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Russian Economy - War with Ukraine

More than 1,000 days since Moscow launched its all-out invasion of Ukraine, Russia had transformed its economy, retooling it to fuel the war effort and cope with Western sanctions. Prices of milk, potatoes, and butter are soaring in Russia. Retailers are beefing up security to prevent shoplifting. Mortgage rates are skyrocketing as the sales of new apartments plummet.

"After two years of growth fuelled by massive injections of money into the military-industrial complex, the creation of a well-paid army of mercenaries, significant deregulation of foreign trade and adept sanctions evasion, the economy is still facing visible challenges ... recent trends will not push the Russian economy into crisis. Tax collection remains robust; the most pessimistic forecasts about declining export revenues have not yet materialised; and the ‘deathonomics‘ model continues to work. Moreover, if active hostilities in Ukraine cease or freeze in the coming year, this will undoubtedly increase the resilience of the Russian economy and (albeit less significantly) reduce the level of military spending.... Russia has now sufficient economic resources to sustain the current course for at least another three years, " wrote By Vladislav Inozemtsev 26 November 2024.

Inozemtsev noted 25 January 2025 "Already in the first year of the full-scale invasion, Russia initiated a policy of circumventing trade sanctions through intermediary countries, mainly its partners in the Eurasian Economic Union. While its closest ally, Belarus, could not help the Kremlin much, having faced similar restrictions earlier and for other reasons, Armenia and, to a lesser extent, Georgia in the Caucasus and Kazakhstan and Kyrgyzstan in Central Asia showed their «true colors». Kazakhstan increased its exports of smartphones to Russia by 2,000 times in 2022, while Armenia exported 225 times more cars to Russia (which it does not produce) and 11 times more gold (precisely after transactions with Russian metal were banned by EU sanctions). While the volume of Russia’s foreign trade transactions fell by 10.2 per cent between 2021 and 2023, Russia’s mutual trade turnover with Kazakhstan increased by 48 per cent, with Kyrgyzstan by 75 per cent and with Armenia by more than 4.2 times. The question is: was it possible to stop the circumvention of Western sanctions by the countries of the Eurasian Economic Union? Yes, it was — and the same tool could have been used to achieve much more ambitious geopolitical goals." " The Russian currency plunged to 114 rubles against the dollar on 27 November 2024 amid mounting geopolitical instability. The Russian ruble continued to slide, trading data from the Moscow Exchange (MOEX) showed. The sharp decline came amid Western sanctions and growing geopolitical uncertainty, analysts say. The ruble was trading at its lowest since March 2022. The Russian currency has fallen to 119 to the euro. The ruble’s slump has been exacerbated by the latest Western sanctions, analysts told business daily RBK. The US had imposed a new round of penalties against a number of companies in the Russian financial sector. The measures targeted Gazprombank, Russia’s third-largest bank, which has played a key role in processing payments for export operations. The Bank of Russia announced it would suspend purchases of foreign currency on the domestic exchange from November 28 until the end of the year, to reduce market volatility.

Government spending on things like tank production, missile manufacturing, and military uniforms has spurred growth across the country. Extraordinarily high wages paid to volunteer soldiers -- and bonuses and benefits paid to widows -- have sent a flood of money into poorer regions. On the flip side, inflation is skyrocketing. The Central Bank has struggled to tame inflation, hiking the key interest rate to 21 percent in October, the highest level in over 20 years. The warning lights, experts say, are blinking. There are fears of a rising tide of corporate bankruptcies as companies drive up wages, struggling to attract employees from a shrinking labor pool. Mortgage rates, driven up by the Central Bank, meanwhile, are scaring off homebuyers in a growing number of regions.

"At the current rate, it is more profitable for companies to stop development, [and] even reduce the scale of business and put its funds on deposit, than to conduct business and bear the associated risks," Aleksei Mordashov, a Kremlin-connected oligarch who heads the largest steel company in Russia, said in October 2024.

