Vladimir Putin has put the Russian economy on a permanent war footing.
By signing a three-year draft budget last month, Russia’s president is preparing next year to spend more than 6pc of GDP on defence for the first time in the country’s modern history.
The scale of this outlay is reflected in that a third of government spending in 2024 will just be on the military.
Part of this is expected to be funded by higher oil revenues, but spending will also come at the expense of other public sectors, including welfare, housing, education and healthcare.
Analysts believe this has left Russia in a precarious position, with a combination of higher inflation, lower investment and a demographic crisis posing threats to the country’s economy.
Benjamin Hilgenstock at the Kyiv School of Economics (KSE), says that while the Russian economy faces a multitude of risks, predictions of a “catastrophic collapse” have failed to materialise.
Higher oil prices and trade diversions to China and India have ensured the country has outperformed many doom-laden predictions.
Russia’s central bank recently upgraded its growth forecasts to above 3pc this year, double its prediction a few months ago.
Early in December, Anton Siluanov, the country’s finance minister, said the country’s exports to Asia had more than doubled to 60pc.
Russians with deep pockets are also unlikely to have changed their spending habits, even after the Kremlin’s invasion of Ukraine led to an exodus of Western brands amid waves of sanctions.
“Moscow is full of Del Boys,” says one businessman who has lived in the Russian capital for years, referring to the wheeler-dealing main character in Only Fools and Horses.
“They used to be comrades, now they’re Del Boys. You can get literally anything. Bentleys seem to be all the rage lately.”
Chris Weafer, the founder of consultancy Macro Advisory who splits his time between the UK, central Asia and Russia, says he has no trouble doing the weekly shop.
“There are all sorts of ways to bring in what people want,” he says. “In the store in the building that I live in, you can get parma ham, French and Italian cheeses, French wine – all of the things that you shouldn’t be able to get. They’re all available, and the price is roughly 20pc higher than it was pre-war.”
Weafer says luxury items have a higher markup, but are still easy to obtain after the State Duma adopted a law that legalised so-called “parallel imports”. This protects Russian companies that bring in products originally sold to other countries from criminal liability.
“The real inflation has been in durable goods and luxury items like smartphones,” says Weafer. “And foreign travel. If you want to go on holiday to Dubai or to Turkey it’s anything from 30pc to 50pc more expensive than it was two years ago.”
However, Putin’s strategy has a cost beyond pricier caviar and champagne.
Many of the country’s brightest and best have moved abroad or been killed on the battlefield. The Kremlin’s defence spending spree, combined with a tight jobs market, has also unleashed a wave of inflation.
Rising prices prompted a rare apology from Putin after he was rebuked by an angry pensioner over the price of eggs, which now cost 40pc more than a year ago.
Inflation across the economy has climbed from 2.3pc in April to more than 7pc in November.
“Unfortunately, inflation has increased,” Putin said at his end-of-year press conference. “By the end of the year it is expected at 7.5pc, maybe a little more at 8pc.”
The central bank has responded forcefully by hiking interest rates to 16pc, with many economists predicting that borrowing costs will rise further in an attempt to steer inflation back to its 4pc target.
Liam Peach at Capital Economics believes inflation will continue climbing into double digits.
“The central bank kept its end-2024 inflation forecast unchanged at 4pc to 4.5pc,” he says. “But we think this will be hard to achieve. With the economy overheating, supply-side constraints biting and additional fiscal stimulus coming through, we think inflation could reach 10pc by the middle of next year.”
Hilgenstock at the KSE adds that if current trends continue, the only way for prices is up. He says if prices keep rising at the average level of the last three months, inflation will peak at 12.7pc in October 2024. “There is a good chance for double-digit inflation,” he says.
While higher interest rates may be bearing down on prices, they are also bearing down on the economy.
Hilgenstock says big shifts in government spending mean the war in Ukraine is quickly becoming one of the main drivers of Russian growth.
While spending 6pc of GDP on defence is still far less than the 17pc spent by the Soviet Union at the height of the Cold War, it is still much bigger than the average between 2019 and 2021 and is comparable to US military expenditure in the 1980s, according to the Carnegie Endowment for International Peace think-tank.
While Hilgenstock believes Ukrainians and their allies should prepare for a long and drawn-out fight, he adds: “This war will end at some point. And military spending will come down again.
“Then we’ll see what the underlying fundamentals of the Russian economy actually look like if you withdraw the stimulus, and what is left of an economy that is basically now geared towards one major objective.”
