Russia’s wartime economy: learning to live without imports

One August afternoon, a taxi pulled up to a hotel in Istanbul and a group of men got out, speaking Russian. They pulled five suitcases out of the car.

The cases were packed with equipment they had purchased in Austria. The goods were not particularly unique — professional electronics, for use in schools — but they were made by a western brand that had decided to boycott Russia over its invasion of Ukraine.

“It was made to look as if it’s just for personal use . . . As if I’d bought it all for myself,” says Stanislav, who met the men at the hotel in Istanbul, took them out for dinner and then flew home to Moscow with the cases.

“Of course, it was contraband, pure and simple,” he says, speaking on condition of anonymity due to the illegal nature of the activity.

This was an unusual consignment for Stanislav. Normally he specialises in using trucks to smuggle out of Europe the much bulkier and more sensitive items that are subject to sanctions on Russia, such as materials for the construction sector and parts and machinery for heavy industry.

Stanislav is one of a growing number of Russian so-called import-export specialists — experts in finding loopholes and getting goods through customs — that have cropped up in response to western sanctions on the country.

Interviews with participants of this underground market reveal a lucrative but highly unpredictable and unstable trade, one on which Russia’s beleaguered economy will struggle to rely.

And yet, increasingly, rely it must. Sweeping sanctions introduced since the outbreak of war have roiled Russian supply chains and left many companies scrambling to source crucial foreign-brand products and parts.

When the heaviest sanctions were introduced in March, some economists predicted a rapid collapse in the Russian economy, perhaps by as much as 30 per cent. But that did not happen: oil and gas revenues continued to flow in and the currency soon recovered.

Instead, what is emerging is something different — not a dramatic decline, but a steady degradation of its productive capacity which economists in both Russia and the west argue is pushing the country back decades. Russia is trying to operate a modern economy without the ability to import many of the components, raw materials and technologies on which it depends.

The impact is being felt across the economy — from the banks that need servers to process payments to the country’s poultry industry, which had relied on the Netherlands as a supplier of the chicks from which broiler hens are grown for the mass production of eggs.

Agricultural firms are struggling to source tractor tyres, while airline companies are unable to secure foreign components to repair their planes.

The hit has already been significant. Data from Russia’s trading partners shows Russian imports have dropped by 20-25 per cent since the start of the war — a blow for a country embedded for decades in the global economy.

“If you look at pharma, chemical production, machine building, metals and mining . . . It’s hard to find an industry in Russia that is not reliant on imports for at least 50 per cent [of inputs],” says Elina Ribakova, an economist at the Institute of International Finance.

In the medium term, the sanctions are likely to set Russia’s economy back years. Consumers will be forced to readjust to a more limited choice of goods and poor product quality that could echo the privations of the late Soviet era.

“Life will be simpler and there’ll be less money. People will make do with less. There will be more paper in the sausage,” says a Russian oligarch who is under sanctions.

“It’s going to be like this for 15-20 years, unless [President Vladimir Putin] dies. Fundamentally nothing will change.”

Ultimately, Russia’s long-term economic future depends on whether Moscow will be able to rapidly produce domestic alternatives to the foreign goods it can no longer access, or source analogues from “friendly” countries such as China. Where these two options fall short, it is left to rely on contraband imports by smugglers such as Stanislav.

For him, the new restrictions have created a land of opportunity. In the past, foreign goods were shipped to Russia by official importers, and there were few ways for a new player to squeeze in. Trying to import brands illegally was also no use, as there was little demand.

“I could have stuck the goods in a double-bass case and brought them in, but no one would’ve bought them, because I couldn’t have offered the buyer an official warranty, and so on and so forth,” says Stanislav.

“Now I can import this, I can import that, just like everybody else. So for me, of course, it’s interesting,” he adds. “The doors have opened.”

‘It is all being imported anyway’

Several smuggling routes have already become popular.

Mostly, Stanislav buys items through front companies set up in Europe, with no visible connection to Russia. The products are then sent in trucks from the EU to one of the former Soviet Union countries that share a customs union with Russia, such as Kazakhstan and Armenia.

“Any brand that has left Russia, no matter what it is — vacuum cleaners, clothes, alcohol — it is all being imported anyway,” says another Russian national based in Europe, who is engaged in the import-export trade.

But the process is patchy at best. Take the example of clinker brick — a material used, among other things, in decorative facades.

“The last deliveries were in June and that’s it. No one knows how to bring it in,” the person explains. Some builders involved in high-end construction have already tiled half their building, he says. “What to do with the other half? It’s not clear.”

Eventually, routes will be found to get the material to Russia, but as with many other imported goods, it will be expensive, and hence only available for specialist orders, the person adds.

Russia classified data on its imports soon after the start of the war, but economists are building a picture using information about exports to Russia from its main trading partners. This shows a steep decline in the spring, immediately after Russia’s invasion of Ukraine, followed by some recovery towards the autumn.

Exports to Russia from the US were down 85 per cent in May compared with the same month the previous year, according to European Central Bank research. The World Bank, IMF and other institutions forecast Russian imports this full year to be down by a quarter on the previous year. During June to August this year, Russia imported $4.5bn less per month than in 2021, according to the Kiel Institute for the World Economy.

