SOCIETY
Russia’s Economy Between the Logic of War and an Illogical Dictatorship
August 16, 2023
Sergei Shelin
Journalist, independent analyst
Sergei Shelin writes that accelerating inflation and a weakening currency are normal for countries mired in long wars. Putin’s technocrats could one way or another cope with these problems if they were not prevented from doing so by the chaotic improvisations of Putin himself.
The Russian authorities have announced that the economic downturn caused by the Western economic embargo is over.
The price of prosperity
“We have come out of the crisis and are starting to develop quite rapidly. It is something special,” Dmitri Peskov, Vladimir Putin’s press secretary, effuses. “According to every forecast, after the imposition of sanctions, Russia should have fallen into the abyss, both economically and socially, but it did not. It will be studied how this happened and what the drivers were in our country.”
Indeed, in April-June 2023, Russia’s GDP was 4.9% higher than it was in April-June 2022. The fall that was recorded then (-4.0%) is now completely pared.
But this prosperity comes at a price. Recent months have seen the collapse of the national currency and a surge in inflation.
In January 2023, the dollar cost 70 rubles. In April-May, it was 80 rubles. At the end of July, it went over the 90-ruble mark, and by mid-August it had reached 100 rubles. This came as a surprise not only to the amateurs who make political decisions in Russia, but also to most of Putin’s technocrats, who quite professionally manage the financial bloc of his government.
The pickup in consumer price inflation was also a surprise. Back in April 2023, the SAAR (seasonally adjusted annual rate of inflation) was 3.7%, fully in line with the official target of the Central Bank (4.0% per year). But it accelerated to 5.0% in May , to 6.2% in June and to a critical 10.4% in July. In some weeks of July, the SAAR reached as high as 16%, more than four times the norm.
Lost strategists
The actions of the captains of the Russian economy speak more of their confusion than decisiveness.
Anton Siluanov, the head of the Ministry of Finance, while saying that the budget deficit in 2023 would be bigger than planned, did not acknowledge that it would be much bigger. The Central Bank, meanwhile, raised the key rate for the first time in a year and a half from 7.5% to 8.5%, though this did not stop the weakening of the ruble. The next hike, to 12.0%, took place just three weeks later, on August 15, when the ruble’s tumble had become serious.
On February 28, 2022, amid the panic that had begun across the Russian economy due to the invasion of Ukraine, the same state financiers hiked rates from 9.5% to 20.0% and introduced several other extraordinary measures. In just 12 days, the ruble stopped falling. Now they are looking up in bewilderment, putting the blame on each other and redoing their forecasts.
The Central Bank has cautiously made it clear that it is not happy with the ballooning government spending. In Russian bureaucratic language, it sounded like this: “The Central Bank proceeds from the strategy of budget normalization implemented by the Ministry of Finance with a gradual return to the budgeting of expenditures in accordance with the fiscal rule.”
The “fiscal rule” regulates state buying and selling of convertible currencies. Its purpose is to balance the budget and reduce swings in the ruble. It was adopted in peacetime, when budget spending was controlled.
The price of prosperity
“We have come out of the crisis and are starting to develop quite rapidly. It is something special,” Dmitri Peskov, Vladimir Putin’s press secretary, effuses. “According to every forecast, after the imposition of sanctions, Russia should have fallen into the abyss, both economically and socially, but it did not. It will be studied how this happened and what the drivers were in our country.”
Indeed, in April-June 2023, Russia’s GDP was 4.9% higher than it was in April-June 2022. The fall that was recorded then (-4.0%) is now completely pared.
But this prosperity comes at a price. Recent months have seen the collapse of the national currency and a surge in inflation.
In January 2023, the dollar cost 70 rubles. In April-May, it was 80 rubles. At the end of July, it went over the 90-ruble mark, and by mid-August it had reached 100 rubles. This came as a surprise not only to the amateurs who make political decisions in Russia, but also to most of Putin’s technocrats, who quite professionally manage the financial bloc of his government.
The pickup in consumer price inflation was also a surprise. Back in April 2023, the SAAR (seasonally adjusted annual rate of inflation) was 3.7%, fully in line with the official target of the Central Bank (4.0% per year). But it accelerated to 5.0% in May , to 6.2% in June and to a critical 10.4% in July. In some weeks of July, the SAAR reached as high as 16%, more than four times the norm.
