Russia and the European Union Continue Transition to Wartime Economies
The Kremlin Believes Russia’s Threshold for Economic Pain Exceeds the West’s
Having declared victory over the “economic blitzkrieg” of Western sanctions in March, Russian President Vladimir Putin must contend with continued Western financial support to Ukraine as it combats Russian forces. In addition, the Kremlin will be forced to finance the reconstruction and integration of conquered Ukrainian territory.
With costs mounting, Putin has increasingly promoted the need to fortify the Russian economy’s immediate and long-term position. In April, the head of Russia’s Central Bank, Elvira Nabiullina, stated that the Russian economy would see a “structural transformation” during the second and third quarters this year to offset inflation, supply chain issues, and reduced imports.
To alleviate domestic concerns related to the cost of the war, the Kremlin increased the minimum wage and pension payments by 10 per cent in May. The initiative also appeared to help muffle any domestic opposition on 30 June, when two bills were submitted to the lower house of Russia’s parliament, the Duma, to give the Russian government greater control over the domestic economy.
The first bill will allow the Russian government to compel domestic companies into accepting government contracts and supply the goods and services required for what it calls its “special military operation” to the armed forces. To reassure the business community that this bill would not impact them negatively, Deputy Prime Minister Yury Borisov said that the proposed law would “not provide for compulsory conversion of civilian small and medium-sized enterprises for the needs of the armed forces.” Instead, the bill would be primarily aimed at companies in the defence sector that already work with the government.
The second bill, which will introduce changes in the federal labour law, permits the Russian government to overcome potential labour shortages by allowing the government to make employees work overtime, at night, and on weekends and holidays.
Even after agreements are signed, the Russian government will be able to alter the terms of any contract. The Kremlin has indicated that without these “special economic measures,” Russia’s military campaign in Ukraine risks grinding to a halt. After being adopted by the Duma on 5 July, the bills now await further review before they can be signed by Putin into law.
These measures are part of Russia’s continuing attempts to stabilize its economy amid rising global economic instability. Despite Western efforts to isolate Russia’s large foreign currency reserves, the Kremlin is also still able to access about half of the $600 billion it built up to protect itself since 2014, after the annexation of Crimea. Russia has attempted to develop rival payment systems and trade networks with China, promoted “a new reserve currency” for international trade to erode the dominance of the U.S. dollar, and supported other similar measures to safeguard its economy.
So far, however, the Kremlin’s saving grace has been the drastic increase in energy prices since it invaded Ukraine in February. Even compared to 2021, which saw relatively high tax revenues for the Russian government, collections were up more than 30 per cent in April 2022 compared to April 2021, despite significant reductions in European demand for Russian energy.
European leaders have called for a more assertive response to the global economic instability similar to the decisive actions taken against Russia. On June 13, French President Emmanuel Macron declared that Europe required a “wartime economy” to manage the economic fallout from the conflict and to reinforce its strategic autonomy. On 6 July, the French government announced it was nationalizing its nuclear company, Électricité de France (EDF). On 22 July, the German government provided a multibillion-euro bailout to the major gas importing company, Uniper, which was the first energy company in the country.
However, these manoeuvres are merely a reflection of Europe’s wider economic vulnerability through energy. After the U.S. and China, the 27 EU states form the third-largest energy market in the world. Much of their energy supply comes from non-member states, notably Russia. And even though the West’s economic strength far outstrips Russia’s, money alone cannot solve the issue of dwindling energy supplies stemming from sanctions and Kremlin initiatives to cut energy exports.
In Germany, the “complete and permanent shutoff of the remaining Russian natural gas supplies to Europe” could result in a GDP loss of 4.8 per cent between 2022 and 2024 in comparison to the 2021 GDP, states a working paper by the International Monetary Fund. The German government already escalated from level one (“early warning”) of its three-tier emergency gas plan to level two (“alarm”) on 23 June. Level three (“emergency”) would allow the German government to impose rationing and to seize control over the allocation of natural gas countrywide. Austria, Denmark, Sweden, the Netherlands, and other countries have also recently raised emergency gas measures.
The EU has sought to introduce collective energy-saving measures to alleviate pain among member states and increase institutional solidarity. The meeting of the European Commission on 19 July saw the EU attempt to introduce the right to impose compulsory gas rationing among member states. But such proposals have faced significant resistance from both the more pro-Russian elements within European politics and the wider political class.
On 13 July, for example, Hungary announced an energy emergency plan that included restricting the flow of gas and other energy sources to other countries in the European energy market. The decision prompted criticism from European Energy Commissioner Kadri Simson. On 21 July, Spain and Portugal announced they would not support the EU initiative to reduce the bloc’s natural gas usage by 15 per cent.
The suggestion by a German parliamentarian in July that Eastern European countries could share gas with Germany also resulted in pushback from several Polish politicians who have previously criticized Germany’s increasing purchases of Russian natural gas since the country’s annexation of Crimea in 2014 until 2022.
As energy concerns push European countries into pursuing self-preservation policies over solidarity, the EU has suggested ambitious price relief initiatives. Alongside the U.S., the EU unveiled a push for a price cap on Russian oil in early July.
Among other issues, however, this would require cooperation with major buyers like China and India, which have already been receiving Russian oil at below-market value, as well as coordination with the Organization of the Petroleum Exporting Countries, which has little reason to take steps to lower the oil prices.
Previous international efforts to influence oil flows and prices from major exporters, such as the oil-for-food program in Iraq in the 1990s and the 2011 sanctions exception regime in Libya, have led to significant exploitation that severely undermined these schemes. Attempts to place a price cap on Russian oil will also likely see the Kremlin use its natural gas reserves to exacerbate the global energy crisis by restricting gas supply further.
And like the problems faced by Russia’s military-industrial complex, supply chain and production issues have become apparent to Western militaries seeking to aid Ukraine’s war effort. By May, for example, stockpiles of various U.S. missiles had been depleted, while the Netherlands announced it could no longer send howitzers to Ukraine.
Additionally, Ukraine’s systemic corruption remains a primary concern of Western governments providing the country with financial assistance. The risk of billions of dollars going to waste will only further add to “Ukraine fatigue” that threatens to erode Western support for Kyiv.
Having grown accustomed to sanctions and economic instability since 2014, the Kremlin believes Russia’s threshold for economic pain exceeds the West’s. As winter approaches and energy demand picks up, the EU risks divisions among member states over supply strains. Bringing the war home to European citizens this way may help Russia reach a diplomatic breakthrough in the conflict and reveals the limitations of the EU in its attempts to supersede the national interests of member states.