on economic indicators has been removed from the public eye. This reduced transparency affects any analysis of the state of the Russian economy and assessments of the effects of sanctions. The strategy is also part of a larger disinformation campaign that has become an integral part of Russia’s war on Ukraine. In this brief we provide a short overview of the main indicators on economic activity that have been masked in various forms by Russia’s data producing institutions. We also touch upon some alternative strategies, employed to gain a better understanding of the actual state of the Russian economy while official data is unavailable or unreliable.

Following Russia’s war on Ukraine, Russia has ceased to publish large amounts of previously publicly available statistics on economic indicators. This reduced transparency affects any attempts to analyze the Russian economy with regular data and models, and is an integral part of the information war that has followed Russia’s aggression. In particular, it aims to reduce or obscure the analysis of the effects of sanctions that have been imposed on Russia by Ukraine’s partners. The reduced precision of this analysis is then used in various propaganda channels to claim that sanctions are useless and that they are, instead of hurting Russia, harming the EU, the US and other sanctions implementing countries.

In this brief we present a short overview of some of the most important statistics on Russia’s economic performance no longer publicly available (with a detailed list to be found in the Online Appendix). We also discuss some alternative measures to track the Russian economy which can be used to provide more accurate assessments of the effect of sanctions and thus reduce the impact of Russia’s data warfare.

What Data is Being Masked?

Russia’s cessation of statistical publications has occurred across several dimensions including foreign trade, budget, and finance.  Most notably, data has been masked by the Central Bank of the Russian Federation (CBR), the Ministry of Finance of the Russian Federation (Ministry of Finance), the Federal State Statistics Service (Rosstat) and the Federal Customs Service of Russia.

Budget Data

Data on federal and consolidated budgets in Russia was previously easily accessible on the Ministry of Finance’s and Rosstat’s webpages.

The Ministry of Finance has however, as of January 2022, ceased publishing data on budget expenditures. This includes monthly data for a wide range of budget expenditure categories such as spending for public administration, national defense and law enforcement, environmental protection, education, healthcare, social politics, mass media and culture. This data is no longer available despite the webpage for budget expenditures being updated as late as March 17th 2023.

Data on certain budget indicators is also missing on Rosstat’s webpage. While statistics on taxes, fees and other mandatory payments are available for 2022, budget expenditures are available only for 2021. This is however not surprising given that Rosstat receives its figures on the financial sector, including figures on public finances partly from the Ministry of Finance.

Foreign Trade Data

Foreign trade statistics is normally published by the Federal Customs Service of Russia, CBR and Rosstat.

Since the invasion, the Federal Customs Service of Russia has however stopped publishing statistics on foreign trade and commodity structure. The latest available monthly data on Russian foreign trade with its main partners (the EU, Commonwealth of Independent States countries and others), and the commodity structure of exports and imports – including processed goods and oil and gas – is from January 2022 (as of April 3rd 2023).

Foreign trade data from CBR has been withheld throughout 2022. CBR has however recently resumed parts of their publications and, as of April 3rd 2023, monthly data on total export and import is available for all of 2022 as well as for January 2023. Still, these figures display total exports and imports only and are not broken down by trade partner or commodity.

Similar to CBR’s publishing pattern, figures on export and import as part of GDP by use were unavailable on Rosstat’s webpage from February 2022 and throughout the year.  As of April 7th 2023, quarterly aggregated data is however available for all of 2022.  Monthly data on export and import by country is nonetheless still available only for 2021, despite the webpage being updated in November 2022.

Financial Data

To provide information on the national finance system and its dynamics is a main tasks of any country’s central bank, with Russia being no exception. Despite this there are about 40 financial indicators that, since the beginning of 2022, are no longer available on CBR’s webpage (as of April 3rd 2023). This contravenes CBR’s calendar, which states that statistics are supposed to be published in the next reporting period, i.e. the next quarter/month for quarterly and monthly data respectively.

The most deferred data (more than 20 indicators) can be found, or rather can’t be found, in the so-called External Sector Statistics category. For example, monthly data on balance of payments, remittances and financial transactions in the private sector, and international investment position of the banking sector is missing as of January 2022. Similarly, quarterly data on foreign investments, foreign assets and liabilities in the banking sector has been unavailable since January 2022. The same goes for data on external debt of the corporate sector of the Russian Federation in the form of loans, credits and deposits raised as a result of non-resident placement of Eurobonds and other debt securities.

