The Russian economy ended 2022 in a far better state than many had anticipated in the spring following the invasion of Ukraine and ensuing Western sanctions. The fall in GDP has only amounted to about 3% or even less, and the US dollar is still trading at less than RUB65. Even the Western ban on high-tech imports, although challenging, has proved manageable as imports of semiconductors from China in particular soared in the second half of the year Trade was down by 15% y/y and retail sales fell 10% y/y, but a doubling of investment by the state held economic growth up as the Kremlin puts the economy on a war footing. None of this means that Russia’s economy is out of the woods: many risks still remain and several serious problems caused by the sanctions were starting make themselves felt as the year wound down. Oil and gas revenues started to fall sharply in November. Oil and gas revenues contributed RUB866bn ($13bn) to the state budget — down 2.1% y/y. This is not a critical fall in revenues. However, in reality, almost half of that sum ($6.4bn) came from a one-off payment of Gazprom’s mineral extraction taxes. Without that money, oil and gas income was down 48.9% compared with 2021. There are two possible reasons for this. First is the near-total cessation of pipeline gas exports to Gazprom’s lucrative European market following the closure and subsequent explosions on the Nord Stream gas pipeline. Second is the fall in prices for Russian oil, which led to November’s oil revenues being down 25.4% y/y. Russia’s Finance Ministry is printing money to cover this deficit. The federal budget ended the year with about a 2% of GDP deficit but reserves and a flurry of Russian Finance Ministry’s OFZ treasury bill issues in the last quarter covered the shortfall. Part of the hole is filled using the National Welfare Fund, but this alone will not be enough. Relying solely on the NWF would mean the liquid part of that fund would run out by 2025 according to the projected budget deficit, Central Bank analyst say. This fall, the Finance Ministry turned to large-scale borrowing in the federal loan bond market to cover the rest of the deficit. These internal loans raised RUB1.44 trillion ($22bn) for the ministry from a total planned borrowing of around RUB2.5 trillion for the whole year. Of this sum, 77% derives from bonds floating rates, which will ultimately be tied to Central Bank rates. The main buyers of these bonds were leading state-owned banks, which previously borrowed RUB1.39 trillion ($21bn) through REPO transactions. This mechanism is in effect the CBR printing money to cover the deficit. This has obvious consequences: it will likely increase inflationary pressure, forcing the central bank to raise interest rates and sacrifice economic growth, although the CBR has kept rates on hold at 7.5% at the last few meetings of the year. Just how inflationary this borrowing is remains a matter for debate. Economist Viktor Tunev calls these loans “Russian QE”: the CBR creates liquidity in the form of federal loan bonds, simultaneously improving standards in assets and enhancing money supplies to the banks’ liability without involving capital. The quality of life in Russia slipped somewhat in 2022 but not by a large amount and not by enough to cause social unrest. Unemployment levels in Russia remains close to historic lows even as foreign companies have left the market and factories have closed. The latest official figures show that 3.9% of the workforce was unemployed in October; the all-time low of 3.8% unemployment was set in August. There are several possible explanations for this paradox. First, Russia’s labour market always responds to a crisis by cutting salaries first, not jobs. Second, the low level of benefit payments in Russia means that people who do lose their jobs are likely to grab any job they can as soon as possible. On top of this, Russia launched its military mobilization amid this “compressed” labour market. The loss of approximately 1-1.5mn people from the labour market due to war-related mobilization and emigration will exacerbate the situation with a growing pool of unfilled vacancies. This serves as a wake-up call that Russia’s labour resources are limited, says Alexander Isakov, an economist specializing in Russia and Central & Eastern Europe at Bloomberg Economics. Because there are no spare resources in the economy, mobilization requires those working in “productive” industries (such as processing, construction and transport) to be diverted into the state sector. All of this impedes potential economic growth: increased defence and public sector spending have structural side effects that will limit potential annual growth to about 0.5% over the coming five years, Isakov says. Russia’s real estate market is currently experiencing a bubble due to cheap mortgages. The current program of discounted mortgages at a rate of 7% was due to end in Russia at the end of this year. Both the Central Bank and the Accounts Chamber have repeatedly called for the scheme to be cancelled. However, President