Import demand has also fallen as the economy entered recession and inflation began to squeeze household incomes, while an increasing number of western companies that had branches in Russia pulled out.

Given the shortages of imported parts, car production has been one of the hardest hit sectors, with output down almost 80 per cent in September compared with the same month the year before, according to Russian state statistics service Rosstat. The slump led officials to loosen some safety requirements over the summer for antiskid brakes and safety cushions.

So many western automobile makers and sellers sold off their Russian businesses that only 14 carmakers were left on the market for Russian buyers, according to an industry analysis published in December. All were Chinese brands except for three domestic brands, including the iconic Soviet Lada.

One billionaire close to the Kremlin says the potential profit on smuggled items is so high that luxury goods will always make it into the country, regardless of sanctions. He says that over the summer he bought two Maybachs instead of the Mercedes he wanted but could not source. If the first breaks down, he adds, he can use the second one for parts.

Others have already spied new opportunities. “It’ll be tough for two, three, four years. Then we’ll adapt,” another oligarch under sanctions says. “Look at Iran. They do everything themselves [ . . . ] they have their own supply chains, and if they don’t have a spare part, they get it on the black market. They can do anything. We are learning our lessons right now and we will eventually be like that.”

A collapse delayed

So far, the economy has avoided the worst predictions. Economists are estimating a decline in gross domestic product of between 3.5 and 5.5 per cent this year.

Partly, this is because export revenues have remained strong, and Russia is increasingly finding alternative buyers for its oil.

There has, for example, been an uptick in exports to Russia among the countries through which some businesses are rerouting trade. Exports to Russia by countries such as Turkey and Kazakhstan are up. While the EU exported 43 per cent fewer goods to Russia during June to August, China exported 23 per cent more, according to Kiel Institute.

But while there has been no disintegration of the economy, analysts believe that long-term growth will be substantially depressed, as import curbs shred the potential for technological upgrades. The local industries that end up replacing production are often more inefficient, they say, while black market import streams are volatile.

“If you go back to the Soviet Union and how they got hold of technology, it was through the FSB and spies and fronts, buying things in third countries undercover,” says economist Jacob Nell, member of an expert working group on sanctions run by former US ambassador to Russia Michael McFaul and Andriy Yermak, Ukrainian president Volodymyr Zelenskyy’s chief of staff. “But it’s very difficult to build up supply chains when you have these sorts of comprehensive sanctions.”

Nell adds: “Even if you can steal the blueprints, it’s very difficult to replicate — in an economic and commercially sustainable way, without subsidy — the production of these things.”

Stanislav agrees. Shipments are volatile, and intermediary countries are introducing new rules intended to weed out this kind of trade. Earlier this month, the EU proposed making sanctions evasion a criminal offence and he immediately felt a massive drop off in suppliers. One of his deliveries got stuck at Kazakhstan customs.

“A loophole was found, and then, thanks to connections and a small bribe, we found a way to move the stuff,” he says. Still, “it’s getting harder and harder every day”.

Across the board, state enterprises and agencies are searching for ways to respond to the import breakdown.

In July, Putin appointed longtime trade minister Denis Manturov to a senior government position with a mandate to restore supply chains. Manturov vowed to uphold Russia’s “technological sovereignty” and make import substitution “a matter of national security”.

Though Manturov later insisted this would not mean “totally abandoning market economy principles”, the drive to boost domestic production will inevitably lead to much more heavy-handed state intervention that limits competition, according to another Russian oligarch under sanctions.

“If you have 10 companies making plates it won’t work. You have excess supply and not enough quality. Nobody needs that,” the oligarch says.

“Instead, you need to make sure that you have just a couple of producers. They need to keep competing with each other and produce a quality product, but you want to avoid excess production. You need to be sensitive to the size and power of the market.”

Some solutions have already been found. A survey of Russian companies by the central bank in April found that two-thirds were struggling with disrupted supply chains. By the summer, that number had decreased to 50 per cent.

“So for companies that are looking for alternative suppliers, there is marginal improvement,” says Ribakova at the IIF, referring to the survey. “But on the other hand . . . these are aggregate numbers. They do not reveal the choke points.”

The critical list

In a new underground complex known as “the bunker” next to Moscow’s Ukraina hotel, Russia’s cabinet regularly meets to discuss presentations dissecting the country’s dire economic prospects on an enormous 180-degree screen.

One of those presentations, prepared by a major state-owned bank from August this year and also seen by the Financial Times, lists some of these critical areas.

In five columns it grouped sectors by their degree of risk, with the last coloured in red and labelled “super critical”. Industries listed in this category include aeroplane construction, pharmaceuticals and medical tech, production of microchips and high-level IT equipment, and tech for spacecraft construction.

The cabinet claims it has already successfully replaced imports in some of the sectors. “They wanted to ground our air fleet. To take the sky away from us,” Prime Minister Mikhail Mishustin said in November at a time when there were multiple reports in local media about how airlines were struggling to source spare parts. “But we have kept our planes and are expanding the release of domestic technology.”

