After almost five months of war, its economic consequences have become «normal» for Russians: McDonald's is now called something else. The automobile industry has almost come to a halt, the crisis is spilling over into other industries, the credit market is in a state of collapse, and the construction sector is on the verge of collapse - but for now few people are worried - the main thing is that no «mobilization» has been declared. Russia has never really made the transition to a military-mobilization economy which is why life in many ways is like before the war, but it's a deceptive perception, says economist Valery Kizilov. Practice shows that people in Russia are able to put up with such a situation for decades, so the «smooth crisis» may only be resolved if the US and the Persian Gulf countries agree to sharply increase oil production.
In July 2022, Russia's economic situation continues to deteriorate. However, it is far from being as bad as one would have expected four months ago. Russia still exports significant amounts of oil and gas. The revenues from them go into the federal budget and make it surplus. Therefore, the government has no need to print money or a build a debt pyramid.
Ordinary citizens and businessmen in general are well aware of it, which is why the panic level is minimal. The Putin government and the Central Bank see that the people do not panic and cancel the emergency measures introduced at the beginning of the war. Market supply and market prices have been preserved in almost every place where they existed. Consumption is not rationed, no centralized redistribution of resource flows in favor of «priority» needs is practiced. Nationalization of «wrongly» operating enterprises is almost non-existent. Most of those who have money can travel abroad and move their financial assets there (in accordance with Elvira Nabiullina's decision of June 30, the limit on such movements of funds is a million dollars a month). But that opportunity is not used by everyone, and not in full. Those who want to buy foreign currency can do so practically without any problems, and it is cheaper than before the war.
The growth of prices has actually stopped after the sharp upsurge. According to official statistics, inflation was 11% from the beginning of the year to mid-April, and the same 11-12% from the beginning of the year to July 1. There's been no nationwide increase in the unemployment rate either. No high-profile insolvencies or bankruptcies have been announced. Coca-Cola is still on the shelves. There is no disappearance of sugar, salt, buckwheat or rice; the prices just went up by 20-30%, as they should have in a depressed market economy. McDonald's is gone, but Burger King and KFC remain.
There's been no nationwide increase in the unemployment rate. Coca-Cola is still on the shelves, as are sugar and buckwheat
The official explanation of this picture is that the Russian economy has turned out to be stronger and more stable, and society is more united and far-sighted than in the West. Supposedly, the G7 countries and the like hardly matter to Russia, while China, India, Turkey, and Saudi Arabia, with which Russia maintains a partnership or at least a mutual understanding and which are de facto neutral, are truly important. Western sanctions hurt the West itself more than they hurt Russia, and if they are expanded, it will only get worse. That is why Russia can remain stable and go to war for 10 years, like the USSR did in Afghanistan or like Iraq and Iran did in the 1980s.
Just a factory shutdown
But something does not fit. Official information on industrial production in January-May 2022 shows a sharp drop in many industries. The worst situation is with car manufacturers: in May their output was only 3.3% of what it was a year earlier. In essence, this means that all automobile plants have stopped. Production of locomotives, freight cars, internal combustion engines, electric motors, buses weighing 5 tons or more, refrigerators, televisions, washing machines, fiber optic cables and certain types of glass has also decreased by more than 50%. Production of trucks, passenger cars, pumps, elevators and bakery equipment fell by more than 30%.
This is the picture of the last month. If we consider the whole period from January to May, then compared to the same period in 2021 the decline by more than 50% occurred only in passenger cars and a decline of more than 30% - in heavy buses, electric motors, elevators and refrigerators. Thus, according to the May results the crisis in some segments of the manufacturing industry has aggravated. The reasons, of course, are the rupture of international economic ties and the loss of access to foreign technologies and components.
For a more complete picture, it is worthwhile to name the types of production which show the most prominent positive trends. Forge-and-press machines have seen twofold growth. Radar, radio navigation and remote-control equipment rose by 59% over five months and almost tripled in May. However, the output for this sector is given in rubles, not in the number of items, so it is not clear how much the increase in prices has contributed to the growth. Next, semiconductor devices and parts thereof increased by more than 40%. Canned meat, cereals, work clothes, suitcases, doors, certain types of glass, concrete, tractors, electric locomotives, pleasure and sport boats - all those items saw a 20% or higher increase in production over five months. The official rate of industrial production in January-May saw an overall increase of 2.8%. However, the failures in a number of important sectors cannot be hidden behind the end result.
Just a credit collapse
What happened in the mortgage market is also not in line with the optimistic picture. In April-May 2021 150,000-190,000 mortgage loans were issued Russia monthly. But only 49,000 in April 2022, and less than 37,000 in May 2022. That is, four times less. The volume of issued mortgage loans decreased slightly less - by about 3 times, because the average loan amount was 2.9 million rubles a year ago and now it's 3.8 million. The total amount of mortgage loans was 434 billion rubles in May 2021, and only 140 billion in May 2022.
