Putin is trying to finance the war, maintain social spending and avoid soaring inflation all at once; ‘an impossible trilemma’, according to experts.
Here’s an interesting statistic. Last year, Russia’s GDP grew by 3%, according to the International Monitory Fund. By contrast, the US recorded a 2.1% growth and the UK a mere 0.5%. So, Russia has emerged from two years of war looking relatively unscathed, despite extensive sanctions imposed by the West that were designed to destroy Russia’s economy. Soon after the start of the war and the imposition of sanctions, the IMF said it expected the Russian economy to suffer a severe two-year recession, contracting by 8.5% in 2022 and a further 2.3% in 2023.
In the event, the economy did shrink in 2022, but by only just over 2%, and last year it rebounded to 3%. This year the IMF expects Russia to experience GDP growth of 2.6%, which is significantly greater than the EU (0.9%) and the UK (0.6). Even better for Moscow, its budget deficit is on track to remain below 1% of GDP, compared to the EU’s 2.8 and a whopping 5.1 in the UK. So why has Russia’s economy proved to be so resilient in the face of such harsh western sanctions?
One reason is Russia’s strong and independent central bank, led by its governor, Elvira Nabiullina. Not only has Nabiullina been credited with ensuring Russia’s economic stability since the West imposed the toughest ever sanctions on a major economy, she has modernised Russia’s bank policy, winning plaudits at home and abroad for steering the country’s economy through an oil-price slump and the first barrage of sanctions following Russia’s annexation of Crimea in 2014.
Her decision to hike interest rates to 20% shortly after the war began and the imposition of capital controls, were crucial factors in defending the rouble and preventing severe capital outflows that could have derailed Russia’s economy. Today it is almost impossible for Russian exporters and the many foreign companies still operating in Russia to take money out of the country. Together, Nabiullina’s policies have helped to avoid a total collapse of the rouble by keeping the currency flowing inside Russia. Another reason for the strength of Russia’s economy is that companies operating in the country have learned how to sidestep sanctions.
Russia’s latest weaponry is heavily dependent on specialist components manufactured abroad. For example, one transport aircraft alone requires more than 80 components that cannot be reproduced or created in Russia. The same problem applies to Russian ballistic and cruise missiles, as well as its drone technologies. So, how is it that in the face of western sanctions, crucial components make it into Russian hands? The answer lies in the use of dual-use components, ranging from microchips to dental drills, which have both legitimate civilian and military applications.
Many domestic and commercial products nowadays contain vast numbers of microchips which can be used in weapons systems by the Russian military, despite the West’s best efforts to cut off the supply. Dental drills, for example, contain gyroscopes that can also be used in missiles. Many countries, such as Turkey, China, Serbia, Bulgaria, and India are among those which have reportedly made substantial amounts of money by playing the roles of intermediaries, circumventing sanctions and carried on selling goods to Russia and trading its oil.
In theory, no Russian oil should be traded with the West above the price cap of $60 per barrel. This cap has two goals: to reduce Russia’s ability to finance its war and to maintain energy market supply. In practice it has been circumvented by a large “dark” fleet of uninsured vessels and the use of accounting loopholes. So, while western countries are trying to tighten sanctions, in reality Russia’s Central Bank has been flooded with oil money. Vladimir Furgalsky, an official from Russia’s Energy Ministry, recently boasted that “even unfriendly countries note that the so-called price cap has not worked.
More than 99% of Russian oil has traded well above the $60 per barrel ceiling”. Yet another reason why Russia’s economy is faring far better than expected as the full-scale war on Ukraine enters its third year, is that Vladimir Putin ensured that Russia was in a strong financial position before he pressed the starter button on 24 February 2022. Oil money has allowed him to provide generous welfare benefits to underpin incomes. At the same time, a tight labour market caused by so many workers fighting in Ukraine and the 500,000 highly educated workers who left the country to avoid conscription, has supported a strong wage-growth.
Salaries of military volunteers have risen to around $2000 per month, four times the average across the country and seven times that in the poorer regions. Families of those killed in action receive a lump sum of 7 million roubles, provided the deceased soldier had served at least five months on the front line in Ukraine. This generosity has not only ensured that money is flowing in the economy, but has also calmed the unrest in the poorer regions which are suffering a disproportionate death rate in the war by comparison with the wealthy cities of Moscow and St Petersburg.
Families with sons killed in action suddenly become the wealthiest in the village! All this money gushing around the economy has become transformative and has led to a rapid and unprecedented redistribution of wealth, with the poorer classes profiting from government spending on the war. A recent Levada poll concluded that 6% of those who “previously did not have enough money to buy consumer goods like a fridge, have now moved upwards towards the middle classes”.
It’s no wonder that overall consumer spending across Russia rose by 6% last year. In order to supply the military with the weapons and ammunition it needs for the war in Ukraine, President Putin has put much of Russia’s manufacturing on a war footing. Total defence spending has risen to about 7.5% of Russia’s GDP and is expected to rise even further to 10% by next year. Supply chains have been redesigned to secure many key inputs and evade sanctions, and factories producing ammunition, vehicles and equipment are working round the clock.
The Moscow Times reported last month that in November, machinists and welders in Russian factories producing war equipment are now earning more money than many white-collar managers and lawyers. In February, Putin claimed that 520,000 new jobs had been created in the military-industrial complex, a massive investment which this year will represent the largest share of GDP since the days of the Soviet Union and the Cold War. As a result of the war, some 6,000 or so companies that rarely turned a profit before 2022 are now blossoming.
But can it last? Vladimir Putin is trying to finance the war, maintain social spending and avoid soaring inflation (currently 7.4%) all at once; “an impossible trilemma”, according to experts. Cushioned by oil prices, the war in Ukraine has transformed the Russian economy from within, an economy entirely geared to a long and deadly conflict in Ukraine. So what happens if Moscow suddenly wins?
It’s unlikely that the country will need to produce such enormous quantities of weapons and ammunition when there’s no longer a need. Will Russia be able to quickly transform the economy back to civilian purposes and avoid largescale unemployment? And if Russia occupies the whole of a defeated Ukraine, a land which Putin argues is really part of Russia, what about the humongous cost of rebuilding the vast amount of damaged infrastructure caused by Russia’s military over the course of the war – all the while being hated by every citizen in Ukraine for destroying their country and taking away their freedom?
This is why there is a growing realisation in the Kremlin that there is no incentive to end hostilities and a protracted stalemate is just fine as it might be the only way to avoid total economic collapse. In other words, while Russia cannot afford to lose the war in Ukraine, it cannot afford to win. John Dobson is a former British diplomat, who also worked in UK Prime Minister John Major’s office between 1995 and 1998. He is currently Visiting Fellow at the University of Plymouth.