Only an oil slump can stop Vladimir Putin
Vladimir Putin is winning the war of attrition against Ukraine. Although the Russian people are also suffering, the pain is not enough to force the newly re-elected president to change course.
He might reconsider if the West could squeeze Russia’s oil revenue. But that will be hard to engineer. Even if receipts from hydrocarbons stay at the same level, the Russian government is going to have to squeeze its citizens.
The economy is overheating as Putin, who has just secured a new six-year term to extend his 24-year rule, pumps more money into the war effort. Defence spending, which is budgeted at 10.8 trillion roubles ($118 billion) this year, has trebled since the war began. Inflation is 7.7% and there are severe labour shortages.
The central bank has jacked up interest rates to 16% and said official borrowing costs will need to stay high for a “long period” to get inflation down to its 4% target. The government has imposed capital controls to prop up the rouble.
The government will also need to take fiscal measures to bring domestic consumption in line with production. Top of the list are likely to be tax increases focussed on richer individuals and companies. Putin has already signalled as much.
While such decisions will be unpopular with some, he will face no opposition ramming them through. Putin boasts that Russia grew 3.6% last year, more than any of the Group of Seven rich democracies which are backing Ukraine.
It will grow 2.6% this year and 1.1% next year, the International Monetary Fund predicts. But the underlying picture is not as healthy as these headline figures suggest.
For a start, a war economy by its nature does not produce goods that ordinary people can consume. As the government directs a bigger slice of national income into churning out tanks and shells, there will be less money for consumer goods and services, says Tim Ash, a strategist at RBC Bluebay Asset Management.
The government has shielded the population from the economic cost of the war by raiding its national wealth fund to finance the budget deficit, which was 3.7% of GDP last year.
But this is not sustainable as the fund’s liquid assets have fallen by more than half since the Putin attacked Ukraine two years ago, and are now just 2.7% of national income. One way or another, the war economy will crowd out non-war spending.
This will happen through a mixture of tax hikes, inflation, high interest rates and spending cuts. What’s more, the war is hurting Russia’s mid-term prospects. Western sanctions are denying it advanced technology.
Labour productivity, which Putin dreams of boosting, fell 3.6% in the first year of the war. Investment dropped to 19.7% of GDP in 2022, from 21.4% in 2017.
About 315,000 Russian troops have died or been injured, according to the US government, while Re: Russia, an independent publication, estimates over 800,000 people had fled the country by last July.
This brain drain of young and educated people is a further drag on the economy. Although the economy seems likely to stagnate, the president does not face any domestic financial constraint to prolonging the war. Nor is he yet under any external restrictions. Putin has been able to sustain the attack because Russia is still earning a lot from hydrocarbons.
Despite Ukraine’s allies embargoing its oil and Europe finding alternatives to its gas, Russia enjoyed a current account surplus of $51 billion in 2023.
Though that was down from a bumper $238 billion the previous year, Moscow is still in the black. Things might change if Ukraine’s allies could drive Russia’s export revenues down so far that it goes into deficit, says Jacob Nell, a senior research fellow at the Kyiv School of Economics.