Four times less mortgage loans issued in Russia in the spring of 2022 than in the same period of the previous year
There are no official data on mortgage volumes for June from the Central Bank, but the results of Frank RG monitoring are available. They show that lending revived significantly in June compared to May, and not only in terms of mortgage. However, if we compare it with June 2021 rather than the May 2022 failure, the feeling of collapse returns. According to Frank RG, 251.5 billion rubles in mortgage loans was issued in June 2022, versus 551.4 billion a year before. The number of home loans issued was 68,000, compared to nearly 179,000 issued in June of the previous year. In other words, if in April and May the volume of mortgage loans was 3-4 times lower than usual, then in June it was 2-2.5 times lower. No doubt such dynamics would be called «the collapse of the mortgage market» in peacetime, and, along with the «collapse of the automobile industry» it would be the main economic concern.
If we look beyond mortgages, and consider all bank loans to the Russian population, their volume was 675 billion rubles in June 2022, and 1,288 billion rubles in June of the previous year according to Frank RG. Also a two times decrease that is being observed for the fourth month in a row since March.
The last months of the construction boom
Recognizing that mortgage lending has collapsed, we need to think about how this might affect housing construction. Less credit means less income and opportunity for developers. And that means fewer new construction projects and more problems with the successful completion of those already underway. And the writing on the wall is clear. The relevant State Duma committee reports that «since the end of last year, the number of problematic new construction projects has almost doubled. Mishustin's government recognized frozen and delayed construction projects as a serious problem, so much so that on July 11 they decided to create a special federal register for such projects. Month after month, the actual volume of commissioned housing in Russia has been steadily declining month-over-month since January 2022 (from 10.3 million square meters in January to 6.9 million in May).
The graph shows that the decrease has a significant seasonal component - the April and May volumes had always been lower than in March. One can also see that in each month of 2022 much more housing was commissioned than in the corresponding period of the previous year. But 84% more in February 2022 than in February 2021, and only 38% more in May 2022 than in May 2021. When the June data is released, one of the two trends should disappear. If the month-over-month decline does not stop, but the June 2022 commissioned housing volume is lower than a year before. In other words, in late 2021 and early 2022, Russia's construction sector was experiencing a tremendous boom, fueled by government subsidization of soft mortgages. Now those subsidies are still in place, but there are fewer signs of a boom. It would be logical to expect that by the end of June a downturn in housing construction will have been registered.
It would be logical to expect a recession in housing construction by the end of June
But the «commissioned housing» indicator is very inertial, and its values for the spring and summer months of 2022 reflect the completion of construction projects launched before February 24. So what will we see when it comes to the commissioning of projects launched after the fateful date? How many are there? How many investors are there who are willing to make long-term investments in Russia at this point? The Ministry of Economic Development expects capital investment to fall by 19.4% in 2022, while other experts predict a 10% to 37% decline. We already know that mortgage lending has dropped several times over since the war began, despite the new wave of government incentives and subsidies. So what will happen next? In particular, what will happen to the Russian metallurgy, given the sharp decline in the production of passenger cars and railway cars and a very likely decline in construction?
A little less than a month ago, NLMK made public its forecast that Russian steel production would decrease by 15% in 2022 and even by 26% in the second half of the year. At the Magnitogorsk Iron and Steel Works, according to TASS and other sources, two blast furnaces out of eight have already been shut down, and iron production has fallen by 30%. Severstal's CEO claimed on June 17 that the combine is forced to put on idle 20-25% of its capacity. The Government does not seem to believe very much that the business of the steel magnates is really suffering. After all, metallurgical companies have all been lobbying for cancellation of additional taxes, the excise tax on steel, and the increased mineral extraction tax on ore introduced since the beginning of the year in order to «confiscate excess profits». Why can't they pretend to be victims and exaggerate their losses? But personally, I'd rather believe in the suffering of domestic Krupps than join the government's optimism. Confiscating companies' profits just because they were too large was a bad idea in the first place.
Rotting or exploding?
So, in a number of important industries, including automotive and personal loans, both demand and supply have been declining simultaneously and sharply. Volumes shrink, and therefore demand also shrinks in related industries such as construction or metallurgy. At the same time, private investment has dried up, and likely for a long time, so it's not clear when production might rebound. All of this is a full-blown economic crisis, and crises of such magnitude always have political repercussions in several areas at once.
