The Patchwork Quilt: The Man-Made Crisis of 2022 and its Effect on Russia’s Regions

The war and sanctions have not inflicted as much damage on the Russian economy as analysts had predicted at the beginning of the year. Regional economic dynamics have been extremely varied in nature: ranging from sharp decline to impressive growth. These discrepancies can be explained by the extensive list of factors that have influenced Russian businesses’ struggle with the ongoing crisis: sanctions, the disruption of supply chains, the introduction of government support measures, increased defence spending, the withdrawal of Western companies from the Russian market and the emergence of new product niches. High revenues from raw material exports have mitigated the negative impact of the crisis on Russian businesses and provided ample opportunity for ‘crisis’ investments and additional government spending on the economy and social issues. Nonetheless, as the crisis drags on and its structural elements remain prevalent, a reduction in export earnings will lead to a significant deterioration of the current situation. Natalya Zubarevich, one of the most eminent specialists in Russia’s regional economics, analyses how the crisis is unfolding in the country’s regions.

Crisis 2022: Expectations, Factors and Results

In March–April, most analysts were predicting that Russia would experience a strong economic downturn, and that its regions would be no exception. Indeed, the author of this text held the same opinion, when assessing the scale of the sanctions and logistical gaps and observing the departure of many foreign companies from Russia.

It was assumed that Russian companies’ supplies of imported components would last only two to three months, but this forecast turned out to be inaccurate. Having experienced the havoc that Covid wreaked on logistics in 2020, many companies increased their stock supplies. To add to this, three important factors that were not considered at this time, have greatly influenced regional economic dynamics in 2022.

First, the significant increase in global prices of many types of resources in 2022 has allowed export income to rise even as the volume of exports fell. Second, Russian businesses have learned from previous crises, and are now able to adapt to a sudden and extreme deterioration of conditions. In 2022, they were quick to look for new markets and supply channels of imported goods, including consumer products, components and equipment. Finally, when the first forecasts were made, it was unclear how the Russian authorities would go about dealing with these impending economic problems. Solutions included allowing parallel imports (which helped to flood the consumer market with goods), increasing budget spending to support low-income social groups (pensions, minimum wages and the living minimum increased by 10%; monthly allowances for low-income families with children were introduced) and expanding subsidised mortgages in order to support housing construction, etc. These decisions, which were fiscally very costly, nonetheless helped to mitigate the effects of falling household incomes and decreased consumer demand.

Although statistics are currently only available for the period January–September, it is already possible to identify the main trends and paradoxes of the crisis dynamics that have emerged during this ‘war year’. Regions with extractive industries will not see any significant decline, mainly due to the fact that such activity can easily be redirected to other markets. In the manufacturing industry, regions with extensive automotive industries will continue to experience a serious slump. Housing construction will continue its downturn (currently most noticeable in Moscow), which will in turn lead to a contraction in demand for metals and building materials.

Non-food retail is unlikely to see a quick recovery due to the decline in household incomes and rising prices for parallel imports. These problems will be felt most strongly in the largest metropolises. The consumption of other services is stagnating, but not decreasing significantly. A slowed decline in income has allowed the population to adjust accordingly. Consumption patterns are shifting towards food, as they have done in all previous crises. Employment rates will fall and the balance between a demand for workers and labour supply can be expected to hover below current levels. At the same time, we are likely to observe some imbalances in the manufacturing industry (namely a shortage of workers), especially in regions with an ageing population. But there is unlikely to be a large increase in unemployment or underemployment in the regions. Regional budgets are currently receiving governmental support, and as a result no collapse is to be expected, however, it is likely that there will be many deficit budgets by the end of the year.

Another question that frequently arises within the business community concerns which regions offer more opportunities and higher risks? The answer is as follows: opportunities for development within the Far East (as part of the ‘pivot to the East’) remain contentious as there is little investment, the territory is losing its population, and there are almost no major projects currently in development. The southern agrarian regions and the Chernozem region are likely to experience a less severe crisis thanks to the continued domestic demand for food products, but much depends on export restrictions imposed by the government. Regions with a military-industrial complex will continue to see industry growth until the end of the ‘special operation’. Moscow will most likely weather the crisis better than other regions (just as the two previous crises), as the capital has huge economic advantages and investment opportunities. This includes the maximum share of personal income tax in its budget revenues, which serves as a stabilising factor.

The effects of sanctions in the ferrous metallurgy and timber processing (North-West) industries have already begun to be felt. At the end of 2022 and in 2023, we will witness an increase in the number of issues in the coal mining industry (most of all in the Kemerovo region) and the gas industry (YaNAO), and 2023 will also see new problems arise in oil refining (Volga region and Centre). Generally speaking, the crisis has been developing slowly, and the next important milestone will likely be in February-March 2023, when the contours of its development will become more evident.