Lost strategists
The actions of the captains of the Russian economy speak more of their confusion than decisiveness.
Anton Siluanov, the head of the Ministry of Finance, while saying that the budget deficit in 2023 would be bigger than planned, did not acknowledge that it would be much bigger. The Central Bank, meanwhile, raised the key rate for the first time in a year and a half from 7.5% to 8.5%, though this did not stop the weakening of the ruble. The next hike, to 12.0%, took place just three weeks later, on August 15, when the ruble’s tumble had become serious.
On February 28, 2022, amid the panic that had begun across the Russian economy due to the invasion of Ukraine, the same state financiers hiked rates from 9.5% to 20.0% and introduced several other extraordinary measures. In just 12 days, the ruble stopped falling. Now they are looking up in bewilderment, putting the blame on each other and redoing their forecasts.
The Central Bank has cautiously made it clear that it is not happy with the ballooning government spending. In Russian bureaucratic language, it sounded like this: “The Central Bank proceeds from the strategy of budget normalization implemented by the Ministry of Finance with a gradual return to the budgeting of expenditures in accordance with the fiscal rule.”
The “fiscal rule” regulates state buying and selling of convertible currencies. Its purpose is to balance the budget and reduce swings in the ruble. It was adopted in peacetime, when budget spending was controlled.
“The irony of the current situation is that the ‘rule’ whose purpose is to ensure the predictability of fiscal policy is being recast several times a year.”
During the very days in August when the Russian financial authorities proclaimed their strategic commitment to the “fiscal rule,” they made several contradictory statements about whether they would follow the rule right now. But in the end, they announced that they would not.
The outlook has become hazy. In one of the Central Bank’s scenarios published in August, its leadership assumes that, if not this year, then next, inflation could rise to 13%. The CMASF (Center for Macroeconomic Analysis and Short-Term Forecasting), which is close to the government, if it has done such calculations, has not shared them. It has put out only one scenario in which, contrary to the evidence, inflation would not exceed 5.7% in 2023 and 4.5% in 2024.
Note that the CMASF currently has a special role. And not only because the remaining think tanks in Russia basically closed their doors after the attack on Ukraine. The ideologist and main author of CMASF reports is Dmitri Belousov, the brother of Andrei Belousov, a first deputy prime minister and the chief strategist of the Russian government. In the content and tone of CMASF analytics, one can see the demands of the people who make economic decisions in Russia.
The professionalism of many of these materials is very high. Just 20 days after the start of the Russian invasion of Ukraine, the CMASF published a medium-term economic outlook that proved to be the most prescient of all the attempts made at the time to assess the impact of sanctions on the Russian economy. There was no attempt to distort the picture.
But in recent months, the CMASF’s monthly updated three-year forecasts have lost touch with reality. The analysts could not or did not want to predict not only the rise in inflation but also the fall of the ruble against the dollar. Back in May, they predicted an exchange rate of 75 rubles per dollar at the end of 2023. In June, they changed their forecast to 82 rubles. And in July, it was changed again to 91.5 rubles, while the current rate was already over 90 rubles.
Apparently, the strategists of the Russian government are now not so ready to see what is in front of them. After all, the Russian economy “from month to month is seeing growth accelerate.” This is what Vladimir Putin said while speaking to the economy’s captains. And Russia’s economy must follow orders from the leader.
No more paradox
Undoubtedly, the Russian authorities were deceived by the economic experience of the first year and a half of the war and sanctions.
By the middle of 2022, it seemed that state finances and the economy had been righted. The ruble, after a short fall (from 76 rubles per dollar on the eve of the invasion to 120 rubles per dollar in early March 2022), had considerably strengthened (to 50-60 rubles per dollar in June-November 2022). Consumer prices, which had jumped in March 2022, almost stopped rising by April.
And a year later, in April 2023, the CPI was only 2.3% higher than 12 months earlier. In any prosperous country not waging war, such inflation prints would be considered quite good.