In the so-called Banking Sector Statistics category, data on indicators such as assets, risks, operational data, international reserves and volume of FX operations is no longer available. Furthermore, figures on turnover of the interbank spot and forward markets have also been unavailable since February 2022.

Two comments are due considering the ease of access to above mentioned data/data sources. Firstly, in order to access the CBR’s and the Federal Customs Service of Russia’s webpages, one at times needs make use of a Virtual Private Network (VPN). Secondly, there are, for all sources mentioned, large discrepancies between the Russian language and the English language webpages, with the latter being severely patchier in its information.

Hiding Data: Reasons and Implications

What drives the authorities to mask seemingly relevant figures? Alexandra Prokopenko, an expert on Russian economic policy, argues that Russian authorities mask certain numbers related to the sanctions to impede evaluations of the effect of sanctions (Prokopenko 2023). Making the data less transparent and accessible in order to hide sanctions’ effect across various sectors to try and paint a better picture of the economic activity has also been a Russian policy goals. The head of the Federal Customs Services, Vladimir Bulavin, in April 2022 announced trade statistics were masked partly to “avoid […] speculation and discrepancies in import deliveries” (Uvarchev, 2022).

In this context, it is worth mentioning that Russia is obliged to report to the International Monetary Fund (IMF) on several of the previously discussed indicators since the country is subscribing to the Special Data Dissemination Standard (SDDS) as of 2005. SDDS aims at providing transparent economic and financial data to the public and according to the IMF “Serious and persistent nonobservance of the SDDS, therefore, will be cause for action” (IMF, 2023). If Russia does not publish data according to the SDSS commitments, it could be excluded from the list of countries that subscribe to the SDSS.  This affects how the country is viewed by investors and others and will further increase the risk premia that is applied to dealing with Russia.

Further, in its efforts to restrict insight into how the Russian economy is faring following the sanctions, the authorities have however created a large uncertainty also for Russian domestic markets, adding to the sanction’s effects. For instance, Elvira Nabiullina, Russia’s Central Bank Governor, has been arguing to revoke the decision to classify large amounts of data saying that investors, analysts and researchers simply need the data to do their work properly (CBR News, 2023).

Alternative Ways of Understanding the Real State of the Russian Economy

How can we learn about the state of affairs in Russia without the previously discussed data? While deducing Russia’s budget expenditures and many financial indicators may be cumbersome, more can be done when it comes to trade data. Specifically, a BOFIT Policy Brief by Simola (2022) proxied Russia’s imports and exports by tracking the imports of Russia’s main trading partners (17 economies) between March and June 2022. Similar proxying efforts have been made by Darvas, Martins and McCaffrey (2023), who tracked Russia’s foreign trade by considering detailed trade data from China, the United States, South Korea, Japan, India, the United Kingdom, Turkey and the EU, putting together publicly available datasets which span from January 2019 to January 2023.

Proxying trade data by considering trade partner’s statistics is emphasized by Sonnenfeld et al. (2022), who not only considers such data but rather a wide variety of available and reliable data sources – emphasizing the need to also crosscheck data from official Russian statical sources with more reliable ones (for a full overview of the methodologies used, the estimated indicators on the Russian economy and the implications from this, see Sonnenfeld et al. 2022).

Other efforts to map out Russia’s economic activity consider more creative methods such as using satellite data and/or ship location (AIS) data. Examples of such efforts include a recent Bruegel dataset which tracks Russian crude oil trade (Heusaff et al., 2023) and CREA’s “Russia Fossil Tracker”. For both examples, the authors utilize the location data for individual crude oil tankers, and (for Heusaff et al. 2023) combine it with data from OPEC, BP and Eurostat, to assess monthly crude oil exports from Russia to a set of major destinations (mainly the EU, China and CIS countries).

Similarly, satellite data has been previously used to estimate carbon emissions from flaring (Böttcher et al., 2021). While there is an ongoing debate on whether flaring can be trusted to give insight into gas and oil production (World Bank, 2023), one could potentially make use of such data to get a better view of the productivity within the Russian oil and gas sector following the imposed price cap mechanism and sanctions.

The struggle of creating reliable estimates for an economy polishing or masking information did not arise with the withdrawal of certain Russian statistics. The actual status of the North Korean economy remains much of a mystery to analysts (see The Economist) as the country, in 2017, was yet to publish a Statistical Yearbook. While Russia is far from North Korea in several aspects, the reality is that the alternative measures used to estimate North Korea’s economic activity (such as making use of Chinese trade data etc.) are partly the ones now being undertaken by analysts looking beyond the figures from Kremlin.

