The surprising resilience of the Russian economy

ADDRESSING a crowd of activists on Friday in Tula, the capital of Russia’s arms industry, Vladimir Putin crowed that the country’s economy had defeated western sanctions imposed after his invasion of Ukraine.

“They predicted decline, failure, collapse — that we would stand back, give up, or fall apart. It makes you want to show [them] a well-known gesture, but I won’t do that, there are a lot of ladies here,” Putin said to a round of applause. “They won’t succeed! Our economy is growing, unlike theirs.”

Russia’s president gloated that Russia’s economy had not only withstood an onslaught of sanctions from western countries — but was now bigger than all but two of them. He was referring to the World Bank’s ranking of GDP by purchasing power parity, by which Russia slightly edges ahead of Germany. “All of our industry did their part,” he said.

On Tuesday, the IMF appeared to concur with Russia’s president. The IMF revised its own GDP growth forecast for Russia to 2.6 per cent this year, a 1.5 percentage point rise over what it had predicted last October.

The Russian economy’s resilience has stunned many economists who had believed the initial round of sanctions over the invasion of Ukraine nearly two years ago could cause a catastrophic contraction.

Instead, they say, the Kremlin has spent its way out of a recession by evading western attempts to limit its revenues from energy sales and by ramping up defence spending.

Russia is directing a third of the country’s budget — Rbs9.6tn in 2023 and Rbs14.3tn in 2024 — towards the war effort, a threefold increase from 2021, the last full year before the invasion. This includes not only producing hardware, but also giving war-related social payments to those who fight in Ukraine and their families, as well as some spending on the occupied territories.

The significant increase in military expenditure marks “a striking break with Russia’s postCommunist development to date”, a recent Stockholm International Peace Research Institute (SIPRI) paper concluded.

Putin’s own top economic officials have warned a surge in public spending comes at the risk of a major overheating of the economy in the near future. But for the time being, it is keeping growth robust.

All of this would have been impossible if Russia had not continued to generate colossal revenues from its energy resources, despite sanctions.

In 2023, Russia’s energy revenues reached Rbs8.8tn — a decline of about a quarter from the record-breaking result in 2022 but above the average for the past ten years. Despite this, the state has had to resort to increasingly irregular methods to generate revenue from one-off taxes and levies, including “voluntary donations” western businesses have to pay when leaving Russia.

“The regime is resilient because it sits on an oil rig,” says Elina Ribakova, a non-resident senior fellow at the Peterson Institute for International Economics. “The Russian economy now is like a gas station that has started producing tanks.”

As he announced Russia’s staggering military spending to lawmakers in September, finance minister Anton Siluanov used a Soviet slogan from the second world war to describe the Kremlin’s approach to the budget.

“Everything for the front, everything for victory,” Siluanov said.

The Kremlin’s shift to what Vasily Astrov, a senior economist at the Vienna Institute for International Economic Studies (WIIW), calls “military Keynesianism” is a radical break from the conservative macroeconomic policy of Putin’s first two decades in power.

Technocrats like Siluanov and central bank governor Elvira Nabiullina helped steer Russia through multiple financial crises by aggressively targeting inflation, shoring up the country’s banking system, building up foreign currency reserves, and attempting to rein in additional spending.

That approach also proved crucial in mitigating the initial impact of the sanctions at the war’s outset, when western countries froze $300bn of Russia’s sovereign reserves and the Kremlin imposed currency controls to halt an exodus of capital and a run on the banks.

“The economic bloc [the finance ministry and central bank] keeps saving the regime. They have proven to be much more useful for Putin than the generals,” says Alexandra Prokopenko, a former Russian central bank official.

Avoiding a bigger contraction in the economy allowed the Kremlin to pivot to fuelling growth through spending, Astrov says. Although the authorities officially continue to refer to the war in Ukraine as a “special military operation”, the entire country’s economy has shifted to producing for the war.

Addressing a group of arms producers on Friday, Putin said they were “guaranteed to be filling orders for years to come” as Russia ramped up its weapons production and said the defence ministry was paying suppliers 80 per cent of the costs in advance.

The drive to produce more missiles, artillery, and drones in particular, is paying dividends for Russia on the battlefield at a time when Ukraine is struggling to secure funding for the advanced western weaponry Kyiv needs to beat back the invasion.

Putin and other top Russian officials have made a point of complaining that even the recent surge in production is insufficient.

