Russian Economic Expert Zubarevich: The Sanctions Will Hit Russia In Stages

In an interview with Rosbalt media’s Anna Semenets, economist Professor Natalia Zubarevich of the Moscow State University’s Department of the Social and Economic Geography of Russia, outlines the effect of continuing sanctions. The sanctions full effect will not be perceived at once, as some will have immediate effect, while others will make themselves felt later. The automotive industry will be the first to suffer, but other sectors including agriculture will feel the brunt of sanctions. The one bright spot is the export trade balance that will be used to subsidize salaries. To maintain production, Russia will have to resort to Soviet era technology to replace Western imports.

The interview with Professor Zubarevich follows below:[1]

On which industries will the sanctions exert the most powerful effect? Can it be said that the regions dependent on these industries will be the first to suffer?

One must distinguish the consequences of sanctions and the departure of foreign companies into short-term (which we can see immediately) and delayed ones (which will be felt later). Things are more or less clear about the short-term consequences. First of all, they will affect the automobile industry regions. At the moment there are only four car plants operating in Russia: GAZ, UAZ Sollers in Ulyanovsk, Mazda Sollers in Vladivostok (it’s tiny and produces very little goods) and the Chinese Haval in the Tula Oblast. The rest are not in operation. In some regions the companies have left, in others there are simply no components, i.e. there are simply no components to assemble cars from.

The Kaluga automobile cluster (where cars and components for Volkswagen, Peugeot, Citroen, Mitsubishi, and Volvo were made – Rosbalt) will go through a very hard time now. The workers will receive their salaries for three months, according to the [Russian] Labor Code, and then it’s unclear what will happen. The situation is similar with “Avtotor” situated in Kaliningrad Oblast (BMW, KIA, Hyundai cars are assembled there – Rosbalt).

The owner of the enterprise is Russian, but the cars assembled there are of German and Korean [companies]. The large automotive cluster in St. Petersburg is focused on Korean and Japanese cars. The employment rate there was significant, however St. Petersburg is a huge city; somehow the unemployment will be offset there. “AvtoVAZ,” Russia’s largest automaker, has suspended manufacturing too. They have announced a leave at the plant lasting to April 24. because they too lack components.

Renault has already announced that they want to quitely sell their share of the Russian business. There is a Renault assembly plant in Moscow, but with so many jobs the [unemployment] situation in the city will somehow be resolved. Russian “KamAZ” also imports components for engines and [truck] cabins (German company Daimler Truck has stopped cooperating with KamAZ – Rosbalt). They have already said they will build Euro-2 trucks. In other words, these are the engines from the end of the Soviet Union. And most of the companies in the country will follow this way.

There will be short-term consequences in other industries, but we don’t yet understand their extent. First of all, they will affect everything that is related to the services sector, including retail trade. Personal incomes have shrunk, and the supply of many consumer goods is stalling. It’s hard to say how employment in services and non-food products will shrink. It’s clear that these spheres will sustain a blow. Its scale is difficult to quantify and predict as of yet.

Now let’s turn to the long-term consequences. Sanctions as well as Western companies’ refusal to supply Russia will affect almost all Russian machine building, which works thanks to imported components. The US and Europe have already banned supplies to the transport and machine building industry. To a certain extent imported components were used at the “Tikhvin” railway carriage factory situated in the Leningrad Oblast.

The Tver Carriage Plant and “Uralvagonzavod” in Nizhny Tagil (Sverdlovsk Oblast) will have it much tougher. Enterprises of “Sinara Group,” all transport and locomotive construction plants of “Transmashholding Group” use either cassette bearings of Western companies (which are gone), or other imported parts.

Relatively high-tech Russian machine manufacturers, who worked in cooperation with global suppliers and global technology companies will suffer the most.

It won’t happen quickly, but the entire industry related to oil and gas machine will also follow this trend. There are quite a lot of imported components used there, and supplies from China import won’t be able to replace everything, because the most advanced high-tech equipment for oil and gas [industry] was either fully imported or contained a very high proportion of imported components.

There are quite a lot of imported components, and supplies from China will not be able to replace everything, because the most modern high-tech equipment for oil and gas was either completely imported, or with a very high proportion of imported components.

But this won’t happen right away. Unlike the automobile industry, where manufacturing has already stopped, the effect will be deferred for the aforementioned spheres (i.e. transport, oil and gas, energy engineering). When the components are finished – a question of two or three months, then I fear that Russian machine building will be downgraded a few decades back, and this must be very clearly understood.

Regarding the agro-sector, it was announced that this year’s seeds have either been purchased, or supplies will still continue. Potatoes, sunflowers, sugar beets are likely to be planted. I do not know what share imported seeds occupy in grain farming, but such share was dominant for the three aforementioned items. The Bayer company has already announced that if the special operation continues, the company won’t supply seeds to Russia next year. And we don’t have our own high-quality seeds selection.

I believe many people would be surprised to learn that we grow even potatoes from imported seeds.