But this prosperity was the product of a paradoxical combination of several factors, the effect of which had run its course by the spring-summer of 2023. And now,
The outlook has become hazy. In one of the Central Bank’s scenarios published in August, its leadership assumes that, if not this year, then next, inflation could rise to 13%. The CMASF (Center for Macroeconomic Analysis and Short-Term Forecasting), which is close to the government, if it has done such calculations, has not shared them. It has put out only one scenario in which, contrary to the evidence, inflation would not exceed 5.7% in 2023 and 4.5% in 2024.
Note that the CMASF currently has a special role. And not only because the remaining think tanks in Russia basically closed their doors after the attack on Ukraine. The ideologist and main author of CMASF reports is Dmitri Belousov, the brother of Andrei Belousov, a first deputy prime minister and the chief strategist of the Russian government. In the content and tone of CMASF analytics, one can see the demands of the people who make economic decisions in Russia.
The professionalism of many of these materials is very high. Just 20 days after the start of the Russian invasion of Ukraine, the CMASF published a medium-term economic outlook that proved to be the most prescient of all the attempts made at the time to assess the impact of sanctions on the Russian economy. There was no attempt to distort the picture.
But in recent months, the CMASF’s monthly updated three-year forecasts have lost touch with reality. The analysts could not or did not want to predict not only the rise in inflation but also the fall of the ruble against the dollar. Back in May, they predicted an exchange rate of 75 rubles per dollar at the end of 2023. In June, they changed their forecast to 82 rubles. And in July, it was changed again to 91.5 rubles, while the current rate was already over 90 rubles.
Apparently, the strategists of the Russian government are now not so ready to see what is in front of them. After all, the Russian economy “from month to month is seeing growth accelerate.” This is what Vladimir Putin said while speaking to the economy’s captains. And Russia’s economy must follow orders from the leader.
No more paradox
Undoubtedly, the Russian authorities were deceived by the economic experience of the first year and a half of the war and sanctions.
By the middle of 2022, it seemed that state finances and the economy had been righted. The ruble, after a short fall (from 76 rubles per dollar on the eve of the invasion to 120 rubles per dollar in early March 2022), had considerably strengthened (to 50-60 rubles per dollar in June-November 2022). Consumer prices, which had jumped in March 2022, almost stopped rising by April.
And a year later, in April 2023, the CPI was only 2.3% higher than 12 months earlier. In any prosperous country not waging war, such inflation prints would be considered quite good.
But this prosperity was the product of a paradoxical combination of several factors, the effect of which had run its course by the spring-summer of 2023. And now,
“Whether Russians like it or not, the Russian economy is moving toward what is normal for a country at war: rising inflation, a depreciating national currency and declining living standards, even amid an overall rise in output.”
Here are the elements of the new normal:
1. Military spending requires very big budget deficits.
A government document, seen by Reuters, says that in the first half of 2023, RUB 5.6 trillion, or 37% of all budget expenditures, went toward the military. This means that spending on the war for the year could amount to RUB 11 trillion, double the military spending of the last year of peace, 2021. Such spending clearly does not correspond to the budget deficit that was planned (RUB 2.9 trillion, 1.8% of GDP). In the first seven months of 2023 alone, the deficit exceeded RUB 2.8 trillion.
2. The labor shortage is growing and the personnel losses in the non-defense sector are intensifying.
Due to the war, the Russian economy lost about 1.5 million workers in 2022-23 (0.8-0.9 million emigrated, 0.3 million were mobilized in the fall of 2022 and 0.3 million last year and this year went to serve in the army on a contract). This is more than 2% of the labor force. Those who have replaced them are, on average, less qualified. Unemployment in Russia, meanwhile, has hit a low (2.4 million in June 2023 – 79.7% of the number of unemployed a year earlier).
This happened against the backdrop of a flow of workers from civilian sectors to those serving the war. The number of employees in large and medium-sized food industry companies decreased 1.1%, while in the furniture industry it was a 4.3% decrease. On the other hand, employment in mining increased 2.2% and 5.9% in computer production.
Producers of most civilian goods and services must rely on a reduced and de-skilled workforce.
3. The overall economic upsurge reflects a boom in militarized sectors and stagnation or recession in civilian ones
For example, let’s look at how the boom in the construction industry is playing out. According to the official statistics, it has been downright explosive. The volume of work was up 10% in just a year (June 2023 to June 2022), while the number of employees had risen 5.1%.