On Wednesday, defence minister Sergei Shoigu gave a public dressing down to the head of one of Russia’s weapons manufacturers over what he said was a lag in production of a “promising new artillery system”.

“If we have the chance, then we need to make use of it,” Shoigu said.

Ukraine’s army chief Valery Zaluzhny admitted this week that Kyiv and its allies had not done enough to improve Ukraine’s capabilities at a time when Russia’s ability to reinvest in its own defence industry had given it a significant firepower advantage.

The Russian finance ministry estimates that war-related fiscal stimulus in 2022-23 was equivalent to around 10 per cent of GDP. In that same period, war-related industrial output has risen 35 per cent while civilian production has remained flat, according to research published by the Bank of Finland Institute for Emerging Economies. Putin claimed on Friday that civilian production had increased by 27 per cent since the start of the war, but did not cite a source for the figure.

“The verities of economic policy cease to apply when a government prioritises war over all else. Russia’s decision [to dispense] with two decades of prudent economic policies caught many by surprise, not just forecasters,” the Bank of Finland researchers wrote in their most recent forecast for Russia.

Economists and even some of the Kremlin’s own top technocrats have warned, however, that the rampant spending is already exposing new cracks in the Russian economy. Instead of lessening its dependence on oil and gas export sales, which make up about a third of budget income, Putin’s wartime drive has created a new addiction: military production.

“The longer the war lasts, the more addicted the economy will become to military spending,” WIIW economists wrote in their

January paper. “This raises the spectre of stagnation or even outright crisis once the conflict is over,” they added.

The growth is already creating imbalances that could become more pronounced over time. This is particularly noticeable on Russia’s labour market, where Russia’s army and its weapons factories are sucking in a growing number of workers on inflated wages — Putin said on Friday that Russia had created 520,000 new jobs in the industry — to man the roundthe-clock shifts needed to achieve defence production targets.

This has created labour shortages in civilian industry amid an already bleak demographic outlook exacerbated by the war. Russia mobilised 300,000 men into the army in 2022 and claims to have recruited a further 490,000 in 2023. At least as many more, meanwhile, have fled the country to avoid being sent to the front.

“The greatest shortage of personnel is observed in the machine-building and chemical industries, many enterprises are forced to work in several shifts to fulfil orders received from the state,” analysts from the Gaidar Institute in Moscow wrote in December 2023.

To compete for labour against military production — which offers an exemption from the draft in addition to generous wages — the civilian sector has also had to increase salaries, which in turn drives domestic demand but adds to inflationary pressures.

If the sanctions have failed to stop Russia from spending, however, the restricted access to international markets has driven up the cost of imports, creating another potential economic trap for the Kremlin.

The circuitous routes goods now take to Russia are hitting consumers hard and weakening the rouble, which lost around 30 per cent of its value against the dollar in 2023.

“The huge budget expenses combined with Russia’s isolation . . . create an effect that’s like when you put dough in a plastic container,” says Prokopenko, a non-resident fellow at the Carnegie Russia Eurasia Center in Berlin. “It rises until it runs into the roof, and then there’s nowhere to go.”

The surge in public spending has driven inflation up to 7-7.5 per cent, prompting the central bank to raise the key interest rate to 16 per cent — a higher rate even than in Ukraine.

Following the rate rise, central bank governor Nabiullina warned the spending ran the risk of overheating Russia’s economy. “Trying to use dovish fiscal policy to grow beyond our potential will drive price growth [inflation] that’s going to eat more and more into savings and wage growth. And there won’t be any real growth in household wealth as a result,” she said.

The pace of growth may also not be sustainable even if Russia keeps up its current level of military spending, economists say.

Even analysts from the stateowned Russian Academy of Sciences say limited capacity means key sectors of the economy are already showing “signs of a slowdown”. These include a decline in railway transport loading, which is one of the primary indicators of an economic recession, they wrote in a note.

Other economists argue that Russia’s economy would have grown in consecutive years at a much more sustainable level if Putin had not ordered the fullscale invasion of Ukraine.

“2022 began from a very optimistic note, and the growth even surpassed most expectations. I would have expected that both in 2022 and 2023, we could have anticipated an annual GDP growth of around 3 per cent,” says Ruben Enikolopov, a research professor with Pompeu Fabra University (UPF) in Barcelona.