Yes, the potatoes we buy are grown from imported seed material, which provides a yield about two or three times higher than our seeds. That is why, naturally, we used imported seed. Hatching eggs are mostly imported, in addition such eggs provide for an absolutely different growth rate of poultry. Imported bull semen is used to inseminate of cows. Cows born from such semen produce 10 thousand kilograms of milk per annum, while our Russian cows produce only 5-6 thousand kilograms of milk. So, following the loss of imports, productivity will deteriorate sharply too.

Which regions will be affected?

The main sunflower growing area is in the Russian south: Krasnodar and Rostov oblasts. Stavropol, Voronezh, Kursk, and Belgorod will be affected slightly less. These regions have the biggest production and the biggest risks as well.

The geography of potato growing is wider, it is planted in many places. In terms of potato production, private farms still dominate in Russia, they still account for almost 70% of the potatoes produced in the country. But those technologically advanced agro-firms, which grew potatoes using modern methods, will face problems if there will be no supply of seeds.

Dairy farming (I’m talking about all of our large dairy agro-firms) was built with the help of subsidies. There are many of them, and they in fact use modern technology. Due to the sanctions, there may be difficulties in this sphere as well. But so far 40% of milk produced in the country comes from private farms. They produce it for themselves, and for their neighbors in the village.

Sugar beet is being planted along a classic black earth strip: Kursk, Belgorod, Voronezh, Penza, Ulyanovsk, Krasnodar Krai.

What other industries may face complications? What is their geography?

All regions that have major seaports bear risks too, due to the interrupted supply of containers. In the Far East the situation is easier because the region enjoys mainly Chinese and Asian transit. In turn, the ports of the Baltic and the Black seas are already reeling. These are not regions, but cities. So, these port cities will experience problems.

The Vologda and Belgorod oblasts, in which the largest enterprises of ferrous metallurgy are concentrated, will have problems. Things will be easier for the Lipetsk, Sverdlovsk, and Chelyabinsk oblasts. All ferrous metallurgy and “Magnitka” [i.e. city of Magnitogorsk] will face difficulties.

What will be the consequences for those regions and for the people who reside there?

The first and main problem is employment, the second is regional budget revenues, which depend on taxes from enterprises.

Can it be argued that the consequences will affect those specific regions, where enterprises, dependent on imports are concentrated, while the rest will not be affected as much?

Will there be no inflation in other regions? Will there not be a decline in people’s income due to inflation and ruble devaluation? Are there no cities in these regions with a service sector and non-food trade? This will affect everyone. Obviously in a village, the service sector and non-food trade are minuscule. In turn, the large cities that play the role of service centers and retail non-food trade will feel the consequences [of sanctions].

How much can retail and services industry shrink?

It depends, first of all, on the inflation rate. So far, the estimates are as follows: judging by the year [dynamics] and taking into account the last few weeks, one can provide inflation estimates of 17%. But that’s for now.

Second, [much will depend on] the rate at which revenues will fall. Neither you, nor I know what support measures will be introduced. So far they affect only the indexation of pensions and salaries of state employees. We don’t know the volume of this indexation. What share of lost earnings will these measures be able to cover? Meanwhile, real wages are decreasing, as well as real pensions. Let’s see what our state will offer as support measures during the entire year.

Today there are a lot of talk about import substitution. In your opinion, what are the prospects?

If your country produces 98% of components, and the remaining 2-3% are some imported gearheads (which are in short supply), then there is a chance that you will commission production of these gearheads in the next two months, although it’s problematic. And in our oil industry, the share of imported equipment in simple technologies is 40%, and in complex technologies (which we have not mastered yet, and the Chinese do not have) is 80-90%. Shall I explain further?

Am I correct in assuming that all the talk that a replacement for sanctioned import goods will be found in India or China is a bit exaggerated?

Something will be replaced, naturally, and something will be scraped together. But it’s impossible to replace everything. Especially in critical sectors [of economy], for instance: in petrochemicals. Now it will slow down, because there is nowhere to supply fuel oil, as its purchase in Europe has almost stopped. I haven’t yet said anything about the coal regions. Their import to Europe will be blocked to a large extent.

Perhaps not all 50 million tons will be blocked, but a significant share. And we are talking about miners, their salaries, the budget of the Kemerovo oblast. I can enumerate for another half an hour. What, for example, will happen with the textile industry considering the rise in the price of cotton due to the devaluation? The demand for cotton wasn’t really high, and now the incomes of the population will also shrink. By the way, we also import wool from Australia and New Zealand. We are part of the global world.

You argue that there are entire industries on which the country’s economy largely depends. These industries were seriously dependent on imports, which we cannot replace. What’s next? What’s the way out?

Degradation, stop a part of manufacturing, return to the technology of the late Soviet period, if one can find the blueprints and the machines that were used to make it all, the most severe economic crisis. These are the results. And even if sanctions will be lifted, there will be no quick way out.

Is it already clear how much unemployment will rise?

