Are Russian sanctions effective?

Recently, Russia’s Central Bank raised its key policy rate to 21% as the Russian authorities tried to manage an economy that is in danger of overheating due to a combination of factors including rising inflation, sanctions pressure, increased social costs and record defense sector spending. While officials and many international analysts insist that the Russian economy remains in remarkably good shape, the country’s longer term economic outlook is more precarious.

There is currently little sign that the Russian economy is in immediate danger. At the same time, if the conflict in Ukraine continues for an extended period, it would put additional pressure on the Russian economy. Ending the conflict also presents economic risks. Russia’s unprecedented military spending since 2022 has enriched elites and boosted domestic demand, in effect overheating the economy. When the conflict ends, this fiscal stimulus will cease, potentially causing a significant drop in real incomes for much of the population. This could lead to heightened social tensions and undermine the political stability.

It seems that U.S.-led Western sanctions have been counterproductive and Russian official data broadly supports this narrative, with Russia reporting strong GDP growth in 2023 and 2024 of around 3.9%, significantly higher than Western economies. A range of factors are fueling the current growth of the Russian economy, with military expenditure perhaps the single most important driver. The Russian authorities allocated around six percent of GDP for the military in 2024, representing the highest total since the Cold War. Further increases are planned for 2025. Significant additional spending is required to fund a range of defense-related industries and to finance Ukrainian regions under Russian control.

Despite the appearance of stability, there are economic challenges. The National Welfare Fund is steadily dwindling, it is about 50% down, while export revenues have gradually declined during 2024 as a result of tightening sanctions and constraints on resource extraction caused by limited access to modern technologies. The Russian economy is in danger of overheating, largely as a result of unprecedented spending. Russia’s low unemployment rate of around 2.5% is more indicative of a severe labor shortage than a healthy economy. The problems caused by this lack of workforce add to the challenges of restrictions on access to Western equipment, exacerbating a technological deficit.

Like in other countries when the government is spending too much, inflation poses the single greatest threat to the Russian economy and was a key factor behind the recent decision to hike the country’s key interest rate. Russia’s Central Bank aims to reduce inflation to around four percent in 2025, but this might be a challenge. Negative economic trends such as rising inflation, labor shortages, and declining activity in some sectors of the economy. Taken together, these negative factors are likely to contribute to a period of slower growth, if not stagnation.

Sanctions have complicated the situation for Russian exports and for the import of technologies. However, Russia has been able to find numerous ways of bypassing or otherwise mitigating the effects of many restrictions. Russia’s economically vital energy exports have been redirected from the West to the Global South, with a shadow fleet of tankers playing a crucial role in this process. Similarly, Russia has been able to continue accessing military technologies and equipment by importing via third party countries including China. This has created some inconvenience and led to rising costs, but it has prevented sanctions from achieving the desired goal of isolating the Russian economy.

A number of additional factors have further blunted the impact of sanctions. These include slow implementation and the continued existence of multiple loopholes. Restrictions on capital transfers have also played into the Kremlin’s hands, keeping wealth within Russia. Many Russians have clearly benefited financially from the conflict in Ukraine. Military contracts have proved particularly lucrative for the country’s business elite, while the departure of Western companies has created vacant niches for Russian companies to fill.

Ordinary Russian citizens have been able to earn unprecedented sums of money by enlisting in the military, with the families of soldiers killed or wounded in Ukraine receiving substantial payments. Those working in factories servicing the war effort have also seen salaries increase as much as five times amid surging demand and labor scarcity. Overall, the situation in Ukraine has enabled millions of Russians to pull themselves out of poverty. The economic benefits enjoyed by a wide range of social groups in Russia because of the war have helped foster pro-war sentiment and bolster support for the government. Ending the invasion of Ukraine would therefore potentially weaken the position of the authorities and fuel instability.

There is still revenue pressure for the Russian economy even though the government has managed to find other markets such as India and China, but there is also increased spending. Domestic bond actions to raise funds have worked to some extent, it might also be worth expanding bond actions to willing international partners. Overall, sanctions on Russia have not been effective, as Russia has managed to circumvent restrictions, build new global export partnerships, and expanded the domestic economy. At the same time, there are pending issues such as labor shortage, higher social services costs, currency depreciation and inflation. In particular the inflation is a threat the health of the economy and needs to be dealt with. The current U.S.-led Western sanctions have clearly not worked, and created global divergence and polarization, and Russia has grown stronger, at least in the short term.