Yet there is no growth in housing construction. The schedule for the construction of living space (adjusted for seasonality) peaked at the beginning of 2022 and has been gradually decreasing since. The area of apartments built in the first half of 2023 amounted to 99.1% of what was finished in the first half of 2022.
1. Military spending requires very big budget deficits.
A government document, seen by Reuters, says that in the first half of 2023, RUB 5.6 trillion, or 37% of all budget expenditures, went toward the military. This means that spending on the war for the year could amount to RUB 11 trillion, double the military spending of the last year of peace, 2021. Such spending clearly does not correspond to the budget deficit that was planned (RUB 2.9 trillion, 1.8% of GDP). In the first seven months of 2023 alone, the deficit exceeded RUB 2.8 trillion.
2. The labor shortage is growing and the personnel losses in the non-defense sector are intensifying.
Due to the war, the Russian economy lost about 1.5 million workers in 2022-23 (0.8-0.9 million emigrated, 0.3 million were mobilized in the fall of 2022 and 0.3 million last year and this year went to serve in the army on a contract). This is more than 2% of the labor force. Those who have replaced them are, on average, less qualified. Unemployment in Russia, meanwhile, has hit a low (2.4 million in June 2023 – 79.7% of the number of unemployed a year earlier).
This happened against the backdrop of a flow of workers from civilian sectors to those serving the war. The number of employees in large and medium-sized food industry companies decreased 1.1%, while in the furniture industry it was a 4.3% decrease. On the other hand, employment in mining increased 2.2% and 5.9% in computer production.
Producers of most civilian goods and services must rely on a reduced and de-skilled workforce.
3. The overall economic upsurge reflects a boom in militarized sectors and stagnation or recession in civilian ones
For example, let’s look at how the boom in the construction industry is playing out. According to the official statistics, it has been downright explosive. The volume of work was up 10% in just a year (June 2023 to June 2022), while the number of employees had risen 5.1%.
Yet there is no growth in housing construction. The schedule for the construction of living space (adjusted for seasonality) peaked at the beginning of 2022 and has been gradually decreasing since. The area of apartments built in the first half of 2023 amounted to 99.1% of what was finished in the first half of 2022.
An attack on the Crimean bridge by Ukrainian missiles. Source: Telegram
But some Russian builders have moved on to new jobs: repairing the Crimean bridge regularly attacked by the Ukrainians, building drone factories, developing the conquered territories, etc. Is it any wonder that the construction industry is now on the rise? It is fed by the war. But this prosperity does not add square meters for either civilian or military use.
4. Wages are growing even faster than the militarized economy
Due to the labor shortage, all employers must increase wages more and more. In 2023, wage growth in real terms is about double the growth of all manufacturing sectors, both military and civilian. The amount of money in the hands of ordinary Russians is growing. As are their opportunities to take out loans. However, the amount of goods and volume of services they can purchase is shrinking or stagnating. A pickup in inflation is simply inevitable in these conditions.
The normalization of war
However, the technocratic wing of the Russian regime continues to hope for what it calls the “normalization” of economic policy. Of course, we are talking about “normalization” against the backdrop of the war, a phrasing that has its own logic.
When powers with large economies have become involved in long-term conflicts, financial crisis in these countries do not immediately follow. World wars have sometimes ended with hyperinflation, but they never started with it.
In two and a half years, from mid-1914 to February 1917, consumer prices in the Russian Empire rose 94% (about 30% per year). The real collapse of finances began, however, only after the fall of tsarism. In 1917, the price index quadrupled. In Germany, from 1914 to 1918, inflation was 140% (about 25% per year). Hyperinflation happened after Germany’s withdrawal from the war and recognition of defeat. Thus, inflation in Russia should not be catastrophic yet, especially since today its economic involvement in the war with Ukraine is clearly less than that of the powers in World War I.
Russia’s estimated defense spending is 7% of its expected GDP in 2023, versus military spending, for example, by the US of approximately 20% of GDP in World War I and 32% of GDP in World War II. Meanwhile, the doubling of military spending by Russia mentioned above compared to the last year of peace is also much more moderate than the increase of 4-5 times (in constant prices) in the Russian Empire after its entry into World War I.