The 2022 Crisis from the Regional and Sectoral Perspective

The mining industry, after a decline in April, was able to restore its production volumes in August. However, in September – October there was a renewed decline (-2.7% compared to October 2021). The situation differed according to various extractive industries, meaning it was also different according to the various regional ‘profiles’. The oil-producing regions — Khanty-Mansiysk and Nenets Autonomous Okrug, the republics of Tatarstan, Bashkortostan, Yakutia, Komi, as well as Samara and Orenburg regions — performed the best (see the left side of Figure 1). In the oil industry, the search for alternative markets was rather successful and was also supplemented by increased purchases of oil and petroleum products by the European Union before the introduction of sanctions. Sakhalin was the only region to witness a strong decline (-40%), as oil production at the Sakhalin-1 PSA was shut down after Exxon Mobil exited the Russian market. It is likely that, following the introduction of new sanctions in December, the economic performance of the oil regions will worsen, but it is currently difficult to predict the extent of this decline.

Despite a dramatic reduction in the production of natural gas (-20% in October), the downturn in the mining industry in Russia’s main gas producing region, the Yamalo-Nenets Autonomous Okrug, has so far been moderate (-6%), as oil production has continued. The coal mining regions (Kemerovo Oblast and the Republic of Khakassia) have seen a more noticeable decline of 10% in October, no doubt the result of summer’s export sanctions. Iron ore has also seen a sharp decrease of -17% in the Kursk Oblast and -6% in Karelia (see the right side of Figure 1).

Figure 1. Dynamics of regional extractive industries, % compared to the same period in 2021

The manufacturing industry witnessed a slower decline (-2% in October) and each region displayed its own dynamics, which depended largely on its industrial specialisation. Regions with large automotive industries suffered the most. For example, production in the Kaluga region decreased by 29% in October, while in the Kaliningrad region this figure was 20%. The regions which have been able to recover more quickly, despite their economies being largely focused on their automotive industries(namely Samara and Ulyanovsk regions) are hubs for companies that have begun making old car models from the 1990s.

In ferrous metallurgy, the decline has been felt most strongly in regions located in the European part of the country (Vologda, Lipetsk regions both saw a 15% decline in October). These regions have metallurgical enterprises that used to export large quantities of products to the EU and US markets. Conversely, metallurgy in the Urals has not suffered as much, namely because its products are more focused on the domestic market, as well as Asia. Another problematic industry — the production of mineral fertilisers – has not suffered from the imposition of sanctions, but rather from export logistic problems: in Novgorod and Kirov regions, manufacturing output decreased by 28–29%.

Sanctions on the oil refining industry will only come into effect in February 2023. The consequences of this may be especially dire in regions with large refineries, given their high percentage of diesel fuel and fuel oil exports (up to 50% of production volumes) and the associated difficulty of redirecting these exports. We will have to wait until the spring to get a clearer picture of this situation.

As was to be expected, regions with a large stake in production for the military-industrial complex (Bryansk, Ryazan, Kurgan, Omsk regions, the Republic of Udmurtia, St. Petersburg, etc.) have seen positive dynamics.

Crisis Investment and the Shift in Consumption and Income Dynamics

Current investment dynamics paint an ever more ambiguous picture. Despite the crisis, in three quarters of 2022, investment grew by 6%. This can largely be accounted for by large companies buying components and equipment for future use, in order to maintain their productions. The second reason is the impact of state budgets on investment growth: the federal budget, using a framework of diverse national projects, provided a 1.5x increase in subsidies to the regions.

It should be noted, however, that the geographic distribution of investments into regions with greater competitive advantage has remained the same. This is typical for Russia, where Moscow accounts for 20.5% of all investments countrywide, and Tyumen (the main oil and gas region) for 13%. The share of investments in the Far East remains low (9% of all investments nationally), making it unlikely that the so-called ‘pivot to the East’, previously announced by the government, will actually happen.

Housing construction has seen a slowdown, despite the positive effect of subsidised mortgages: if in the first half of the year completion of housing projects grew by 44%, then in January–October it only grew by 21%. The slowdown is especially noticeable in month-to-month trends: in September, the number of completed housing projects decreased by 10%, in October this figure was 12%, compared to the same monthly figures from last year. Among the regions with the highest numbers of completed projects, the highest growth rates have been observed in the Moscow Region (+53% in January October), and almost three-quarters of growth was observed in individual housing construction (IZHS). This shift is due to the growing attractiveness of individual housing after the lifting of Covid restrictions, alongside the accelerated process of registration of previously built houses and summer cottages, in the hope that these properties will get connected to gas supplies courtesy of the government.

