February 8, 2023

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Russia’s economy is threatened by war and sanctions

KALUGA, Russia — Valery Volodin, a welder at a sprawling Volkswagen plant in western Russia, spent most of the summer relaxing at his dacha or weekend home, planting his garden and taking care of his children. Mr Volodin, 41, had no choice: the car factory closed in March, joining more than 1,000 multinationals that had restricted their operations in Russia over their invasion of Ukraine.

Since then he has been sitting at home while Volkswagen is looking for a buyer. Once a month he goes to the factory in the industrial zone of Kaluga to collect 50,000 rubles, about $800, a payment required by Russian labor law that is two-thirds of his previous salary.

“We go to work, but the factory is empty,” said Mr. Volodin in an interview. He doesn’t mind taking a temporary break from the physically demanding job, but is unsure how to plan for the future.

“We live from day to day for now,” he said.

His experience is playing out for hundreds of thousands of workers across Russia after the West imposed sweeping economic sanctions designed to hamper Moscow’s ability to wage war and undermine public support for President Vladimir V Putin.

More than nine months after the invasion, neither the war effort nor the economy have collapsed, and economic pain is still contained for many Russians. Mr Putin has avoided any substantive domestic pressures that would threaten his leadership. But the ramifications of what some have described as the most coordinated and deepest economic sanctions in modern history are evident in communities across Russia – and the worst may be yet to come.

The sanctions have hampered Russia’s faltering attempts to modernize its economy along Western lines and catch up with European living standards after the fall of the Soviet Union, said Vladislav Inozemtsev, the Washington-based director of the Center for Post-Industrial Studies, a Russian research group. That has dampened hopes that the country could become a modern, prosperous nation in the near future.

“The slogan is now ‘Prevent it from getting worse’ and that is an important change,” said Mr. Inozemtsev. “Even the government has stopped betting on national development.”

Beneath the veneer of normalcy, he said, key growth drivers like technology transfer and investment are eroding. “It’s like a cake that fell on the table and looks more or less good, but inside everything is blown up,” Mr Inozemtsev said.

The most visible and dramatic impact has been in manufacturing, a sector that employs 10 million Russians and has been at the heart of Mr Putin’s ambitious program to diversify the economy away from dependence on oil and gas exports. The auto industry makes up a large chunk of those workers: automakers employ 300,000 Russians, according to the country’s statistics agency, and the association representing their interests says as many as 3.5 million more work in related industries.

Through September, production in the auto industry fell 77 percent year-on-year, while auto sales fell 60 percent compared to the same period in 2021. A major reason is that Russian industry is highly dependent on Western components. Even Mr Putin has acknowledged the problem, admitting last week that in some sectors reliance on imported parts is as high as 90 percent.

To adapt, Russia is turning inward, cutting ties with the rest of the world and moving towards an economic model similar to Iran’s, where political legitimacy rests on providing necessities to citizens rather than transformative ones Stimulate growth, Mr. Inozemtsev said.

Russia’s government was better prepared to withstand the sanctions than many in the West expected.

Since the war began, the International Monetary Fund has twice upgraded its economic outlook for Russia, forecasting a 3.5 percent contraction in gross domestic product this year, in line with government forecasts. While this decline is a clear reversal of pre-war growth expectations, it stands in sharp contrast to the double-digit slump in Venezuela’s economic output following a wave of US sanctions in 2019.

“Sanctions have not destroyed the resilience of the Russian financial system, nor have they affected macroeconomic stability,” Prime Minister Mikhail Mishustin said during a government meeting last week.

A combination of high oil revenues, large foreign exchange reserves and an expert team of economic officials has allowed Mr Putin to soften the blow – much to the frustration of some Western leaders who had hoped the sanctions would now have more bite.

But the loss of investment, technology and skills caused by the sanctions is likely to reverberate for generations, depriving many Russians of a brighter economic future, experts said.

When Volkswagen started the full production cycle in Kaluga in 2009, Mr. Volodin got not only a job, but also unexpected support.

“I was paid to get training for my job,” he said, still impressed. When a robot replaced him, he was retrained.