Conclusion

Russia’s decision to stop publishing regular economic data is part of the disinformation and propaganda efforts that are integral parts of its war on Ukraine, with the purpose being to complicate any analysis of what is going on in the Russian economy. While being partially successful in this regard, the data withholding likely creates further negative implications for Russia’s external economic relations and undermines the functioning of its domestic markets.

Given the lack of data following Russia’s disinformation efforts it is essential that any analyst concerned with mapping the Russian economy not only considers alternative but also multiple sources and consult experts with a plethora of competencies. Already today, new creative ways of getting hold of relevant data is providing increasing insight into the state of the Russian economy. With continued efforts, these measures will progress over time, improving our understanding of how sanctions affect the Russian economy.

Online Appendix

An overview of all indicators discussed in this brief can be found in the Online Appendix. The information in the Appendix is valid as of April 7th 2023.

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.

Georgian Economy and One Year of Russia’s War in Ukraine: Trends and Risks

Posted on March 13, 2023 | News

20230228 Georgian economy and one year of Russia Image 01

Russia’s invasion of Ukraine profoundly impacted the global economy, immediately sending shockwaves across the globe. The attack of a country that was once a major energy supplier to Europe on the country which was one of the top food exporters in the world, sent food and fuel prices spiralling, causing major energy shortages and the prospect of protracted recession in the United States and the European Union.

The unprovoked and brutal aggression resulted in nearly universal condemnation and widespread sanctions placed on Russia by the United States, the EU, and other Western allies. Financial sanctions were perhaps the most unexpected and significant with the potential for immediate impact on Russia’s neighbours, including those that did not formally join the sanctions regime. In addition to sanctions, the major consequence of the war was mass migration waves, particularly from Ukraine, but also from Russia and Belarus to neighbouring countries.

At the start of the war, it was expected that the Georgian economy would be severely and negatively impacted for the following reasons:

  • First, as a former Soviet republic, Georgia historically maintained close economic trade ties with both Russia and Ukraine. The ties with Russia have weakened considerably in the wake of the 2008 Russo-Georgian war but remained significant. Russia was the primary market for imports of staple foods into Georgia, such as wheat flour, maize, buckwheat, edible oils, etc. Russia and Ukraine were both important export markets for Georgia. Russia was absorbing about 60 percent of Georgian wine exports and 47 percent of mineral water exports, while Ukraine was one of the leading importers of alcohol and spirits from Georgia (46 percent of Georgia’s exports). Tourism and remittances are other areas where Georgia is significantly tied to Russia and somewhat weaker to Ukraine. Before the pandemic, in 2019 Russia accounted for 24 percent of all tourism revenues, while Ukraine for 6 percent. Remittances from Russia accounted for 16.5 percent of total incoming transfers in 2021.
  • Second, while the Georgian government chose to largely keep a neutral stance on the war (announcing at one point that they would not join or impose sanctions against Russia), the main financial and trade international sanctions were still in effect in Georgia due to international obligations and close business ties with the West. These factors were reinforced by strong support for Ukraine among the Georgian population, where the memory of the Russian invasion of Georgia in 2008 remains uppermost.
  • In addition, Georgia is a net energy importer, and while the dependence on energy imports from Russia is not significant, the rising prices would have affected Georgia profoundly.

Original publication: This policy paper was originally published in the ISET Policy Institute Policy Briefs section by Yaroslava Babych, Lead Economist of ISET Policy Institute. To read the full policy paper, please visit the website of ISET-PI. 

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 Belarusian Currency Market During War in Ukraine: Hidden Problems and New Trends

Posted on December 5, 2022 | Policy Brief

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Belarus has faced unprecedented sanctions during the last year and the new economic conditions have led to a GDP decline and inflation growth. At the same time, the situation on the currency market has been stable since April 2022. The Belarusian Ruble demonstrated a gradual appreciation to the US Dollar and the Euro and a decline to the Russian Ruble. The appreciation of the Belarusian Ruble against the US Dollar has given households the illusion that the economic situation is not that bad. This brief analyses the main factors of the current situation on the currency market as well as describes the challenges which might destabilise the market. The importance of changing selected currencies in the currency basket and the start of a reorientation of the Belarusian economy from Western to Eastern partnerships, are also described.