Government spending on the war effort drove GDP growth in 2023 to 3.6 percent despite sweeping Western sanctions and efforts to cut off trade with Russia. In 2024, forecasts predicted the economy would grow 3.9 percent. Unemployment, meanwhile, dropped to 2.4 percent in September 024, with labor shortages helping to drive up wages. High interest rates not only affected the real estate market. Rising corporate debt made it significantly more expensive for companies to take out loans to expand operations -- or to raise wages to compete with workers who choose to sign up to fight in Ukraine. In some regions, men are promised the equivalent of one year's wages just for enlisting.

There are no sectors in Russia that are growing, except for the military. A million people have left Russia. If there is mobilization, if they try to close the borders, people will flee the country again, the demographic situation will worsen. Obviously, the long-term problems are big, the longer the war goes on, the worse it will be. When it will get really, really bad is unclear. Will there be political problems? Most likely, no, since you can always say: it is our enemies in the West who are creating problems for us. Or say: if you complain about inflation, it means you are simply unpatriotic. The economy does not fall, because growth is happening through the military industry, simply put, they produce tanks, which are then destroyed, and more tanks need to be produced. There is demand for people.

Andras Toth-Czifra concluded by October 2024 that the Russian government’s plans to economically boost its Far Eastern regions were on shaky foundations. "The development of the Russian Far East will happen eventually, but the war has created a conundrum, from which there is no easy way out. It has shifted planning horizons for economic actors, but only gradually. For the first two years of the full-scale invasion, the Kremlin’s underlying promise was that victory was always around the corner, after which economic actors would be able to go back to «business as usual» with the West. This promise has not been fully revoked, but the Kremlin has started to prepare the country, both in its rhetoric and in its economic planning, for a prolonged confrontation with the West, signaling, also, that businesses will need to focus more on the Far East. But at a time of high interest rates, uncertain returns on investments, growing taxes and a worsening labor market pressure — all, to a considerable extent, also consequences of the war — development will either take enormous federal financing or considerable foreign investment."

The Russian economy continued to grow in lae 2024 but at a slower pace than in 2024 H1. This deceleration was mainly caused by increasing supply-side constraints, including a decrease in the availability of spare production capacity and labour resources. Domestic demand is supported by growth in lending and incomes of households and businesses, as well as by increased fiscal spending. The upward deviation of the Russian economy from a balanced growth path was still significant. This is also evidenced by high current inflationary pressures. The labor market remained tight. Unemployment was at its record low. The labor shortage was growing in many industries. Rising wages continued to outpace growth in labour productivity.

On 25 October 2024, the Bank of Russia Board of Directors decided to increase the key rate by 200 basis points to 21.00% per annum. Inflation is running considerably above the Bank of Russia’s July forecast. Inflation expectations continue to increase. Growth in domestic demand is significantly outstripping the capabilities to expand the supply of goods and services. Additional fiscal spending and the related expansion of the federal budget deficit in 2024 have proinflationary effects. Further tightening of monetary policy is required to ensure the return of inflation to the target and reduce inflation expectations.

Putin’s economic miracle continued to be supported by foreign exchange earnings from the export of natural resources, primarily oil. There are no people who are ready to sacrifice the world economy in order to undermine Russia. There is democracy in the West, and even Western countries that support Ukraine, their voters will not support politicians who would completely cut off oil from Russia, because of this the price of oil will rise. The share of Russian oil on the world market is only 5 percent. Even 5 percent can have a big impact on the price. Even just rumors that there would be problems with Russian oil, they would raise oil by 20, 30, 40 dollars, and to close it completely - that would be even more. American oil plays a very significant role in the supply of oil on the world market, its cost is somewhere around 50 dollars.

Fortune magazine published an article 19 August 2024 entitled "Economic Disaster Lurks Behind Russia's Growing GDP." Its authors claim that they oppose "cynics who paint an unrealistically optimistic picture of a supposedly resilient Russian economy." In reality, they say, the Russian government is throwing huge sums at military production, starving the Russian economy of funds. It is taxing oil companies to finance the war, raising taxes, and fueling inflation with its actions. The flight abroad of hundreds of thousands of educated Russians, the lack of investment and access to technology guarantee, at the very least, a protracted decline of the Russian economy. The National Welfare Fund is drying up.

