ANDREY KUZICHKIN ⟩ Russian economy is on the verge of a nervous breakdown

Andrey Kuzichkin, columnist. Photo: Mihkel Maripuu

The Russian economy uses enormous resources to produce goods that are largely destroyed on the battlefield, columnist Andrey Kuzichkin writes.

On November 19, the head of the Central Bank of Russia, Elvira Nabiullina, addressed deputies of the State Duma, outlining the main directions of the country's monetary policy. Ms. Nabiullina's speech was filled with optimism, centering around an intention to firmly adhere to the monetary policy course and reduce inflation from the current nine percent to four percent next year. To this end, the Central Bank of Russia has raised the base interest rate to a record 21 percent and does not rule out the possibility of a further increase in December.

The task is to cool down the country's overheated economy, align industrial supply and demand, and reduce the amount of money in the financial system. At the same time, Elvira Nabiullina never mentioned that Russia's economy is in such a difficult situation precisely because of the war started against Ukraine. She cautiously referred to Western sanctions as a «shock».

In the fight against excess money, it is even possible to freeze the population's savings. Although Nabiullina denied this information, as you know, there's no smoke without fire. And we've already seen depositors' money burn in Russia. And although Russia's statistics lie and conceal a lot, we will now try to assess Russia's real situation based on various sources.

Putin regime's oil and gas safety cushion

Some experts (such as Oleg Buklemishev of Moscow State University) assume that Russia is showing signs of «military Keynesianism» – a policy characterized by fiscal stimulation of the economy through unavoidable defense spending. Such policies have a short-term positive effect, but undermine strategic development.

Recently, the Russian State Duma approved the key parameters of the state budget for 2025: according to the document, revenues must total 40.3 trillion rubles, or 383 billion euros (hereinafter I use the exchange rate of 1 euro = 105 rubles), expenses – 395 billion euros. Defense spending will grow by 27 percent to 126 billion euros, or more than 30 percent of expenditure, surpassing social spending for the first time in the history of modern Russia. And 30 percent of budgetary spending is classified.

Question: Where does the Putin regime get money for the war? It's surprising but true: despite the harsh sanctions against Russia's oil and gas industry, the revenue from oil sales to the Russian budget remains stable. As a result, budget revenues from January to September 2024 totaled 250 billion euros, which is 33 percent more than during the same period in 2023. Oil and gas revenues for the nine months grew 1.5 times, exceeding 80 billion euros. Revenues in sectors not related to energy resource production also grew by 30 percent. Industry growth in Russia is about four percent.

A look at the structure of growth reveals that computers, electronic and optical products (growth of 40 percent); metal products (+30 percent); pharmaceuticals and materials (+20 percent); and the manufacture of vehicles (+20 percent) are playing the leading role. All these industries are related to the war: drones, control systems, tanks, missiles, heavy vehicles for the front, and medicines for military hospitals are produced. Defense industry companies in Russia are working in three shifts. Shopping centers and food industry companies are being converted into manufacturing facilities.

Ninety percent of output is produced under state order and financed from the federal budget. However, the state pays a fixed price for the goods ordered, which greatly reduces the profitability of defense companies. But these are not all the problems associated with the shift of Russia's economy to a war footing.

Expensive money

The Russian economy uses enormous resources to produce goods that are largely destroyed on the battlefield. To cover the losses, the central bank needs to print money and weaken the exchange rate of the ruble. Inflation is an inevitable consequence of such a policy. There are four main sources for inflation in Russia: a sharp increase in salaries (the average salary is 820 euros, and up to 3,000 euros in the defense sector) due to labor shortages and high competition in the labor market; a sharp increase in incomes due to «war-related» payouts to the population; high demand for production of the defense industry; and price increases due to rising labor and logistics costs for goods imported from abroad.

This prompted Russia's central bank to raise the base interest rate to 21 percent. At the same time, preferential mortgages for home purchases and industrial mortgages for new projects were canceled. The interest rate on housing loans rose from seven percent to 28 percent. As a result, demand for housing in Russian regions fell by 30-70 percent. This, in turn, will soon lead to a drop in construction volumes and a decline in the production of building materials. The issuance of unsecured consumer loans also fell by 70 percent.

Investors prefer to keep their money in commercial banks. The outflow of funds from the industrial sector to the banking sector is catastrophic for the national economy. For example, Russia's largest automaker, AvtoVAZ, forecasts a 30 percent decrease in sales. The production of trucks has already declined by 42 percent.

Pessimism in the business environment has deepened and reached a ten-year high. Even industrial giants are experiencing a deterioration in their financial well-being. For example, Gazprom shares have depreciated by 91 percent over the past 16 years. An increase in corporate income tax threatens companies like Trans Neft, whose tax rates are set to rise from 20 percent to 40 percent. This has already led to a 6 percent decline in the company's shares.

It's surprising but true: despite the harsh sanctions against Russia's oil and gas industry, the revenue from oil sales to the Russian budget remains stable.

