Kaliningrad’s Economy Buckles Under Sanctions

Executive Summary:

• Western sanctions have severely hurt Kaliningrad’s economy, particularly for cross-border transit, tourism, and fishing.
• The Kremlin has allocated increased subsidies to the region raising questions regarding the sustainability of Kaliningrad’s growing reliance on Moscow for economic aid.
• The region’s economy remains highly vulnerable to the West tightening the sanctions regime, which would potentially cut off Kaliningrad from mainland Russia altogether.

On December 12, 2023, Anton Alikhanov, the Moscow-appointed governor of Kaliningrad Oblast, called for Lithuania to “return to normal cooperation” in cross-border transit. He expressed concerns that Vilnius is taking measures well beyond the Brussels-backed economic sanctions, greatly hurting Kaliningrad’s economy (RIA Novosti, December 29, 2023). Earlier, Alikhanov lamented that the region had suffered heavy losses as a direct result of sanctions, comparable to the subsidies Moscow allocated for maritime transit between Kaliningrad and mainland Russia (Newkaliningrad.ru, November 22, 2023). Local freighters have complained that Western sanctions have put the local economy in a “dire” situation, leading many operators to unemployment (Newkaliningrad.ru, July 27, 2023). Despite conspicuous optimism and joyful forecasts, the state of Kaliningrad’s economy is much more decrepit than the image local officials have tried to project.

Since 2022, four branches of Kaliningrad’s economy have played a vital role for the region and have been adversely affected by Russia’s war against Ukraine. First, cross-border transportation, a lifeline for the region, has become one of the most severely disrupted spheres of the region’s economy (Newkaliningrad.ru, September 29, 2023). Local sources report cumulative losses of more than 6.2 billion rubles ($67 million) suffered by international freighters working in Kaliningrad between 2022 and 2023. As a result, in December 2023, industry representatives asked the local government in an open letter for a long-term solution to the increased border closures, which are destroying the transit sector of the local economy (Newkaliningrad.ru, December 11, 2023).

To address these issues, Russian President Vladimir Putin signed a decree allocating an additional 380 million rubles ($4.2 million) from the federal budget to subsidize maritime transportation between Kaliningrad and mainland Russia. This arrangement, however, comes with two primary difficulties. On the one hand, it is unclear whether the extra funds will help alleviate the “quasi-blockade” for land-based freighters in Kaliningrad. On the other hand, the region’s need for subsidies will likely grow over the coming years, thereby rendering the approach financially unsustainable (T.me/aa_alikhanov, December 28, 2023).

Second, the lack of growth in Kaliningrad’s tourism industry remains a bitter disappointment for the local economy. While never popular among foreign tourists, Kaliningrad started to attract more domestic visitors after 2014, following the first set of economic sanctions. These numbers grew in 2022 when Western sanctions were expanded to prohibit many within Russia from traveling to the West. As a result, in 2023, Kaliningrad hosted 2.5 million tourists, the most since 1991. The region aims to raise that figure to 5.4 million by 2030 (Newkaliningrad.ru, December 18, 2023). Andrey Ermak, the local minister for culture and tourism, stated that, in addition to growth in domestic tourism, he also expects “wealthy Chinese tourists” to start arriving in Kaliningrad beginning May 2024 (Newkaliningrad.ru, December 22, 2023). Local officials are considering a project near Yantarny that would include 10,000 rooms, a 500-meter swimming pool, and the capability to host 1,000,000 tourists per year to prepare for the expected influx (Newkaliningrad.ru, December 20, 2023). Developers estimate that the project will cost more than 400 billion rubles ($4.4 billion).

The economic sustainability of this initiative and its profitability for Kaliningrad’s tourism industry are highly questionable. Local tourism officials have admitted that the average Russian tourist traveling to Kaliningrad has not changed significantly over the years, with most tourists still coming from Moscow and St. Petersburg. The average monthly income of these tourists, however, has notably decreased in recent years, limiting their ability to travel (Newkaliningrad.ru, December 22, 2023). Additionally, in 2023, the average tourist stayed only three nights in Kaliningrad, spending an average of 4,201 rubles ($46) per night (Newkaliningrad.ru, December 18, 2023). Given the ambitious infrastructure plans, the region is unlikely to break even on the project for the foreseeable future.

Third, the development of Kalinigrad’s offshore zone (established in 2018) has stalled recently. The most recent development in this regard came on December 27, 2023, when Russian tech company Yandex registered with the offshore special administrative region (SAR) on Oktyabrsky Island in Kaliningrad. The local authorities, however, failed to provide any concrete information on the financial side of the deal, more specifically, the amount of taxes that will be collected and the number of jobs that will be created (Kommersant, December 27, 2023).

In 2018, Putin signed a series of laws establishing a number of SARs in Russia. These regions are designed “with flexible tax and currency regulations for international companies and the possibility of redomiciling offshore and incorporating international funds” (Special Administrative Region of Oktyabrsky Island, accessed January 16). Data published in December 2023 shows that the number of international participants in the Kaliningrad offshore zone currently stands at 270 companies and one foundation (Newkaliningrad.ru, December 26, 2023). According to official data from 2022, the total amount of taxes paid by offshore companies in Kaliningrad was slightly above 700 million rubles ($7.7 million) (Newkaliningrad.ru, September 15, 2022).

Fourth, Kalinigrad’s fisheries and related industries have fallen on hard times. In 2023, fisheries in the region increased the overall amount of fish they caught by 2 percent. Exports of finished products, however, decreased by almost half, from 72,000 to 47,000 tons (TASS, December 8, 2023). According to local sources, problems with exports can be attributed to a combination of Western sanctions and Moscow’s dubious economic policies, which have introduced a flexible export quota depedent on fluctuations in the ruble’s value. These challenges led the Za Rodinu fish-processing holding group, consisting of several local companies, to halt the export of its products abroad (Newkaliningrad.ru, December 9, 2023).

The Western sanctions imposed on Russia following its full-scale invasion of Ukraine in February 2022 have had major negative consequences for Kaliningrad’s economy. The region will likely be unable to reverse the economic fiasco in the short term based on a combination of two factors. First, the United States and European Union still have room to strengthen the sanctions regime and tighten its loopholes, specifically for maritime transportation, thereby completely cutting off Kaliningrad from mainland Russia. Second, Moscow continues to pour additional resources into the oblast’s economy, deepening its dependence on the Russian federal government. That growing dependence looks to further hurt Kaliningrad’s economy as the Kremlin steadily increases expenditures for its war effort in Ukraine.