The main evidence of the difficult situation of the Russian economy is inflation, the fact of economic growth on unproductive investments, on unproductive consumption. Reduction of buffers, such as the National Welfare Fund. And signals that the state itself is not ready to spend more or less acceptable amounts on supporting people who have suffered greatly - such as the migrants in Kursk. These 10 thousand rubles are a ridiculously small amount.

Internal problems are accumulating in Russia. It is like in the Soviet Union in the 80s: problems accumulated, but it existed. Some trigger or shock will be needed, a fundamental trigger, for example, oil prices will fall or there will be serious political instability. Then, of course, the economy will collapse. The crisis is approaching due to the fact that the health of the economy is deteriorating.

But the forecasts and hopes of many, including economists, that unprecedented sanctions and the seizure of half of Russia’s foreign exchange reserves would deprive the Kremlin of the ability to wage war did not come true. It is relatively easy to fight – the state has to pay people money, then they can go and die even with shovels. As long as this money is there, the state can pay it. The poorer the society, the less it has to pay. Therefore, there is usually no quick crisis, it will only happen if all the sanctions, for example, and trade were hit in one day to generate real panic and loss of trust in the system. The economy adapts to sanctions introduced gradually.

As long as oil is traded and traded at high prices, it is possible to fight. When there is even a temporary drop in prices or for some other reason a significant increase in the costs of oil production, then a crisis will occur. Therefore, the work that the world is doing, especially the sanctions coalition, with respect to the shadow fleet, so that trading oil is more expensive – these are systematic cuts in a specific direction. About 50 vessels of the shadow fleet were subject to sanctions for violating the price restriction policy, and the fleet itself is approximately 10 times larger. If, of course, the entire fleet is subject to sanctions, then the discount will be completely different.

The Central Bank of Russia in July 2024 predicted a slowdown in the economy to almost zero in 2025 and inflation that would exceed government forecasts by one and a half times. The head of the Central Bank, Nabiullina, said that labor reserves and production capacity are almost exhausted, which creates a risk of stagflation. The growth in consumer prices will reach 6.5-7%, and supplies of imported goods will continue to decline. To curb inflation, the Central Bank raised the key rate to 18%, but this could lead to a slowdown in economic growth. Additional complications are created by sanctions due to the war in Ukraine, which complicate the financial transactions of russian companies.

China has leveraged Russia’s shift in energy trade focus from Europe to Asia, in the wake of Western sanctions imposed over the invasion of Ukraine. Chinese companies have seized the opportunity presented by discounted prices, increasing purchases of Russian energy. However, Chinese entities have remained cautious and compliance-driven, ensuring they steer clear of violating sanctions.

Russia’s February 2022 invasion of Ukraine propagated through multiple channels, including direct exposures from commodity markets, trade linkages, tourist inflows, and remittances. The war came in the midst of the COVID-19 pandemic, which had already precipitated widening inequality both within and between countries, particularly among lower-income groups due to severe job and income losses.

Following Russia’s invasion of Ukraine, the Russian economy plunged into a deep recession, with output projected to contract 11.2 percent in 2022 amid a collapse in domestic demand. Sanctions impaired Russia’s sizable macroeconomic buffers and triggered trade, financing, and confidence shocks. Domestic demand is expected to be depressed as job and income losses, increased poverty, inflation, and supply disruptions reduce consumption while investment continues to fall amid the loss of foreign investment, supply shortages and trade disruptions, weakened economic prospects, reduced domestic lending capacity, and high interest rates. Foreign firms continue to pull out of the Russian market, with more than 400 U.S. companies withdrawing from Russia. Import compression due to the collapse in demand and export bans to Russia ameliorated external financing pressures and elevated export prices. Still, the disruption of imports interrupted some domestic sectors, including automobile production and aerospace.