The completion of housing projects in the Krasnodar region increased by a third, taking the region’s share of all nationwide completed housing projects up to 7.3%, overtaking Moscow’s share of 5.8%. The warm south is becoming increasingly attractive to the Russian population.

In Moscow, the problems of housing construction are on the rise. Completed housing projects fell by 14% between January–October 2022, and the situation was especially bad in October (it decreased more than twice as much as in September). It is possible that construction companies were anticipating a decrease in demand, thus limiting their construction activity, but it is unlikely that they had been planning for mobilisation and the mass exodus of potential home buyers. It is likely that, if the crisis worsens, this will be reflected in higher rates of bankruptcy among smaller development companies.

The macro-regional proportions of completed housing projects have, however, barely changed: the Far East makes up only 3% of the total amount, while the Central Federal District accounts for almost a third. These numbers also fail to demonstrate any visible ‘pivot to the East’.

The decline in retail trade remains the most obvious indicator of the economic crisis. Sales fell in April by -10% and then remained at that level (a -10% decrease in October 2022 compared to October 2021). This can be explained by the departure of global retail chains and a drop in car sales, meaning the non-food commodities segment of retail contracted by 15–17%. The biggest drop was observed in large cities, where retail chains and car dealers are concentrated, including the Moscow region and St. Petersburg, where retail fell by 18–19%. In Moscow that figure stood at 14%, and trade of non-food commodities declined even further, by 24–28%. The population shifted their spending to food, not only due to immiseration, but also due to dwindling supplies of non-food commodities, especially cars, which exhibited a 50% drop in sales.

Services proved to be more resilient to the crisis than industrial production and retail trade. Thus, catering services (restaurants, cafes, bars), after a slight decline in the spring, recovered in August. In October growth in this sector was almost 8% (in St. Petersburg — 9%, in Moscow and the Moscow region — 5–6%). The dynamics of this sector are determined by the largest metropolises, which account for 31% of the total catering turnover in the country. It is difficult to explain the ‘survivability’ of public catering, the only suitable argument being that the Russian population wants to ignore the growing problems around them in an attempt to maintain a sense of normality.

Paid services have also performed relatively well. In January–October their volume increased by 3.5%; there was also evidence of some minimum growth in October (+0.7%), and in Moscow and St. Petersburg it was higher by 1-2%. Housing, communal services and public housing make up the primary share of paid services, although they are indexed, which means the positive dynamics are largely artificial. Using these statistics, it is impossible to gauge the sentiment among hairdressers, fitness centres, dry cleaners, beauty salons, cinemas, etc. But it seems unlikely that they view the situation positively given the loss of a considerable portion of their client base (who left the country) and declining population income.

The labour market has managed to avoid the crisis completely. The unemployment rate (according to ILO methodology) fell to 3.8% in July–September. There was an improvement in regional performance, compared to the first half of the year, although geographic disparities persisted, from 2–3% in Moscow, St. Petersburg and most Central regions, to almost 28% in Ingushetia, Altai and Tyva. A consistently high level of unemployment also persists in some regions of the Far East — the republics of Yakutia and Buryatia, the Trans-Baikal Territory (6–8%), and this has not been affected by the crisis in any way.

The absence of a response to the crisis in the form of a decrease in employment can be explained by various factors — the scale of the exodus from the country, which was mostly made up of residents of large cities, the stronger effect that mobilisation had on both the periphery and industrial cities, and the relatively slow pace of decline in both industrial production and the service sector. The peculiarity of the 2022 crisis is that part-time employment also increased insignificantly, namely by 270 thousand people in the second quarter of 2022 (more recent data is not yet available), which is significantly lower than in the second quarter of 2020, even despite the Covid lockdowns. The most typical mechanism for the Russian labour market to adopt in times of crisis — adapting by means of increasing part-time employment — has so far been contained to regions with robust automotive industries, where production output has been affected the most.

Many doubt the credibility of population income statistics. But nonetheless, we must remember that there were significant measures implemented in 2022 to support the general public, and they helped mitigate the decline in income. According to Rosstat, the real income of the population decreased by as little as 1.7% in the three quarters of 2022. However, the decline then accelerated in the third quarter, reaching -2.4%. A more prominent drop in the population’s real income in the third quarter occurred in the Centre, in the North-West and in the Volga Federal District. It has also been particularly noticeable in regions with automotive industries (Kaluga, Kaliningrad, Ulyanovsk regions), due to underemployment and lower wages, the forestry regions of the North-West and the ferrous metallurgy and coal mining regions, which have been affected by sanctions. Ultimately, in a crisis, income dynamics are vulnerable to the sectoral specialisation of specific regions, although their vulnerability is partially mitigated by social payments handed out to the population.