Russia's stock market as a whole is unstable: it fell by four percent against the backdrop of Elvira Nabiullina's optimistic speech. Perhaps the stock market was also hit by the ATACMS missiles launched from Ukraine into Russia's Bryansk oblast.

It also has to be acknowledged that Putin's favorite toy – import substitution – almost isn't working. Recently, artificial intelligence assessed the use of imported products and technologies for a thousand Russian products. Imported components were found everywhere, even in the simplest wood products, where imported glue and paint pigments are used. In technically sophisticated products such as cars and elevators, imported parts account for up to 90 percent. But while Russian exports are still growing by one to two percent, imports have fallen significantly – down 15 percent this year.

Russia-related foreign trade growth for Putin's main foreign donors – China and India – has slowed sharply, by two to three percent. And India has reduced imports of Russian diamonds by 25 percent. The main trade items are oil, coal and metal from Russia. But demand and coal prices are falling, China's economy is slipping into recession, and this is reducing demand for commodities. Deliveries of Russian steel products to other countries decreased by 22 percent. Russia's oil reserves are decreasing, and their growth in 2023 was the lowest in the past six years.

Besides, a further trend has arisen that testifies to the systemic crisis in the Russian economy: «creeping nationalization». There are already cases where, based on a protest by the prosecutor's office, large enterprises, such as an iron alloy plant and the Ivanovo machine-building plant, were transferred from private to state ownership. Then the state handed them over to Rostec, the defense industry holding company headed by Putin's friend Sergey Chemezov. When making such decisions, the principle «the law has no retroactive effect» was renounced: the results of privatization carried out in the 1990s were canceled due to inconsistency with current laws, which were adopted many years after the privatization.

Deterioration of the civilian sector and the food market

The redistribution of money in favor of the war inevitably leads to stagnation in other sectors of the economy. In addition, the federal government has transferred some of its authorities in financing the war to Russia's regions. A competition was announced in Russia where regions seek to outperform one another in terms of the amounts they pay to participants in the «special military operation». Including the federal contribution, payments can reach up to 50,000 euros per person, which places a heavy burden on the regional budgets. Moreover, Moscow has obligated all regions to finance, at their own expense, the reconstruction of the «new territories» – the Donetsk, Luhansk, Kherson, and Zaporizhzhia oblasts – occupied and destroyed by Russia.

In this way, the total public debt of Russia's regions increased by 14 percent in 2023. This year, the debt decreased by four percent, but only because commercial loans became inaccessible to the regions due to banks' interest rates of 21-25 percent. As a result, the condition of urban utilities, which have always required high spending in Russia, is deteriorating. For example, in Kazan, half of the utility networks are 100 percent worn out. Repairing them requires 480 million euros. The city authorities do not have such funds, although the city recently spent 240 million euros on the BRICS summit held in Kazan. In Novosibirsk, the capital of Siberia, the utility network dilapidation rate is 65 percent, and in Saratov, a large city that is home to numerous military enterprises, the dilapidation rate is 90 percent.

Utility failures are daily occurrences in almost all cities of Russia: people live for weeks without water, electricity, and heating. Explosions and fires in residential buildings caused by faulty gas equipment have become common. Even Moscow, Russia's richest city, had for the first time in ten years to raise transport tax rates by ten percent through annual indexation to increase budget revenues.

Russia's food market is also suffering. With a general inflation rate of nine percent, the prices of many food products have risen by 50 to 100 percent. For example, butter has become 1.5 times more expensive in many cities. Large dairy companies, such as Wimm-Bill-Dann, managed by America's PepsiCo and continuing to operate in Russia despite the sanctions, recently announced a price increase for their products. The Russian prosecutor's office demanded the cancelation of this decision. The company abandoned its plans.

A representative of one of the retail chains meanwhile announced recently that freezing prices will lead to a decrease in the quality of products: for example, out of six samples of butter from different manufacturers subjected to a test, only two turned out to be real butter, while the rest were products adulterated with vegetable oils.

This year, the shortage of many products in Russia is being covered by imports from Turkey, India, the Emirates, and China. However, difficulties in paying for the goods are limiting imports. As a result, prices for butter and vegetable oil, eggs, sugar, milk, and flour have risen. Due to a 20 percent decrease in grain yields in Russia, a shortage of high-quality bakery flour and livestock feed is anticipated. The same problems may arise with potatoes. Russia's salmon and trout harvesting has decreased by a third this year, and the price of red caviar, a sacred commodity for Russians, has increased from 55 euros to 120 euros per kilogram in the past ten months.

It is interesting that wine imports to Russia halved this year, but imports of alcohol-containing chocolate candies tripled. These are likely intended to sweeten the bitter pill prescribed by «Doctor» Putin for the Russian economy and the Russian people.

But if the Kremlin visionary does not choke on this candy and stop the war, the Russian economy will inevitably become seriously ill and miserable. And Russia will go completely out of its mind.