Therefore, better examples for comparison would be the Korean and Vietnam wars of the US. In the three years of the Korean War, American consumer prices rose 14%, and in the decade of the Vietnam War the figure was 66%. In Germany, which was not at war, the rise in prices was just one and a half times less in both periods.
If the current war does not become total for Russia, then the Russian authorities can theoretically “normalize” it, while citizens will get off with a moderate acceleration in inflation and a gradual decline in living standards. Still,
4. Wages are growing even faster than the militarized economy
Due to the labor shortage, all employers must increase wages more and more. In 2023, wage growth in real terms is about double the growth of all manufacturing sectors, both military and civilian. The amount of money in the hands of ordinary Russians is growing. As are their opportunities to take out loans. However, the amount of goods and volume of services they can purchase is shrinking or stagnating. A pickup in inflation is simply inevitable in these conditions.
The normalization of war
However, the technocratic wing of the Russian regime continues to hope for what it calls the “normalization” of economic policy. Of course, we are talking about “normalization” against the backdrop of the war, a phrasing that has its own logic.
When powers with large economies have become involved in long-term conflicts, financial crisis in these countries do not immediately follow. World wars have sometimes ended with hyperinflation, but they never started with it.
In two and a half years, from mid-1914 to February 1917, consumer prices in the Russian Empire rose 94% (about 30% per year). The real collapse of finances began, however, only after the fall of tsarism. In 1917, the price index quadrupled. In Germany, from 1914 to 1918, inflation was 140% (about 25% per year). Hyperinflation happened after Germany’s withdrawal from the war and recognition of defeat. Thus, inflation in Russia should not be catastrophic yet, especially since today its economic involvement in the war with Ukraine is clearly less than that of the powers in World War I.
Russia’s estimated defense spending is 7% of its expected GDP in 2023, versus military spending, for example, by the US of approximately 20% of GDP in World War I and 32% of GDP in World War II. Meanwhile, the doubling of military spending by Russia mentioned above compared to the last year of peace is also much more moderate than the increase of 4-5 times (in constant prices) in the Russian Empire after its entry into World War I.
Therefore, better examples for comparison would be the Korean and Vietnam wars of the US. In the three years of the Korean War, American consumer prices rose 14%, and in the decade of the Vietnam War the figure was 66%. In Germany, which was not at war, the rise in prices was just one and a half times less in both periods.
If the current war does not become total for Russia, then the Russian authorities can theoretically “normalize” it, while citizens will get off with a moderate acceleration in inflation and a gradual decline in living standards. Still,
“The rational, economic logic of technocrats is being opposed by the irrational logic of big Russian politics.”
A Wagner soldier in Belarus. July 2023. Source: VK
The irrationality of the regime
The general level of predictability of public decisionmakers in today’s Russia is much lower than that observed during the conflicts of the last century.
For example, in the first years of even the toughest wars, there were no military rebellions in any country. The Prigozhin rebellion took place just 16 months after the invasion of Ukraine. The fall of the ruble in July-August would not have been so deep had the fragility of the Putin system not manifested itself so clearly.
In the two months since the rebellion, more adventurous decisions and threats have been made by regime leaders than in all the previous months of 2023.
The refusal to renew the “grain deal,” announced on July 17, clearly contradicted the logic of the technocratic “normalization” of the war. It came as an unpleasant surprise for Russia’s key partners (mainly Turkey) and provoked Ukrainian retaliatory strikes against Russia’s own Black Sea-Azov Sea trade infrastructure.
This decision worsened the economic situation in Russia, though the negative effect is difficult to quantify. The same can be said about the threats of a Wagner proxy incursion into Poland voiced at the meeting between Putin and Lukashenko – the threats themselves hardly seemed realistic to Western leaders but nevertheless triggered the redeployment of Polish troops to the borders with Belarus and Russia.
Recently, Russia has been taking more and more actions that hardly look rationally justified and rather seem directed by the geopolitical fantasies of its ruler. These include, for example, deliveries of huge volumes of oil to India, the trade balance with which is already skewed, while payment for the deliveries is difficult due to sanctions. Trade volumes with Turkey change dramatically from month to month, not only due to fluctuations in the prices of Russian raw materials but also depending on the constant fluctuations in Putin’s personal relationship with Erdogan. Meanwhile, the 20 new military agreements signed with African countries in July do not promise commercial benefits and do not meet the real interests of Russia, just Putin’s dreams of global hegemony.
