Russia’s Import Figures Improve: Impact On Import Substitutions

Exports to Russia likely to increase as domestic manufacturing remains non-competitive

Russia’s Central Bank has forecast that the conditions for the importation of goods into Russia over the period 2023-26 have been significantly improved, with the bank predicting that 2023 import rates will be similar to pre-sanctions 2021.

However, this has an immediate impact on the much-discussed import substitution structures, which many businesses in Russia and overseas have invested in. How will these alternatives face an improved Russian import environment? This depends upon what and from where the Russian economy is going to import in the coming years in direct and indirect ways. In principle, Russia’s relationship with foreign markets may increase, rather than decrease. We discuss the implications.

Change in data analysis

At the February meeting of the Board of Directors of the Bank of Russia, the Central Bank updated its macroeconomic forecasts and calculations for the balance of payments for 2023-2025. In theory, as a contributing set of numbers, for Russian companies that are not involved in export-import operations on a large scale, as well as for ordinary investors, the bank’s economists are usually only interested in data related to the forecast of the Rouble exchange rate as opposed to the actual trade flow data.

However, following the early 2022 introduction of severe sanctions by the G7 countries against Russia, coupled with the freezing of part of Russia’s foreign capital reserves, the mechanisms for calculating the Rouble exchange rate have been significantly simplified. Now, the Rouble exchange rate, as a simplification, depends mainly on the Russian state balance of the financial account. This means calculating the foreign trade operations bringing currency to the country in comparison with how much is spent on paying for the import of goods, services and on the reserve assets account. The more unstable this trade is, the more likely it is the Rouble would devalue and, as a result, create higher inflationary pressure.

It was from this perspective that the changes made to the Central Bank forecast from October 2022 to February 2023 now look positive. The October version of the balance of payments forecast assumed that in 2023 the current account balance would amount to a solid US$123 billion, Russian exports would amount to US$631 billion, and imports to US$340 billion.

In 2024, the Bank of Russia assumed, the balance will drop to US$53 billion, and in 2025 it will approach a rather dangerous minimum of US$15 billion. For such a large economy as the Russian one, just US$15 billion excess of exports over imports is very small, objectively, the Central Bank’s calculations assumed that over the next years the Russian economy would reduce exports from the record US$631 billion in 2022 to US$515 billion in 2023, US$464 billion in 2024 and US$431 billion in 2025.

It is worth noting that due to sanctions, Russia’s 2022 exports, and especially in oil, increased by an estimated US$80 billion in additional export earnings. If sanctions had not been imposed, the excess would have been about US$120 billion. That US$40 billion shortfall has actually helped Russia adapt its economy faster than it would otherwise have done.

Import-Export Assumptions

This decline in October 2022 by the Central Bank was based on assumptions about two overlapping processes: the reduction of Russian raw material exports to the G7 countries and its partial reorientation to India and China; and a reduction in (mainly non-commodity) exports due to increased domestic demand, and the restructuring and incentivizing of Russia’s export industry to meet the needs of the domestic economy. The government also discussed the need to introduce import substitution programmes and assumed that any import-substituting production would also stimulate exports. However, at least for the immediate few years, sanctions restricted and in some cases completely ceased inbound imports from the EU, the United States and other G7 countries. That meant Russia had to replace this short term need with domestic production and left Russia with no export market to these players, except for the food Russia has been exporting to the West for over a decade and which were largely sanctions-exempt lest they go hungry. (The European markets still consume large amounts of basic Russian foodstuffs such as cereals and dairy products).   

Shifting Supply Chains

But more importantly, in the new Central Bank forecast, non-export figures and import data began to assume greater importance. An analysis of 2022 led the banks analysts to assume that exports of goods and services from Russia in the coming 3-5 years will remain at about US$500 billion a year, and imports would also remain at similar levels, indicating market and economic stability.