It’s clear that it won’t rise to 20%. At large and medium-sized enterprises, people will be put on a paid leave, administrative leave, and legally-speaking won’t be listed as unemployed. Some will continue to receive wages, some may be placed on leave without pay, provided, of course, an employee will agree and sign such a paper. If you don’t want to do it, quit your job, go to the employment service and apply for benefits.

Now the unemployment rate [in Russia] according to ILO methodology is 4.5%. At the height of the crisis in 2009, the unemployment rate was 8.5%. During the 1998 crisis, it was around 10%. What will happen this year? Estimates so far are 7-8%.

How can employment be maintained under such conditions?

The Russian labor market responds to crises not by layoffs, but by wage reductions for all employees of such an enterprise. Any underemployment (i.e. downtime, leave without pay or with pay) always means a decrease in wages.

But for how long will businesses that don’t work be able to pay salaries to the employees?

Small and medium-sized businesses won’t be able to do that, unless they will be provided with substantial payroll loans to maintain employment, which will then be forgiven, as was the case during the Covid-19 epidemic in 2020. However, this time it will require more money than 500 billion rubles, because the unfolding events will affect a much wider range of vulnerable industries.

Back then, the money was allocated mostly to small businesses. Large and medium-sized businesses were not given money, in the belief that the owners had the means. So [it was decided to] let them continue to run their own business and somehow to pay salaries to their employees. Now things are different. So far big business can use the strategy of part-time employment. That option is unavailable to small businesses, because if you don’t work, you simply have nothing to pay your employees with.

If there are payroll loans, technically-speaking employees will be kept. Should there be no large-scale distribution of loans, naturally one should expect layoffs. Some companies will turn to the gray economy, i.e. to the informal sector. There will be all sorts of things. Our business is experienced. But some businesses will go bankrupt, it’s already clear.

Does the state have money for such salary credits, which then have to be forgiven?

Our main income is come from oil and gas import in form of USD and euros, which are later converted into rubles. At first, the USD and Euro exchange rates [against the ruble] rose strongly, later it was artificially decreased, because a few people are trading on the stock exchange. The point is that we do not know at what rate the petrol dollars and petro euros will be converted at “Gazprombank.” If the exchange rate is high, then even if we sell less oil, gas, fuel oil, income denominated in rubles might be the same.

In addition, import has sharply decreased. We have a lot of foreign exchange earnings, which we do not need to spend on imports. This year the budget will enjoy a huge foreign trade surplus. Imports have collapsed much more than exports. So there will be some saved assets. In addition, no one has abolished the [banknotes] printing press. However, the printing press accelerates the inflationary spiral, so they will resort to this solution at the very last. As long as the cost of all the export goods that we supply is very high, as long as a significant part of it is bought, the export revenues that the Russian budget receives will be the basis for the support of the population and business.

We’ve discussed imports. What about exports?

A decline in exports is inevitable for two reasons. The first is sanctions. Part of these states (i.e. the US, Britain, and Canada) will simply stop buying Russian fuel and energy products. The second reason is public opinion pressure as well as reputational risks, under the influence of which some Western traders and companies will also refuse to buy from Russia.

We don’t know to what extent exports will decrease. As of March data, our oil exports have already decreased from 7 to 15%. They are not buying. Let’s see what happens over the year.

What other exports might be affected by this decrease?

Practically every sphere. An entire fuel and energy complex (i.e. oil, gas, coal) will decrease. Regarding coal, decisions could be faster and tougher. Naturally, some European countries depend on Russian coal, but it can be replaced by coal from other states.

The iron and steel industry are in the same boat as fuel and energy. The US and Europe refuse supplies from Russia, and it is rather difficult to redirect all the flows to Asia. Besides, an attempt to reorient to other markets is partially feasible, but only at a huge discount. We sell 10-35% below world prices so they will buy from us. This applies to all commodities.

Fertilizers won’t be affected by the reduction in exports: global food inflation is very high right now. It won’t affect non-ferrous metals either, as Russia is an important supplier, and there is a big deficit in the world right now. Meanwhile, Australia has already banned the export of alumina for Oleg Deripaska’s Russian plants. This means 20% less raw material. In Nikolayev, where the alumina processing plants are located, there are hostilities. That means another 10% of raw materials should be discounted.

Russia itself introduced quotas on grain exports. At first it was argued that they would curb the export altogether, but so far they seem to allocate quotas. Grain is expensive, and we sell it not to Europe, but to Egypt, Turkey, Iran and etc. Everything is OK with grain. Only a ban by our state is in operation. Heavy restrictions were introduced so that the domestic prices for grain and bread wouldn’t rise.

You talk about exports in terms of whether the goods will be bought from us. Will we sell is another question?

Hotheads are already screaming, “Let’s stop selling uranium to America,” “Let’s not sell fertilizers to the world.” So far no such decisions have been made. As I said, strict quotas have only been introduced for grain. Also, if I remember correctly, there is some kind of export quota for sunflower [seeds]. I would put it this way: our motherland can do something seriously weird, but I can’t guess the scale of what it will pull.

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