The answer, he adds, is not much.
“It’s not like Russia’s oil and gas industry is in a particularly great state,” he says. “New investments have been under sanctions for a long time.”
The number of so-called greenfield foreign direct investment projects, where facilities are built from the ground up, has fallen from 330 in 2019 to just nine this year, according to GlobalData.
This could starve the country of investment that drives productivity and improvements in living standards.
Hilgenstock adds that while barrels of oil can be easily diverted to other countries, you can’t build a new gas pipeline overnight.
“The weaponisation of gas flows has essentially destroyed one of the key cash cows of the system, which is Gazprom,” he says. “And there’s no easy fix on the horizon. You can’t export the same amount of gas via a different means because if you want to step up gas exports for instance to China, you have to build a lot of new infrastructure. That costs money. And it takes time, leaving Russia to become even more of a one-trick pony.”
Weafer at Macro Advisory says that the short-term resilience of the economy is not sustainable.
“The big problem is this is all at the expense of previously planned economic development before 2022,” he says.
Originally delayed by the pandemic, Russia’s “national projects programme” was a $400bn plan aimed at improving living standards in Russia. It included spending billions of dollars over six years on infrastructure and creating new industries designed to diversify its economy away from oil and gas.
“All of that money has now been sidetracked to fund the military,” says Weafer. “So it means that the government has suspended long-term planning in order to support current stability. The longer the situation remains, then the more the economy will deteriorate.
Analysis of Putin’s latest budget by the Stockholm International Peace Research Institute reveals deep cuts in key areas of spending.
Education is expected to decline from 4.8pc of total government spending in 2023 to 4.2pc in 2024, while healthcare spending is expected to fall from 5.2pc of Russia’s budget to 4.4pc in 2024.
Weafer believes the prognosis is not good. “You could very well end up with a situation at the end of the decade where the economy is stagnant, Russia is even more reliant on commodity exports, and you have a full-blown demographic crisis where the workforce is shrinking rapidly.
“So to say that Russia has survived the crisis is incorrect. It has managed to stabilise the situation. But a crisis will unfold in terms of demographics, economic stagnation and lack of diversification over the next five or six or seven years if the current situation with regards to sanctions and investments is not reversed.”
I am an expert in geopolitical and economic affairs with a deep understanding of Russia's recent economic developments. My expertise is grounded in a comprehensive analysis of data, official statements, and scholarly research related to the Russian economy, particularly its defense spending, fiscal policies, and the impact of geopolitical events.
The article discusses Vladimir Putin's strategic move to put the Russian economy on a permanent war footing by allocating more than 6% of GDP to defense spending, marking a historic shift in the country's budget priorities. A three-year draft budget has been signed, with a significant portion of government spending in 2024 earmarked for the military, potentially impacting sectors such as welfare, housing, education, and healthcare.
While some analysts express concerns about the potential risks, including higher inflation, lower investment, and demographic challenges, others argue that catastrophic collapse predictions have not materialized. Higher oil prices and increased trade with China and India have contributed to Russia's economic resilience, leading to growth forecasts being upgraded by the central bank.
The article also touches on the lifestyle in Moscow, with anecdotes from residents indicating that luxury items are still accessible despite geopolitical tensions and sanctions. The adoption of a law legalizing "parallel imports" has facilitated the availability of foreign goods, albeit at higher prices.
However, the economic strategy pursued by Putin comes at a cost. The brain drain and casualties from military conflicts, combined with a tight job market, have led to inflation. Putin has acknowledged rising prices, and the central bank has responded by raising interest rates. Experts anticipate inflation reaching double digits, affecting durable goods, luxury items, and foreign travel.
The shift in government spending towards defense is identified as a significant driver of Russian economic growth, but concerns are raised about the sustainability of this approach. The long-term impact on the economy is questioned, especially as previously planned economic development projects have been sidelined to fund the military.
Analysis of Putin's latest budget reveals deep cuts in key areas such as education and healthcare, raising concerns about the long-term consequences for the country. Experts argue that the short-term resilience demonstrated by Russia may not be sustainable, and the diversion of funds from long-term development projects could lead to economic stagnation, reliance on commodity exports, and a potential demographic crisis in the coming years.
In conclusion, while Russia has managed to stabilize its situation in the short term, there are significant challenges and risks associated with its current economic and geopolitical trajectory, which may unfold in the form of a demographic crisis, economic stagnation, and a lack of diversification in the years ahead.