Fortress Russia: Understanding Putin’s efforts to sanction-proof his economy

By Veronica Carrion
ABA Data Bank

Following Russia’s invasion of Ukraine in February, the United States and other NATO nations took steps to degrade the economy of the Russian Federation through various financial sanctions. As of May 2022, the United States has sanctioned new investment in Russia and several of its most critical state-owned enterprises and banks. Additionally, Russia is prevented from making debt payments with funds subject to U.S. jurisdiction, and Russian government officials and their family members have been sanctioned.

Figure 1. (Click image to enlarge.)

While Russia’s economic activity has decelerated as a result, the country is no stranger to Western sanctions, as Elina Ribakova of the Institute for International Finance pointed out in a recent lecture. Those implemented in 2014 following Russia’s annexation of the Crimea Peninsula of Eastern Ukraine caused a flight of foreign and domestic capital. While the capital flight issue was officially downplayed, it had a significant negative effect on Russian businesses.

However, over the past eight years, President Vladimir Putin has refashioned the Russian economy into a fortress prepared to weather such external shocks. (See Figure 1.) The Russian Federation aggressively paid down external debt by over $200 billion over the past twelve years. The nation is now a net creditor on international markets. Russia has also accumulated substantial reserves since 2014, nearly $650 billion as of last January. This stockpile can cover the government’s balance sheet and support the ruble.

Figure 2. (Click image to enlarge.)

While sanctions are limiting Russia’s ability to tap into foreign exchange reserves; a sizable portion (estimated at 20%) of Russia’s assets are in the form of monetary gold. Russia is one of the largest producers of gold in the world, second only to China. Physical gold is typically held within a state’s own vaults and safe from foreign adversaries. While using gold can be difficult and requires complicated arrangements, it is also difficult to track. The U.S. Treasury Department has announced that Russian transactions using gold are subject to sanctions and penalties, but that does not stop opportunistic countries from doing business with Russia.

Putin has made strides to “de-dollarize” the nation. (See Figure 2.) There has been a prominent shift away from U.S. dollars to the Chinese yuan. Russia has reduced dollar reserves from nearly 40 percent in 2014 to just over 10 percent at year-end 2021. This has meant a near complete disinvestment in U.S. Treasurys.

Figure 3. (Click image to enlarge.)

Russia’s efforts to disengage with the global economy and isolate itself may have helped minimize the initial shock from the most recent sanctions and could explain why Putin has yet to back down from the Ukraine invasion. Despite its preparations, Russia has suffered severe effects from the recent sanctions. (See Figure 3.) The IIF forecasts that Russia’s GDP will fall 15 percent in 2022. Unemployment is expected to skyrocket as international companies leave the country. Russian businesses are reporting mass shortages, and inflation in Russia has hit a 20-year high. After the sanctions in March, the value of the ruble hit an all-time low. Though it has rebounded since then, some experts suggest the ruble is overvalued considering the country’s troubled economic situation.