According to Rosstat, the poverty rate fell to 10.5% in the third quarter of 2022, as low-income social groups received the most significant social support. It is hardly worth discussing how reliable this data is, as it is impossible to verify. But it should be noted that the government’s policy during this crisis has been much more targeted as the authorities want to support their voter base.

Regional Budgets: Income Dynamics and Anti-Crisis Support

Regional budgets have remained relatively prosperous (see table). Income tax was the main driver of income growth between January–September, but this is a considerably slower rate of growth than January–May 2022, when it increased by more than one and a half times. According to the latest data for January–October, the growth of consolidated budget revenues amounted to 15%, while income tax increased by only 12%.

The period of rapid regional fiscal growth due to high world prices for raw materials is coming to an end. It has already evidently concluded for metallurgical regions. The decline in income tax revenue has exacerbated issues pertaining to their core revenue sources. In addition, it is necessary to either return these tax overpayments (they are paid in advance), or to credit the excess paid amounts to future tax periods, as proposed in a draft law submitted by the Ministry of Finance. This will inevitably lead to a reduction in regional budget revenues in the last quarter of 2022 and in the first half of 2023. The holiday is over... It is clear that the main risks will be concentrated in more developed regions, which have a high share of export industries.

The stability of regional budgets is facilitated by interbudgetary transfers, which increased by 11% in January–September. Based on the experience of previous crises, we can predict that the federal centre will not ‘forget’ the regions, and assistance will be provided to the most troubled of these. The reason for this is simple: regional budgets are the main source of the spending that is funnelled into social issues (the share is more than 60%), and the destabilisation of social spending would be both unnecessary and dangerous for the federal authorities.

The growth of regional budget spending in January–September correlates with the revenue dynamics (see table). Priority was given to the national economy, as well as housing and communal services. In the first case, this was due to the nearly 1.5-fold increase in subsidies from the federal budget, most of which were allocated to national projects, including road construction. The growth in spending on housing and communal services was facilitated by the decisions taken by the Ministry of Finance, which allowed the regions to spend a portion of their budget loans on infrastructure projects. In terms of social spending, priority was given to education, and increased thanks to the financing of national projects. However, there was slower growth of spending on social policies due to the partial delegation of responsibility for these expenses to the Social Fund. Weak growth in health care spending occurred as a consequence of spending optimisation after a sharp increase in expenditures during Covid in 2020. The regions carried out this optimisation at various speeds. Some did it fairly quickly, which may lead to increased public discontent in the future. However, against the backdrop of hostilities and mobilisation, this is unlikely to be a significant destabilising factor.

Growth in income and spending of consolidated regional budgets, January–September 2022 versus January–September 2021, %

Income		Expense
Total	18	Total	17
Income tax	22	National economy	27
Personal income tax	15	Housing and communal services	25
Excises	20	Including optimisation	24
Property tax	13	Education	16
Total income tax	22	Healthcare	5
Transfer payments	12	Social policies	8

In January–September, the budgets of most regions were running a surplus, and only the Belgorod, Murmansk, Magadan regions and the Jewish Autonomous Region had a significant deficit. By the end of this year, the situation will inevitably deteriorate, and up to half of all regions may end up in deficit. However, in reality, the situation was worse in 2015, when 77 regions posted a budget deficit. Therefore, it would be unwise to anticipate a significant disbalance in regional budgets in 2022, nor any risks of a reduction in social spending.

Figure 2. Volume and types of regional budget debt as of November 1, 2022, billion rubles

Another important decision taken by the federal authorities was to mitigate the risks associated with debt burden in regional budgets by replacing bank loans with budgetary ones. This decision was provoked by a sharp increase in interest rates in the spring, which became an additional burden for regional budgets, forcing them to spend more money on servicing bank loans. In the summer of 2022, the Ministry of Finance allocated 570 billion rubles to regional budgets for these purposes at a rate of 0.1% per annum, and the payback date may be extended. This greatly reduces any risks, but the institutional effect of such a step is, of course, negative. Regions which have tried to pursue a more cautious budgetary policy, balancing their incomes and expenses, ended up losing out. This initiative mostly benefited regions which had accumulated debts to commercial banks. As always, the hasty introduction of support measures aimed at reducing risks for regional budgets and, more broadly, political risks for the federal authorities, have not encouraged the regions to act rationally. But they remain the go-to solution as long as export earnings remain high.