Russia’s invasion of Ukraine prompted several countries to impose a wide array of sanctions, with Russia estimated to be the most sanctioned country in the world. As of late March 2022, financial sanctions encompassed about three-quarters of Russia’s banking sector by assets. Sanctions have constrained Russia’s access to global financial markets, including through the removal of seven Russian banks from the Society for Worldwide Interbank Financial Telecommunication (SWIFT) network. Restrictions on the Central Bank of the Russian Federation (CBR) have been among the most damaging sanctions, with the freezing of Russia’s gross international reserves held overseas inhibiting Russia’s ability to meet its financing obligations. Russian external debtors, both private and public, face severe challenges to servicing external debt given capital controls and sanctions on international transactions.

Sanctions triggered an initial sharp depreciation of the ruble against the dollar, forcing the CBR to more than double the policy interest rate, impose capital controls, and provide bank liquidity and broad forbearance measures. Going into the second quarter of 2022, the banking system largely stabilized, outflows somewhat stemmed, and the ruble nearly returned to its pre-war level against the US dollar. The Russian stock market reopened in late March after being closed for about a month. Since reopening, authorities intervened in the market to curb volatility by restricting investor activity, including through measures that limit trading to certain securities and bans on short-selling and non-resident trading.

Since Russia and Ukraine are large exporters of commodity inputs that are upstream in many global value chains, shortages of their commodity exports may severely affect a wide range of industries, including food, construction, petrochemicals, and transport. For sectors that are dependent on key commodity inputs from Russia and Ukraine, the war has already caused logistical disruptions—including from security concerns and lack of insurance coverage due to the surge in risk premiums—which are likely adding to existing supply chain strains. Russia is a major supplier of agricultural inputs, accounting for over 90 percent of cereal product imports in Kazakhstan, Armenia, and Georgia, as well as automotive products, stainless steel, and batteries.

Starting on February 28, Russia closed its airspace to airlines from 36 countries, including those within the European Union. Regional tourism was impacted by the war through prohibitively higher fuel prices and reciprocal airspace closures, with flight routes over Russian, Ukrainian, Moldovan, and/or Belarusian airspace disrupted. The need to reroute flights resulted in higher fuel costs, crew block hours, and travel times, in turn causing some flights to be canceled as these routes are rendered infeasible or economically unviable. Capacity on routes between Europe and East Asia — which often must fly over Russian and/or Ukrainian airspace — was reduced, with airlines cutting 2 to 9 percent of flights scheduled between March and June.

Together, Russia and Belarus — both of which are under heavy international sanctions — supply nearly 38 percent of the world market in value terms for potassic fertilizers, 15 percent of nitrogenous fertilizers, and about 17 percent of compound fertilizers. Russia is the world’s largest exporter of fertilizer, accounting for 13 percent of global exports. More than 40 percent of Russia’s chemical exports consist of fertilizers, with almost all CIS countries importing at least 30 percent of fertilizer from Russia. Belarus, Mongolia, and Moldova import over two-thirds of fertilizers from Russia, Honduras and the Central African Republic over half. Higher natural gas prices doubled the price of fertilizer. Russia recommended that fertilizer manufacturers halt exports of fertilizer, which will hinder food production elsewhere.

The Russian monetary unit in the summer of 2023 entered the top three weakest in the world and leads in terms of volatility. August is traditionally a "cursed" month for the ruble. The economy is experiencing a currency shortage, while imports continue to grow. During 2023, the ruble lost 57% against the dollar, the euro - 73%. And the fall continues. The main reason is the simultaneous reduction of exports and expansion of imports. In July, oil and gas revenues were less than planned by 32.7 billion rubles. There was a currency famine in the country.

“The reduction in export earnings and the growth of imports create an imbalance in the supply and demand of the currency. Although oil prices are increasing, this is not enough to stabilize. For a correction in ruble pairs, a decrease in foreign purchases is necessary. In addition, export contracts in rubles reduce foreign exchange earnings,” Vladislav Antonov, financial analyst at BitRiver points out. The most likely range in early autumn is 94-100 per dollar and 100-108 per euro, the analyst predicts.

According to investment adviser Yulia Kuznetsova, the potential for ruble weakening is wider. "By buying currency at such a high rate, the Central Bank is likely to expect even greater growth in the dollar and the euro. In the fall, we will see 120 for the dollar and 130 for the euro, if the Central Bank does not intervene," she said.