One way Russia’s government has stepped in to support importers, especially of consumer technology goods, has been through the legalisation of what it calls “parallel imports”.

The law made it legal to pass a long list of western-brand goods through customs into Russia without the consent of the brand itself. Previously, this would have been considered piracy, but is now Stanislav’s semi-official trade.

The government has estimated that $20bn worth of goods were imported into Russia this way this year, including the new iPhone 14, released in September and not officially for sale on the Russian market. “If consumers want to buy these phones, you’re welcome,” Manturov said in September.

Kirill, another imports specialist in Moscow, opened a grey imports business focused on furniture and fixtures soon after the start of the war. He says that one of the most common schemes for parallel imports is to work with a company in, for example, Kazakhstan, that has an existing relationship with a western brand.

This company then places its usual orders, but in significantly larger volumes. The Russian partner quietly pays to import the excess to Russia, which is easy to do once the goods are safely in Kazakhstan, since it has no customs border.

But the grey market route is less effective for harder-to-source imports, particularly microchips and servers, according to an executive at a Russian technology company.

“You can’t make it a mass [business] because banks need servers too” and will outbid smaller buyers, the executive says. “That makes it much more expensive and not sustainable.”

Producers have become much more wary about the increased volume of orders for microchips in Armenia and Kazakhstan, which have become home to large communities of exiled Russian IT specialists since the war but are also hubs for customs-free parallel imports ordered through fronts.

“Some US companies stopped shipping to Armenia. They say, ‘We had one licence a year before. Now you are asking for 100 licences? Fuck off!’” the executive says.

A senior executive at a major Russian technology company warns about the long-term impact of the microchip shortage.

If the sanctions last two to four years, paying for the most ubiquitous chips at twice the market price is still worth it, the executive says. However, if they last for longer, the executive believes Russia will be forced to switch to inferior Chinese chips. Expanding Russia’s own microprocessor production capacity to the level of China — itself now struggling under US export restrictions — would be likely to cost $50bn a year for 10 years, and even then not be guaranteed to work, the executive adds.

To go through the complex compliance procedures required to demonstrate customers are not avoiding sanctions, some manufacturers require their customers to prove they are physically not in Russia while placing an order, the executive adds.

“You want 10 mainframe servers to Gyumri?” the executive explains, referring to a city in Armenia, another parallel imports hub. To prove it, “you go on Zoom with a procurement officer to show him you are in Armenia and you have people in the office”.

Even Russian government organisations are turning to parallel imports as a result of sanctions. Stanislav says he has been approached by two different regional Russian chambers of commerce, one located in Siberia and the other in central Russia, asking him for help sourcing foreign goods that are under sanctions or an embargo.

“They turn to us entrepreneurs and say: ‘Guys, can you bring us this? Can you import that?’”

The do-it-yourself economy

Soon after the first sanctions packages were introduced, Grigory Bolotin, head of the Cheboksary Power Machinery Plant, got his team together around a large blank sheet of paper and began to draw.

He plotted out a huge map of his business — a vast factory on the banks of the Volga river, east of Moscow, that produces forklifts, tractors and other heavy machinery — and traced all of the supply chains on which it relied.

Quickly, the team spotted the areas too dependent on western parts. Those product lines had to be suspended.

In other areas, they got creative. Where they used to import microchips to run their tractors, they decided to try making their own. They bought basic transistors and other chip parts in Asia, and learnt how to solder them themselves. “It turns out . . . fairly simple, but it does the job,” says Bolotin.

For other key components they found domestic replacements. The Japanese motors used in their forklifts were swapped out for alternatives produced in Minsk, capital of Russian ally Belarus.

“Of course, the Minsk engine is noisier, less economical, less reliable. But it’s there, it’s available. And everyone has kind of gotten used to it,” says Bolotin.

Overall, they managed to make do. But Bolotin could see the wide-ranging effect of import curbs on quality and technological level.

Cheboksary’s products were once considered to be of average quality. But since the sanctions were imposed, they have “moved into the upper segment of the market”.

“We will probably not be able to produce equipment of the same technological level as the products that were supplied by western countries,” Bolotin says. But right now, he said, Russian customers don’t care.

Economist Branko Milanovic has labelled this process a “technologically regressive import substitution”, replacing imported goods with “inferior, old-fashioned domestic substitutes”.

The economies of scale that came with importing raw materials and components are being lost.

Ribakova at the IIF explains: “You will be able to produce it, it will be just much more expensive, because it’s inefficient.” She adds: “If you’re a factory in Russia producing buttons for half the world, your unit cost of production is completely different from having to produce a limited number of buttons for a specific production.”

For example, Finland was a key exporter to Russia of chemicals that are used in bleaching paper. After its shipments stopped, several Russian pulp mills had to learn to do without or have started producing the bleaching chemicals themselves. The Soviet Union was also self-sufficient in these products.

But one result of using no or lower-quality chemicals is that some of the paper used in Russian offices has been coming out a sort of greyish-brown.

A deputy industry minister insisted earlier this year there was a silver lining, citing new findings that show overly white paper can damage your eyes. “Really shiny white office paper is actually bad for one’s health,” he said.

Data visualisation by Chris Campbell