Those were boom times for Kaluga, an industrial region around 200 kilometers south of Moscow. The former governor actively wooed western investors, learned English and built a modern airport with several flights a week to Germany. He transformed a regional economy 80 percent aligned with the Soviet military-industrial complex into one linked to the West. Pharmaceutical companies flocked to the Kaluga region, which has a population of millions, as did car manufacturers.

Volkswagen hired around 4,200 employees. Volvo and Stellantis, which produced and sold Peugeot, Citroёn, Opel, Jeep and Fiat brands in Russia, also established branches in the region. According to Dmitri Trudovoy, the head of the Independent Union of Labor Unions, an ecosystem of suppliers and related industries has emerged to serve them, employing at least 25,000 people. Courses in German and other foreign languages ​​at the local university were the way to an office job in the company.

It seemed that a new, modern business model was gradually being built in the region, an indication of how Russia’s economy could develop.

By 2020, the production of Volkswagen alone accounted for about 13 percent of the total industrial production of the Kaluga region.

Now most automakers in the region have shut down operations and Mr Trudovoy said workers had no idea who could take over the western factories and whether they would keep their jobs.

“They are nervous and afraid for their future,” he said.

Kaluga’s industrial production fell 30 percent between February and July this year compared to the same period last year, according to Rosstat, Russia’s statistics agency, making it one of the hardest-hit regions.

Russian state companies and the government have promised to replace lost production with local brands. But there were several signs of regression. In June, AvtoVAZ, maker of Lada, Russia’s most famous domestic car brand, announced that its new cars would only meet 1996 emission standards and would not have passenger airbags.

In a symbolic move, an AvtoVAZ subsidiary, Kamaz, announced it would use a Moscow plant that Renault vacated after the invasion to resume production of a Soviet-era car brand, Moskvich or Muscovite, which has long been a had been an almost comic slogan for the shortcomings of communist consumer goods.

The slowdown in car production also means that even the Russian police will have a hard time getting new patrol cars. According to the Russian newspaper Kommersant, the Interior Ministry could not find a supplier for the 2,800 new vehicles needed for the traffic police.

Kamaz plans to produce 50,000 “modern, comfortable, high-quality and safe” cars at the plant next year, including many with electric motors. To support these efforts, the Russian government plans to channel about $500 million to domestic automakers.

But modern history offers few examples of successful attempts to replace imported Western technology with local substitutes, said Mr. Inozemtsev, the economist. Russian companies lack the know-how and skilled workers to replace Western capital in technology-intensive industries. Relying on domestic substitutes will lead to “primitivising,” Mr. Inozemtsev said

Production will not go away, he said, but will gradually deteriorate, leading to lower quality and quantity of products, which will progressively lower Russians’ living standards.

In Kaluga, the collapse of the auto industry has far-reaching side effects. The real estate market ground to a halt after the war began, said Kirill Gusev, editor of the online real estate site Kaluga House. It began to improve over the summer as people adjusted to a new normal, but then collapsed after Mr Putin announced in September that hundreds of thousands of men would be called up for military service.

“Real estate is essentially long-term planning, but right now we’re at a point where that’s not possible at all,” Mr Gusev said. “We’ve all seen how easily normalcy collapses.”

“After mobilization, banks stopped lending because customers were available,” he added.

Natalia Zubarevich, a geography professor who tracks socio-economic data at Moscow State University, said: “What we’re seeing is falling incomes, a broad depression, less consumption. All of this will have a negative impact on the country’s economy.”

Kirill Mikulin, who owns a popular bar in Kaluga, feels concerned. He had already adapted by finding replacements for half the beers in his pub, which he imported. Buoyed by what seemed to be a return to normal over the summer, he opened Hops & Hopes, which sells 13 craft beers on tap and another 250 in bottles.

His downtown store wasn’t attracting any paying customers the other night.

“We believe in the New Year,” he said, hoping sales would pick up ahead of the holiday.

“But after that, we could be screwed.”

Valerie Hopkins reported from Kaluga, Russia and Anatoly Kurmanaev from Berlin.