The general level of predictability of public decisionmakers in today’s Russia is much lower than that observed during the conflicts of the last century.
For example, in the first years of even the toughest wars, there were no military rebellions in any country. The Prigozhin rebellion took place just 16 months after the invasion of Ukraine. The fall of the ruble in July-August would not have been so deep had the fragility of the Putin system not manifested itself so clearly.
In the two months since the rebellion, more adventurous decisions and threats have been made by regime leaders than in all the previous months of 2023.
The refusal to renew the “grain deal,” announced on July 17, clearly contradicted the logic of the technocratic “normalization” of the war. It came as an unpleasant surprise for Russia’s key partners (mainly Turkey) and provoked Ukrainian retaliatory strikes against Russia’s own Black Sea-Azov Sea trade infrastructure.
This decision worsened the economic situation in Russia, though the negative effect is difficult to quantify. The same can be said about the threats of a Wagner proxy incursion into Poland voiced at the meeting between Putin and Lukashenko – the threats themselves hardly seemed realistic to Western leaders but nevertheless triggered the redeployment of Polish troops to the borders with Belarus and Russia.
Recently, Russia has been taking more and more actions that hardly look rationally justified and rather seem directed by the geopolitical fantasies of its ruler. These include, for example, deliveries of huge volumes of oil to India, the trade balance with which is already skewed, while payment for the deliveries is difficult due to sanctions. Trade volumes with Turkey change dramatically from month to month, not only due to fluctuations in the prices of Russian raw materials but also depending on the constant fluctuations in Putin’s personal relationship with Erdogan. Meanwhile, the 20 new military agreements signed with African countries in July do not promise commercial benefits and do not meet the real interests of Russia, just Putin’s dreams of global hegemony.
The damage from a drone strike on Moscow City. August 2023. Source: VK
‘Iranization’
The listlessness of Putin’s technocrats, who are promoting the “normalization” of the war economy more in words than in deeds, is understandable – they cannot plan for the long term and are constantly worried about unforeseen decisions by the ruler and attendant new disturbances and rebellions.
Ukrainian strikes on Moscow (since the beginning of May there have already been seven attacks by drones) and other regional centers deep in Russian territory have also become a new factor of uncertainty. The property damage is often minor, but local authorities and businesses face increasing risks.
The drift of the Russian military-economic model toward Iran is no longer a journalistic metaphor. It is to the Iranian version of stability that the Russian regime is increasingly gravitating.
The Islamic Republic wages permanent wars and is permanently under sanctions, while its convoluted economic policy is the product of technocrat recommendations combined with orders from theocratic rulers. For 43 years, since 1980, annual inflation in Iran has come in below 10% only four times, and in the last five years it averaged about 40%. Still, GDP rises more often than it falls, and in the last five years it has increased an average of 1.5% per year.
The Iranian masses have endured such a life for the past five decades, and Moscow’s rulers are eyeing this alternative with growing interest.
The listlessness of Putin’s technocrats, who are promoting the “normalization” of the war economy more in words than in deeds, is understandable – they cannot plan for the long term and are constantly worried about unforeseen decisions by the ruler and attendant new disturbances and rebellions.
Ukrainian strikes on Moscow (since the beginning of May there have already been seven attacks by drones) and other regional centers deep in Russian territory have also become a new factor of uncertainty. The property damage is often minor, but local authorities and businesses face increasing risks.
The drift of the Russian military-economic model toward Iran is no longer a journalistic metaphor. It is to the Iranian version of stability that the Russian regime is increasingly gravitating.
The Islamic Republic wages permanent wars and is permanently under sanctions, while its convoluted economic policy is the product of technocrat recommendations combined with orders from theocratic rulers. For 43 years, since 1980, annual inflation in Iran has come in below 10% only four times, and in the last five years it averaged about 40%. Still, GDP rises more often than it falls, and in the last five years it has increased an average of 1.5% per year.
The Iranian masses have endured such a life for the past five decades, and Moscow’s rulers are eyeing this alternative with growing interest.
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