External Russian analysts were also surprised that in January 2023, based on currently classified customs data, the Central Bank estimated imports for Q4 2022 to be US$20 billion higher than it had expected a month earlier. This was revelatory, as Russia’s 2023 New Year’s consumer demand was weak, and no one had rational assumptions that this would change.

But the forecasts of the Central Bank for imports in 2023–2025 have changed. Already during 2023, according to the bank, imports should return to 2021 levels at US$384 billion and in essence, to remain at the same level or be slightly higher for the next three years.

From the Rouble exchange rate perspective, this is the end of a potential exchange rate crisis as the current account surplus should remain on the forecast horizon above US$40 billion (although its estimate for 2023 by the Central Bank has halved to US$66 billion. This is apparently enough for the stability of the national currency, even taking into account the G7 freezing most of Russia’s international foreign exchange reserves.

2023-26 Russian Import Projections

However, this still asks the question of what Russia is going to do about creating an import-export balance – and has the country already begun to import in quantities greater than in 2021 and 2022?

Analyzing the structure of Russia’s 2022 imports would give us answers should this data be available, but it remains classified, mainly because some of this is related to G2G agreements (such as between Russia and China and India, among others) and are not intended for either the public’s and certainly the West’s consumption, particularly as the G7 has been financially and trade aggressive towards Moscow. Why make available trade data unfriendly countries can then use against you?

The Case Against Import Substitutions

However, in general terms, these forecasts paint a negative picture for those businesses and individuals who had intended to generate profits from import substitutions. This is because there is no weak Rouble, parallel import channels are working, and domestic demand is stable.

If Russia’s imports are expected to recover, then where is the place for import substitution?

Import substitution assumes that Russian companies will compete successfully in the domestic market against foreign goods that are now returning through the back door. These include products under sanctions or those that were officially withdrawn from the market by the foreign companies that exited Russia. It also assumes that formerly Western-sourced imports will be replaced by goods from China, India, Southeast Asia, and Latin America.

Finally, the expectations of economists concerning investments into Russia for 2023-2025 have also spoken against this. From mid-2022, very few investment project imports were delivered into Russia – such as auto imports, machine tools, production lines and electronics. This indicates that the increase in imports from the end of 2022 is related instead to massive consumer imports, including parallel imports, and from the black market. Meanwhile the accumulation of warehousing stocks of critical imports by Russia is continuing in fear of a further tightening of sanctions.

Both the first and second options for import substitutes are problematic in different ways. On one hand, the process looks more or less natural. If electronics, the automotive industry, power engineering and aircraft manufacturing are all excluded, the Russian economy will replace all remaining imports. However, it is generally believed, that it is in these precise sectors that the entire Russian long-term economic structure depends. Importing products from these industrial sectors, at new increased prices, with expensive and poor logistics, and without global support from manufacturers will still prove a more reliable for any product, than getting involved in developing import substitution manufacturing.

This is akin to the Russian experience during the pre-Covid and sanctions eras and, apparently, more reliable than building up import-substituting domestic production. Doing so means it is necessary not only to achieve the production standards of a competitive product, but also to make it cheaper than foreign competitors, no matter if they are friendly Chinese or unfriendly Dutch, whose products will still be brought here through parallel imports and either by the same China or by other routes. On the other hand, if state structures create and continue to create large stocks of foreign imports, domestic import substitution will not be required.

But for now, these concerns are somewhat academic. Most likely, both options are correct, as Russia does need to build up domestic production and create its own import substitutes and start to compete. Meanwhile, the general economic pessimism in Russia has not become much worse and some important, but subtle changes in the 2022 budget structure has led to the fact that the natural level of imports under these circumstances increased; and did not decline as expected.

Central Bank’s forecast compared to previous versions are essentially an expectation that there will be no import substitution in Russia in the coming few years, and that Russia’s dependence on imports, including those from parallel imports and the black market will generally grow. That could be a blessing in disguise: only Russian manufactured products with a strong development and innovative component will prevail in what remains a domestic market with intense competition from foreign brands and products.

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