Vladimir Putin announced in December that the program would continue, albeit at a slightly higher rate of 8% as construction is a way of boosting economic growth and employment. These discounted mortgages are causing Russia’s real estate market to overheat. The primary and secondary housing markets are unbalanced (the price difference between a new apartment and a “maintained” apartment is now 40%). Subsidies have made housing more affordable for more citizens, who have decided to take out mortgages now rather than wait. Demand has risen sharply — faster than supply can adapt — and prices are soaring. In Moscow, it is now impossible to buy a comfort-class apartment in a new building without taking out a mortgage. However, this bubble is unlikely to burst as developers have already sold more than 51% of the housing due to come onto the market by the end of 2023. They need to sell a further 10-20%, which is entirely achievable even if demand falls to summer levels. Defaults on mortgage portfolios could also burst the bubble, but with a failure rate of just 0.4% (and 0.15% in the primary market), this is also unlikely, analysts say. The sanctions leakage remains significant, but is impacting everything, and the productive industries that rely on western inputs, technology and equipment most. Consumer goods have largely rerouted to enter Russia via “friendly” countries, with Turkey playing the leading role. The ban on seaborne shipments of Russian crude oil to EU countries went into effect on December 5. The ban does not apply to crude oil transmitted by pipeline. Germany and Poland, the largest European buyers of Russian pipeline crude, have announced that they will also suspend their pipeline imports. A few EU buyers (Hungary, Czech Republic and Slovakia) will at least temporarily continue to import Russian pipeline oil. Most of EU crude oil imports from Russia, however, are now ending. Russia must find new buyers for about a quarter of its crude oil exports. The import ban on Russian petroleum products enters into force in February 2023. Russian oil exports were halved in the second half of December as shippers paused to assess the risks, but analysts expect the volumes to pick up in the first quarter of 2023 as new routes are found. In addition, Greek shipping that increased its share of transporting Russia oil from 35% pre-war to 55% in the second half of 2022 have been selling old tankers to Russia, which is building up an unsanctioned fleet of its own that will aid this process. Under the G7 sanctions maritime services related to the transport of Russian crude oil can only be offered for oil priced below the price cap. The price cap is currently set at $60 a barrel, but could be revised downwards later. Russian Urals-blend crude was already trading below the cap price before the cap entered into force. Russian officials have discussed countermeasures to address the price cap and have threatened to cut production by half a million barrels a day or about 7% that could send oil price up over $100 in the first quarter of 2023. A similar price cap for petroleum products should enter into force in February 2023 and will further unsettle the market. The European Commission also proposed its ninth package of Russia sanctions in December, but they contain nothing of particular note, consisting largely of an expanded list of people added to the Specially Designated Nationals and Blocked Persons (SDN) List. Gas production in Russia in January-November 2022 decreased by 11.6% compared to the same period last year and amounted to 612.9bcm. The main contribution to the overall dynamics was made by the decline in production at Gazprom. The largest independent gas producers - Rosneft and Novatek - showed an increase in production. While there has been a lot of talk of peace talks starting in September no concrete action has been taken. Kyiv is calling for a UN sponsored peace summit in February, while the Kremlin has said it is willing to talk peace “at any time”. However, the positions of the two sides is so far apart that no talks are likely. Kyiv is insisting that Russia quit Ukraine completely before talks can start whereas the Kremlin is insisting that Kyiv recognise the annexation of four Ukrainian regions on September 30 before it is willing to talk. Neither side will recognise the other’s demands. In the meantime, both sides are running low on ammunition and their manpower is stretched. Following the partial mobilisation that started on September 21 the new General Sergey Surovikin has reorganised and adopted a more defensive stance. Russian troops are dug in in multilayer defensive lines in Donbas and from the 300,000 men mobilised, 120,000 are in reserve in the rear allowing for rotation of troops to keep those at the frontline fresh. At the same the rate of artillery fire has been reduced to preserve resources. Analysts were widely speculating that Russia will mount a major counter offensive in the winter, sometime between January and May, with the goal of taking the whole of the greater Donbas region.