Shutting down the Nord Stream is a sign sanctions are working

Vladimir Putin’s recent demand that Western sanctions be lifted before gas supplies to Europe resume is a sign that sanctions are beginning to hurt the Russian economy. Many have wondered, given the Rouble’s strong recovery shortly after sanctions were introduced, whether widespread embargo's on the Russian economy would have any sustained impact long term. 

In 2012, for instance, when the US placed sanctions on Iran for abandoning its nuclear plan with the West, it pressured SWIFT to ban Iran from its payment system. The results at first were catastrophic for the Iranian economy. The rial collapsed as bank runs and hyperinflation ravaged the country. But Iran fought back and its economy soon made a quick recovery. By exporting oil to India in exchange for gold, Iran used its gold to buy food and manufactured goods from China. Gold became its new currency and the attack on the rial was short lived. 

Although the ban from SWIFT affected Iran's ability to transact with Western banks, its allies refused to join the sanction regime given their dependence on Iranian oil. As a result, the sanctions didn’t have the desired effect on the Iranian economy as the US had hoped. Sanctioning China for its role in facilitating Iran was also out of the question, as it is now too in the case of Russia.
 
Indeed, China’s trade relations with Russia is a big factor in explaining Russia's recent turnaround in good fortunes. Chinese imports of Russian oil have already risen by 20% in 2022 compared to a year ago. According to Kitco News, Russian gold exports to China have increased by a staggering 750% in July on a month to month basis. 
 
Reluctantly, Europe itself is playing a major role in propping up the Russian economy. Helsinki based Centre For Research On Energy And Clean Air note that €93 billion worth of energy was exported to Europe from Russia during the first 100 days of Russia’s invasion of Ukraine - 20% higher on the same period a year ago. It is also estimated that Russia exports €930 million worth of energy per day; €100 million more per day than it spends on the war. As the largest gas producing country in the world, Russia enjoys a privileged position of having inelastic demand for its energy from its trading partners.
 
Seen in this light the remarkable recovery of the Rouble should be no surprise. Even as sanctions closed off foreign exchange markets to the Russian central bank, Russia simply responded by creating a loophole in existing energy contracts and demanding payment in Roubles. Much to the annoyance of Europe, these new arrangements forced ‘unfriendly’ buyers of Russian gas to open a Rouble account at state-owned Russian bank, Gazprombank. As one of the few banks that are not sanctioned by the West, Gazprombank now exchanges Euros for Roubles and transfers them back to a foreign bank in Europe. From there, the buyer transfers Roubles to Gazprom, Russia's energy provider, in exchange for Russian gas. This financial trickery has pushed up the Russian exchange rate and strengthened the Rouble.
 
In the longer term, however, the economic problems facing Russia in future will stretch far beyond its oil revenue or exchange rates. Rather, the drag to its domestic economy from a lack of vital imports will be a major concern for Russia in the years ahead. Without a steady supply of raw materials and technology, Russia’s manufacturing base risks grinding to a halt. 
 
According to the Russian statistic agency, Rosstat, industrial output in locomotives is down 63% in 2022. Manufacturing of minibuses is down 77%, cast sheet glass is down 60%, domestic refrigerators and freezers are down 58%, internal combustion engines are down 57%, freight cars are down 52% and AC and TV receivers are down 50%.
 
Another study by Yale University shows that since sanctions began in February, imports have fallen by 50%. One thousand Russian businesses have curtailed their operations and half a million Russian citizens, vital human capital for a growing economy, have emigrated. The study estimates that three decades of foreign direct investment have now been erased as a result of sanctions. 

Since the invasion of Ukraine commenced, the Russian government ended its publication of economic statistics. Like China, official data on unemployment and GDP in Russia are likely fudged. The common narrative that the Russian economy is weathering the storm, therefore, should be taken with a large pinch of salt. 
 
There is no official data available on foreign trade, for instance. Inflation, productivity, and exchange rate calculations are thus unreliable, skewing the harsh realities facing many Russian businesses and households. Indeed, considering the capital controls in place that prevent large amounts of Russian cash leaving the country, the exchange rate looks suspiciously overvalued. In time, however, this will change as businesses fail and unemployment rises. The real effects of the sanctions, should they persist, will eventually be laid to bare. 
 
While Russia’s relationship with China is undoubtedly important, China too depends on many of the same raw materials from the West as Russia. Copper, iron, steel, chemicals, car parts, textiles, semi conductors and so on. In 2022, there has been a 90% fall in semiconductor exports to Russia from Western allies due to sanctions. The rollout of Russia’s 5G network has since been postponed as a consequence. While China can import Russian oil, it can't export many of the necessary goods to Russia to sustain its domestic economy or save it from industrial collapse. 
 
Russia’s dependency on Western markets should not be understated, therefore. Its prolonged technological isolation from the world could be fatal to its weakening economy. His promise to reopen the Nord Stream pipeline on condition that Western sanctions are relaxed suggests that Vladimir Putin knows this himself too. His recent citing of a Russian fairy tale in which a fox lets a wolf’s tail freeze is a clear signal of his intentions over the winter months. By inflicting enough pain perhaps Europe will flinch. “Freeze, freeze the wolf’s tale!” he declares. As Western sanctions bite, however, and leave everlasting scars on the Russian economy, it could become less clear who plays the wolf in Putin's fairy tale.