Moscow touts the resilience of the Russian economy, claiming continued growth and improved living standards despite sanctions. Yet, it is worth examining the underlying reasons for this performance and what the future may hold for the aggressor’s economy.
What’s happening?
Had economic experts in early 2022 peered two years ahead, they would have been confounded. Despite unprecedented sanctions, Russia’s economy has not collapsed as predicted in the third year of the war. On the contrary, it has demonstrated a surprising level of resilience.
Initially, the onset of the full-scale conflict saw Russia’s economy falter, hampered by the exodus of foreign companies, widespread emigration, and bleak expectations. Yet, this picture has since shifted: Russians are spending more than ever, and domestic businesses are flourishing.
The Kremlin’s decision to inject significant funds into the economy by dramatically increasing state expenditure is the driving force behind this resilience. According to the German Institute for International and Security Affairs, wages for the average Russian have surged at a startling pace. Those who once struggled to make ends meet before the invasion are now earning considerable sums.
Rosstat reports that over the past two years, real wages in Russia have risen by 14%, while consumption of goods and services has surged by 25%. Wages are expected to increase by a further 3.5% by the end of 2024, and unemployment has dropped to a record low of 2.6%.
Sanctions, coupled with stringent capital controls, have effectively curtailed Russian businesses’ ability to spend abroad. Wealthy Russians, once keen on acquiring real estate or assets in the UK and other countries, are now funnelling their money back home.
The Russian state is actively fostering this trend, offering preferential lending to spur domestic investment. Low interest rates have fuelled a boom in the mortgage market, with the value of transactions jumping by 34.5% in 2023. As the Financial Times notes, Russian developers are currently flush with cash, having pre-sold construction projects up to three years in advance.
Why did this happen?
Russia’s consumption boom is directly tied to a substantial surge in government spending. Since 2022, the Kremlin has channelled vast resources into the defence sector, alongside bolstering agriculture, infrastructure, and the real estate market. Government spending has soared by 20% compared to 2021, with the state’s footprint in the Russian economy now accounting for an estimated 50-70%. The Central Bank of Russia (CBR) concedes that state intervention is the primary engine of the country’s economic growth.
The proportion of government expenditure dedicated to the war effort and its related industries—including military apparel production, fuel manufacturing, and compensation for the families of fallen soldiers—has climbed from 23% pre-invasion to 40% today.
Russia’s three-year budget plan for 2024-2026 originally anticipated a reduction in military spending by 2025. However, the intensification of the conflict suggests that these projections are increasingly unrealistic. The government is already signalling potential shifts in fiscal policy, with proposed tax hikes, particularly targeting the oil and gas sector, as a clear indication of the financial pressures mounting on Moscow.
What’s next?
Before the onset of the full-scale war, experts recognised that Russia possessed significant reserves, accumulated over decades of dominance in resource markets, particularly energy. However, they likely underestimated Moscow’s resolve to sustain heavy expenditure over an extended period. Additionally, Russia has successfully redirected some of its oil and gas exports to new markets, such as India and China, rather than relying solely on Europe.
Russian officials are undoubtedly aware of the risks inherent in their current strategy. The Financial Times cites a former Kremlin official expressing concern over the economy’s dependence on state-funded programmes: “Agriculture. Defence. Energy. Everything is financed through the same mechanism, despite our efforts to limit this approach before 2022.”
The Central Bank of Russia is grappling with the effects of escalating government spending. Conservative economists are concerned that this policy sets the stage for economic overheating and rising inflation. Despite the Central Bank’s attempts to curb inflation—currently at 8.7% and rising—the effectiveness of its interest rate hikes is diminishing. The central bank’s efforts are unlikely to counterbalance the government’s ongoing infusion of cheap money into the economy.
The Vienna Institute for International Economic Studies forecasts that inflation and a labour shortage will likely decelerate economic growth by the end of 2024. Russia’s Ministry of Labour anticipates a shortfall of 2.4 million workers by 2030. Deputy Prime Minister Denis Manturov has highlighted a current deficit of 160,000 workers in the defence sector despite millions of Russians having transitioned to roles within defence industries.
The Russian economy is currently navigating a landscape of profound uncertainty. On the one hand, the dramatic increase in government spending has catalysed a consumption boom, enabling the government to counter predictions of a swift economic collapse. On the other hand, such extensive investments in the defence sector are inherently unsustainable. Eventually, financial resources will be depleted, potentially causing the economy to overheat and triggering hyperinflation. Furthermore, the heavy emphasis on defence spending has distorted the economic structure, which could create significant difficulties if a shift towards a “peaceful” economy becomes necessary.
The foremost objective for Ukraine and its allies is to sever Russia’s access to its revenue streams. Achieving this entails imposing sanctions across every conceivable sector, intensifying the enforcement of existing restrictions, and engaging with nations hesitant to comply with the sanctions regime.
Despite the apparent robustness of Russia’s current economic indicators, these figures have been achieved through fundamentally artificial means and are unlikely to endure. The primary goal must be to persist in applying economic pressure on the aggressor, aiming to precipitate its downfall as expeditiously as possible.