On the one hand, the political reaction to an economic crisis often exacerbates it and becomes an even greater source of anxiety than the original problem. In March and early April it seemed that this was what was happening in Russia, that it was heading towards a reality without a convertible ruble, a stock exchange system, and maybe even without entrepreneurship and market prices for vital and strategic goods. Then there was a partial normalization. Russia never transitioned to a military-mobilization economy, and without such a transition it was possible to maintain a life largely similar to the pre-war one. Yes, the economy is in crisis again and it is not clear when there will be a recovery, but we have been living this way since 2008, for almost 14 years now.
Russia never transitioned to a military-mobilization economy, and without such a transition it was possible to maintain a life largely similar to the pre-war one
On the other hand, economic downturns, especially deep and prolonged ones, provoke a search for those responsible and the punishment of the guilty, and some kind of action, symbolic or real, but definitely visible, which should give hope for renewal. And all of this, of course, must become a subject of a fierce political struggle.
The current crisis has a number of very peculiar features. At the level of the highest Russian authorities, it cannot be called an outright crisis, and the official view is that the economies of the opposing countries are suffering much more. In this sense, the regime has returned to the stagnant rhetorical models of the late 1970s and early 1980s, and it will very soon begin to instill a suffocating sense of unbearable all-pervasive lies. As then, we will increasingly feel that economic development is impossible without private initiative and private investment, without key decisions being made by forward-thinking private owners. But the current political situation prevents this from happening, and the most probable scenario is a slow rot with a ten percent annual drop in national income until the country's new leadership takes over.
Could this process be accelerated to the point where we're no longer talking about a slow rot, but a rapid collapse of the system? It is possible, but such acceleration requires an additional «catalyst» which is not currently available. This could be an «outbreak of madness» on the part of the authorities, a «sudden outrage» of the masses, or a «cunning move» by the regime's foreign opponents. Or, the least likely but the most favorable possibility for the country - normalization through a coup d'etat.
What an «outbreak of madness» could look like is fairly easy to imagine. Escalation, mobilization, opening a new front, stepping up the fight against internal enemies, reducing those types of economic activity that the government does not need, removing the remaining «bourgeois specialists» from important positions, or anything similar in the spirit of the March experiments. However, right now Putin and his entourage seem to believe that time is on their side, and they are not planning anything of the kind.
As for the limits of patience of ordinary citizens, on the one hand, they have not been really tested yet. People accustomed to false patriotic rhetoric can remain silent for decades. On the other hand, the economic expectations of ordinary people have been increasingly at odds with reality, and this is really fraught with the risk of an explosion.
Former partners in search of a lockpick
And then there are the «cunning moves» by external forces that can, in principle, undermine the very structure where the economy and society are degrading, but the constant inflow of petrodollars allows the Russian authorities to confidently maintain fiscal and financial stability. Such a move could be an agreement between the U.S. and the Persian Gulf countries, under which the latter would significantly increase oil production. Or the liberalization, contrary to the demands of the Greens, of the developed countries' own fossil fuel development. All this could lower the world oil and gas prices, but the political obstacles to such decisions are still too great. Moreover, for reasons that are not very clear, Western politicians have so far been suppressing rather than welcoming capital flight from Russia.
For reasons that are not very clear, Western politicians have so far been suppressing rather than welcoming capital flight from Russia
On the other hand, the G7 leaders have generally agreed upon a different plan: to form a cartel of Russian oil buyers, which would impose a considerable price cut on the oil suppliers. That decision was quite expected. Its effectiveness, however, is by no means guaranteed, and an interesting article by analyst Sergei Vakulenko shows that the idea of a purchasing cartel with a price cap may not work.
«This idea,» Vakulenko writes, «is based on the assumption that Russia would prefer to earn at least some revenue, as long as it exceeded marginal production costs and brought at least some profit, rather than leave the oil market and give up earnings altogether. This would indeed be a rational approach if the game lasted only one move. But Russia is a strategic player, and it does not really need currency that it has nothing to spend on. Therefore, Moscow could «expose the West's bluff» and declare it would not export oil at all at a price below some fairly high level. And then it would «just have to wait for the renegades from the purchasing cartel to come knocking at its door.»
Here the assumption is that «Russia has more resilience than some oil-importing countries,» which therefore «will be first to waver.» But this is more of an intuitive judgment than one supported by conclusive evidence. An intuition gravitating toward the opposite conclusion is just as good.
Without money, Russia is very difficult to rule. Nicholas II learned that well during World War I, as did the Provisional Government, Gorbachev, and Yeltsin after him. Putin, on the other hand, had always had a lot of money throughout the 22 years of his reign, which has been the basis of all his successes. That's why the suggestion that he might give up money for strategic reasons and still survive for a while on some kind of non-financial «stability» sounds strange. In Russia, the phrase «there's no money, but you hang in there» sounds like a paragon of absurdity to oppositionists and loyalists alike. In such conditions, can the system remain solid without oil revenues?