The National Bank of the Republic of Belarus’ Policy on the Currency Market

In Belarus, currency has always played an important role as an indicator of economic stability. Household’s reactions to sharp fluctuations of the Belarusian Ruble have been expressed in an immediate demand growth for foreign currency (US Dollar and Euro mostly). After the war in Ukraine started and the exchange rate of the Belarusian Ruble began declining, people tried to make currency deposits from banks and buy foreign currency. In contrast to the Central Bank of Russia, the National Bank of the Republic of Belarus (NBRB) introduced no restrictions on the currency market. However, Belarusian financial institutions imposed their own limits on carrying out non-cash exchange operations, cash withdrawals from ATMs and from bank accounts. Financial institutions also limited the availability of currencies in exchange offices and imposed limits on payment transactions by credit card outside of Belarus. All these processes took place under the condition of a sharp devaluation of the Russian Ruble.

The dynamics in the Russian Ruble have affected the Belarusian Ruble fluctuation (see Figure 1). The correlation between the currencies was strong even before the war, given that the Russian Federation is a dominant economic partner for Belarus, and has since become stronger.

The share of Russian Ruble in the Belarusian currency basket is at 50 percent. Moreover, in Q1-Q3 2022 the Belarusian dependency on the Russian economy increased in the aftermath of losing the Ukrainian market and facing European export shortages. Between January and August 2022, the share of export of goods to CIS countries (where the main share of exports goes to Russia) was 65,7 percent, as compared to 58,4 percent for the corresponding months in 2021. The same tendencies are apparent when considering the import of goods. The share of import from CIS countries reached 64,7 percent between January and August in 2022, as compared to 61,3 percent for January-August in 2021 (BSCBR, 2022).

Figure 1. The weighted average exchange rate of the Belarusian Ruble, in Belarusian Rubles.

Source: Statistical Bulletin #9 (279) 2022.

Sanctions and the Russian Central Bank’s policy have led to a stabilisation on the Russian currency market. The Central Bank of Russia has introduced restrictions on capital outflow from the country, limited cash withdrawals from bank accounts and foreign currency purchases in exchange offices (Tinkoff, 2022). The cancelation of budget rule has further supported the Russian Ruble exchange rate. But the main reason for the Russian currency exchange rate reversal post March 2022, relates to the situation regarding foreign trade. Due to sanctions, imports had significantly decreased. At the same time, high energy prices allowed for export growth. Between January and June 2022 Russia displayed a high positive trade balance (169,62 billion USD), the largest in the last 7 years (CBR, 2022). As a result of sanctions, the Central Bank of Russia started to prepare the market to work with currencies of friendly countries.

Similar tendencies can be seen in Belarus. NBRB has changed the composition of the foreign currency trade to turn the Belarusian economy from a Western to an Eastern direction regarding economic cooperation. In July 2022 the Chinese Yen was included in the currency basket. At the same time the share of Russian Ruble was at 50 percent, the US Dollar at 30 percent, the Euro at 10 percent and the Chinese Yen at 10 percent. In August 2022, the NBRB began to define daily exchange rates for the Vietnamese Dong, Brazilian Real, Indian Rupee and UAE Dirham. Finally, since October 2022, the exchange rate for the Qatari Riyal has been defined on a monthly basis (The National Bank of Belarus, 2022). These changes are indicators of ongoing and planned structural changes to the economy to accommodate increased cooperation with the Eastern economies.

Currency Market Stabilisation and Current Risks

The Belarusian Ruble has not repeated the fluctuation of the Russian currency. It did however copy its tendency to appreciate to the US Dollar and the Euro, as of April 2022. Besides the appreciation of the Russian Ruble and personal bank’s restrictions on national currency markets, the stabilisation of the Belarusian Ruble can be explained by the positive trade balance. In contrast to Russia, the growth of net export in Belarus was due to a faster decline of imports than exports. There are several reasons why this can be a problem for currency market stabilisation in the future.

First, Belarus’ foreign trade has become more and more oriented toward the Russian market. If the main trade partner experiences difficulties (for example, oil price caps) this could lead to a devaluation of the Russian Ruble and, as a result, declining competitiveness of Belarusian goods on the Russian market.

Second, reorientation of Belarusian exports from Western to Eastern countries require time and additional financial resources and exports are not always profitable due to high logistical costs. Any additional sanctions may further limit such opportunities.

Third, main export-oriented services, such as the Transport and ICT sectors, are affected by sanctions and their consequences. In Q3 2022, the transport turnover was equal to 68,3 percent, as compared to the same period 2021. The ICT sector is still having a positive impact on GDP growth. However, in January-September 2021 the positive contribution from this sector to the Belarusian GDP was 0,9 percent, while it between January and September 2022 was only 0,2 percent.

