What is happening
If at the beginning of 2022 economic experts looked two years into the future, they would be confused. Despite the unprecedented sanctions, the Russian economy did not experience the predicted collapse in the third year of the war. On the contrary, it shows considerable vitality.
At the beginning of a full-scale war, the economy of the aggressor slowed down significantly due to the exit of foreign companies, emigration and general negative expectations. However, things have changed now: Russians are spending more than ever before, and domestic business is booming.
The reason for this is the government’s decision to fill citizens’ pockets with money by radically increasing public spending. According to the German Institute for International Affairs and Security, the wages of ordinary Russians are growing at an incredible rate. Those who lived on pennies before the full-scale invasion are now making huge sums of money.
According to Rosstat, in two years the real (inflation-adjusted) wages of Russians increased by 14%, and the consumption of goods and services by 25%. It is expected that by the end of 2024, wages will increase by another 3.5%. At the same time, unemployment fell to a historic low of 2.6%.
Sanctions combined with strict control over the movement of capital deprived Russian businesses of the opportunity to spend money abroad. Instead of buying property or other assets in the UK or elsewhere, wealthy Russians are now investing at home.
The state encourages domestic investments in every possible way, for example through preferential lending. Thanks to low interest rates, the mortgage market grew significantly: in 2023, the amount of mortgage transactions increased by 34.5%. As the Financial Times points out, Russian developers are currently swimming in money, because they sold their construction projects three years ahead.
Why did this happen?
The boom in consumption in Russia is associated with a significant increase in government spending. Starting in 2022, the government has channelled huge amounts of money into the defence sector, as well as supporting agriculture, infrastructure and the real estate market. Compared with 2021, the government is spending 20% more, and the state share in the Russian economy has increased to 50-70%. The Central Bank of Russia (CBR) recognizes that the state is the main driver of the country’s economic growth.
The share of spending on war and related industries, along with clothing for the military, fuel production and payments to the families of the dead, has risen from 23% before the invasion to 40% today.
According to the three-year budget plan for 2024-2026, Russia’s military spending should be reduced in 2025. However, given the constant increase in the intensity of hostilities, the Moscow government will be forced to change its intentions. A sign of this is initiatives to increase taxes, particularly for the oil and gas sector.
What will happen next?
Before full-scale war, experts understood that Russia had significant reserves, accumulated thanks to decades of dominance in resource markets, primarily energy. However, they obviously underestimated Moscow’s willingness to spend a lot for a long time. In addition, Russia was able to partially reorient itself to new sales markets, selling oil and gas to India and China instead of Europe.
Without a doubt, Russian government officials understand the riskiness of such an approach. The Financial Times cites the words of a former Kremlin official who does not like the fact that the economy grows only through government programmes: “Agriculture. Defence. Energy. Everything is financed through the same mechanism, although until 2022 we tried to limit it.”
The Central Bank of Russia acts as a force trying to counter the increase in costs. Conservative bankers understand that such a policy will soon lead to overheating of the economy and rising inflation. Price growth in Russia is currently fixed at 8.7%, and this value is increasing despite the increase in the base rates of the Central Bank. No matter what measures the central bank takes, it will not be able to do anything if the government continues to flood the economy with cheap money.
According to the conclusions of the Vienna Institute of International Economic Research, inflation and labour shortages will cause a slowdown in economic activity growth by the end of 2024. The Russian Ministry of Labour expects that by 2030 the shortage of workers will amount to 2.4 million people. Deputy Prime Minister Denis Manturov claims that the defence sector already lacks 160,000 workers, despite the fact that millions of Russians have moved to work in the defence industry.
In general, the Russian economy found itself in a state of maximum uncertainty regarding the future. On the one hand, the increase in public spending caused a real boom in consumption, which allowed the government to shame those who predicted the rapid collapse of the Russian economy. On the other hand, such frantic investments in the defence sector cannot be sustained for a long time: sooner or later the funds will run out, and the economy can quickly overheat with consequences in the form of hyperinflation. In addition, the emphasis on the defence industry will form an unhealthy structure of the national economy and create great problems if necessary to transition to a peaceful economy.
One way or another, for Ukraine and its allies, the main task is to block Russia’s access to sources of replenishment of the state budget. For this, it is necessary to impose sanctions on all possible sectors of the economy, strengthen control over the already introduced restrictions and work with countries that do not want to comply with the sanctions regime.
No matter how bright the economic indicators are in Russia today, they were achieved in a completely unnatural way, and they will not stay at this level for a long time. Our task is to continue, in particular, the economic pressure on the aggressor so that his downfall takes place as soon as possible.
Oleksandr Chupak, head of economic programmes of the analytical centre “Ukrainian Studios of Strategic Studies”
Український тиждень
