War expenditures are hurting Russia’s economy — opinion
Russia’s official growth rates have been confusing since it started the full-scale war on February 24, 2022. In 2022, Russia’s GDP fell by only 1.2%, and in 2023 it grew by 3.6% and the official growth is likely to be similar in 2024.
Yet, everything suggests that Russia is in a tight economic situation, which is likely to lead to minimal growth in 2025.
In their classical article in Novy Mir in 1987, the two Soviet economists Vasily Selyunin and Grigory Khanin showed that the Soviet Union exaggerated its economic growth by about 3 percentage points each year by doctoring the statistics. The main trick was that the Soviet authorities claimed that the quality improved when they altered a product, though in reality the quality often deteriorated. Selyunin and Khanin showed that most of the official growth was actually hidden inflation.
The same thing appears to be happening now. All the economic “growth” occurs in the military and related sectors, being produced by primarily state-owned companies and delivered to the state. The civilian sector is flat. But we know that the Russian state sector is massively corrupt, as the Anti-Corruption Foundation has shown. Embezzlement of state funds must not be accepted as value added. Independent Russian economists, notably ROMIR and Defense Minister Andrei Belousov’s old macroeconomic center claim that the hidden inflation is substantial – up to 5%.
Russia’s financial situation is very tight and worsening. At the beginning of 2024, inflation was 7.4%. The Central Bank of Russia set an inflation target of 4% for the end of 2024, but inflation rose to 9.1% in July and August, and it was probably more in reality. The Central Bank seems to know something. Since fall 2023, it has raised its key interest rate from 7.5% to currently 21% and it set to hike it further. The Central Bank now predicts that growth will decline to 0.5-1.5% in 2025 because of its high interest rates.
The Central Bank is also interested in defending the exchange rate of the ruble, but that has not worked very well. The ruble has fallen to RUB100=$1. It was RUB34=$1 in 2013. This suggests huge capital flight, which has been a permanent Russian conundrum since the end of the Soviet Union.
A major cause of inflation is the extreme shortage of labor. Russia has overfull employment with official unemployment at 2.4%, leading to huge and seemingly uncontrolled increases in real wages. Russia’s demographic situation has long been cumbersome, but in 2022, Russia experienced a net emigration of about 1 million young, well-educated men who wanted to avoid the war or the mobilization in September. Meanwhile, Central Asians are fleeing Russia to escape being conscripted into the war. Putin appears most reluctant to launch another mobilization, unwilling to face a new exodus of able young men.
The Western financial and energy sanctions bite. Thanks to Western financial sanctions since 2014, Russia can't obtain any international credits, not even from China. It has been forced to cut its foreign debts from $729bn in 2013 to about $300bn now. Thanks to lower oil and gas prices and Western sanctions, their share of Russia's federal revenues has fallen from traditionally 50% to 31% in 2024.
Undaunted by economic reality, Putin is raising defense and security costs to officially $176 bn in 2025, 41% of the federal budget expenditures. Yet, Russia can only finance 2% of GDP in budget deficit a year (=$40bn), because its only reserve is the National Welfare Fund. At the end of March 2024, its liquid resources amounted to a mere $55bn. With current low oil prices and budget deficits it is likely to run out in the fall of 2025. Then, Putin will be forced to go for defense cuts or even worse repression.
A little noticed fact, is that Putin has slashed social expenditures sharply. They used to amount to 27-30% of federal expenditures in 2019-21 but will plummet to 16% in 2025, since Putin does not care about the Russian people.
Unlike the Russian people, the elite matters to Putin. Leading industrialists, especially Putin’s KGB friend from Dresden in the 1980s, Sergei Chemezov, CEO of the state-owned armament giant Rostec, are now attacking the Central Bank and its long-time chair Elvira Nabiullina for 12% real interest rate and commercial credit rates around 30%. Ash-gray, Nabiullina looks as if she anticipates her imminent ouster. If so, inflation can really take off in Russia.
The Russian economy is frailer than generally understood because of the combination of Putin’s mad war in Ukraine and the Western sanctions work. Growth fueled by military spending will not last forever.