Recent success in foreign trade is mostly due to the continuation of selling potash, nitrogen fertilisers and other products on the global market, a strong Russian Ruble and Russian market openness towards Belarusian companies, low levels of Belarusian imports, and cheap Russian gas (the special price for Belarus is 128 US Dollars for 1000 cubic meters). If the terms of trade with Russia worsen and key export-oriented industries suffer from sanctions and reputational risks, the currency market could however be destabilised.

Another problem for the Belarusian Ruble stability in the middle and long term is related to household behaviour. In January-August 2022 Belarusians sold more foreign currency than they bought. Despite the Ruble fluctuation, the high levels of net sales in March was due to bank restrictions. In June, the net purchase was related to seasonal factors (see Figure 2). For the other months of the period the net selling can be explained by a stable situation on the currency market and real incomes declining. People sold currency in an attempt to maintain their previous standards of living.

Figure 2. Balance of purchase and sale of foreign currency by households (+ “net purchase”, – “net sale”), mln. USD.

Source: Based on data from the National Bank of Belarus.

In September-October 2022 Belarusian households bought more than (an equivalent of) 300 mln. USD on net basis, primarily in USD or Euro, which is very unusual for the Belarusian market situation. There are several possible explanations for such behaviour:

  1. Despite difficulties with obtaining visas Belarusians are going to Poland and other European countries to shop. Because of sanctions, retaliatory sanctions as well as a high price control on the domestic market, the range of goods has shrunk, and prices have risen. In European countries Belarusians can purchase much cheaper goods both for personal use and for resale.
  2. Partial mobilisation in Russia has increased the uncertainty of further political steps in Belarus. Households thus purchase foreign currency to establish an extra safety cushion.
  3. In Q3 2022 there was a net cash outflow on international remittances, for the first time since 2017. Traditionally, Belarus has seen a net inflow of foreign remittances. In 2022 Belarusian banks were switched off from the SWIFT system which incurred problems with operations in foreign currencies for banks under sanctions. As a result, cash inflow has declined (see Figure 3). Cash outflows however remained on the same level as in previous years. This can be explained by high-level specialists and people employed within ICT leaving the country. During relocation people have sold apartments and cars and exchanged accumulated incomes from Belarusian Rubles to US Dollars or Euros and sent to foreign bank accounts (even under the conditions of facing difficulties with conducting money transfers).

Figure 3. Net cash inflow (+)/ outflow (-) for international remittances, USD mln.

Source: Based on data from the National Bank of Belarus.

Maintaining the trend of net currency purchase together with possible trade balance deterioration may exacerbate the situation on the domestic currency market. Another risk to the currency market stability is posed by the insufficient size of FX reserves (in the amount of less than 3 months of import). Moreover, the 900 mln. US Dollars in reserves, given by the IMF in 2021 as support to fight Covid-19, can’t be used as this financial support is given in the form of SDR (Special Drawing Rights), and the exchange of SDR to US Dollars or other currencies is challenging due to sanctions (Congress, 2022).

At the same time, the Government’s decision to make external debt payments in Belarusian Rubles supports the FX reserves level. It has also been decided that payments on Eurobonds to the Nordic Investment Bank, the European Bank of Reconstruction and Development and the International Bank of Reconstruction and Development are to be paid in Rubles. These decisions have decreased the country’s long-term rating on foreign liabilities to the Restricted Default level. In that sense, short-term gains can lead to significant financial losses in the long term. In the future it will be necessary not only to pay outstanding debts but also to improve Belarus’ reputation on the international financial market. Today, the Russian Federation is the main investor in the Belarusian economy. But since its support is limited, it is likely to be insufficient for the safe functioning of the Belarusian economy.

Conclusion

The stability of the Belarusian currency market is not the result of economic success, but rather a reflection of the tightening of the economy. The appreciation of the Belarusian Ruble to the US Dollar and Euro has taken place during an accelerated reduction in Belarusian imports. At the same time the weakness of the Belarusian currency to the Russian Ruble entails competitiveness of Belarusian products on the Russian market. Foreign exchange reserves, although insufficient, have maintained in size due to the low demand for foreign currency and foreign debt payments in Belarusian Rubles. Disruptions to economic and political relations with Western countries stimulates the Belarusian authorities to reorient the economy towards Eastern partners, which has led to a modification of the currency basket composition. In the long run, the current stability of the Belarusian currency can quickly disappear in case one or several risks are realised. If the Russian Ruble devaluates or trade balance deteriorates and demand for foreign currency increases, the stability of the Belarusian Ruble exchange rate can be ruined.

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.