- Sergey Aleksashenko
Economist
- Yevgeny Senshin
Journalist
Many experts acknowledge that the Russian economy, though ineffective, has proven to be a tough nut to crack. There is no development, yet there is growth. How long can the Russian economy bear the burden of growing defense spending?
Your question essentially contains two questions. The first is: how long can the Russian economy survive with defense spending at 6-8% [of GDP]? The answer: for a while. There are many examples of different countries that have lived with such a level of defense spending for years and even decades. Obviously, this comes at the cost of either a less generous social safety net or higher inflation. It is a political choice that the government makes and society accepts.
The second question is: is it possible to live with this level of defense spending? Yes, it is. Might this lead to social upheaval at some point, as happened, for example, in the Soviet Union? No, it will not. Because the Soviet Union had a planned economy. To bring it into a state of equilibrium, a decision was needed from bureaucrats at some level: either at the highest, Gorbachev, or a lower one. But in a market economy, equilibrium is achieved through changes in prices. Scarce resources and services become more expensive, and thus the economy comes into equilibrium.
You say that defense expenditures will have to be paid for. In our Russian case, how exactly? We are already seeing unhealthy inflation, but at the same time, wages are rising. One of the reasons [for that], it seems, is the labor shortage, meaning unemployment is decreasing. What else can Russian society expect in the tradeoff for this political choice?
You are right: inflation. But it is much higher than the indexation of public-sector wages (by the way, this year, they were not indexed), pensions and fiscal expenditures unrelated to wages. That is, incomes across the rest of the economy are being devalued by inflation. And the resulting delta goes to the Ministry of Finance. In fact, it is the main beneficiary of higher inflation, thanks to which it is able to finance the huge defense expenditures.
As for the labor shortage, I have already spoken about it. A scarce resource is becoming more expensive; in this case it is labor.
So, where to get the money for constantly rising defense expenditures? Obviously, it is earningsfrom oil sales, the reserve fund, borrowing in the local market, maybe someone will even risk investing. But recall the Central Bank’s recent warning: there is a high likelihood that the National Wealth Fund (NWF) will be depleted in 2025 since oil prices “over the entire horizon” are significantly lower than the base-case figures penciled into the Russian budget. Could you break down all these [revenue] sources – to what extent is it justified to count on them?
In my view, it is quite justified. The Central Bank’s forecast that the NWF may be depleted by the end of next year looks very alarmist. I do not envisage such a scenario. If the oil price falls, the ruble will depreciate, and the Ministry of Finance will receive additional revenues because of that depreciation, as it did in 2023. Today, the budget has a minimal deficit, less than 1% of GDP, meaning it is fairly sustainable.
But the Central Bank is still worried, which is reflected primarily in continuing rate hikes. At the next meeting this month, it is expected to hike the key rate to 20%. And still, inflation is not slowing. The issue is: the key rate as an instrument is no longer working. So, what else can the Central Bank do?
Albert Einstein said insanity is doing the same thing a hundred times and expecting different results, like stepping on a rake. It seems to me that the Central Bank should have already concluded that raising rates will not lead to lower inflation; it is defense spending, as part of the budget, that is pushing inflation higher. And the Central Bank and the Ministry of Finance have no way of reducing it. At the same time, I do not think that we should shoot the pianist, he is doing his best.
The Central Bank is responsible for the stability of the ruble, i.e., for low inflation, and it is pretending to pursue that. Its actions are ineffective and unlikely to produce results. So, what can I recommend? Resign and let others solve the problem.
And what will those others, in the place of Nabiullina and her team, be able to do, aside from hiking the key rate?
There is only one thing that can be done – reduce defense spending. If inflation is driven by defense spending, then why does anyone think that raising the key rate, constantly stepping on the same rake, will change anything?
The economy minister recently made an optimistic forecast [on inflation]: its peak [was said to have] passed in the summer, its pace is slowing and it will come down to 4% as soon as 2026. How should we understand such statements?
I think that Economy Minister Maxim Reshetnikov is trying to be optimistic and talk about something good that no one else sees. The Central Bank, meanwhile, says that inflation is accelerating, and we see this in the latest data for September.
Wages have risen steadily this year. And this is probably good. But, as we discussed above, inflation is also rising. Some experts believe that the arms race in wages is ending, and businesses cannot raise them any further. Still, the number of workers in Russia has not increased, and they will go to work where they can get the most money. What should [employers and employees] do in this situation?
At this point, we only see that the growth of nominal wages – what Rosstat reports – has really stopped in the last three or four months. But how long-lasting that is, whether it is another six months or two, I am not ready to say for sure. Most likely, it will not last, because otherwise there will be unrest and indignation. So, someone will definitely find money to increase wages, and a new migration of workers will start.
The fact that wage growth has temporarily stopped may indicate that the economy has reached equilibrium. When the supply and demand curves intersect at some point, this is called equilibrium. But everything can change quickly. Let’s say the budget allocates some money at the end of the year for construction or the production of new weapons, or exporters want to build a new airport and buy 250 planes – this will mean new sources of wage growth in the economy and everything will continue. Therefore, it seems to me that all this equilibrium is temporary.
What about small and medium-sized business? How can they get by in such conditions?
It is impossible to find a common solution for hundreds of thousands of small or medium-sized firms in one go. Understand: small businesses are often individual. A person makes his own small business and thus creates jobs for himself and his family.
You open some family cafe on the highway, and you live there with your family. You cannot be dragged to a neighboring city, 150 kilometers away, to work as a metalworker, a machinist, a mill operator or an electronic equipment fitter.
So, not all Russians, not all workers are ready to take off for a higher salary. In the end, the defense sector has become the engine of the economy, and it requires very specific qualifications and skills. Or another option: you can go to Ukraine, selling your life.
Therefore, if you are the owner of a cafe, a barbershop or a dog grooming salon, then you have little choice in terms of keeping your business going other than to raise the prices for your services as inflation rises.
Perhaps customers will be willing to pay 20% more, or perhaps only 5%. That can only be determined in practice.
I do not really trust the talk that Chinese banks have stopped [accepting] payments. If you look at Chinese statistics on exports of goods to Russia, you will see that exports have been growing steadily throughout almost the entire year.
I do not believe that Chinese companies are ready to supply anything to Russia without payment. As a rule, they ship to Russia based on prepayments. This means that payments are being processed. The volume of exports from China to Russia continues to grow. This indicates that, generally speaking, there is no problem with payments.
Overall, how do you describe current Russia-China economic ties? Is this the pivot to the East, with one side dominating and the other submitting?
To say whether the pivot to the East has been effected, we need to define what it is. When Russia was oriented toward the West, it was well understood that the West was a source of technology, equipment and capital for Russia. That is, Russian banks and companies could borrow money, place bonds and shares, raise capital and gain access to modern technological solutions.
If we look at Russia-China trade data, we see that Russia is not receiving any new technology. Putin has been talking about pivoting to the East since 2014. Yet during that time, practically not a single large Chinese enterprise with new equipment has been created in Russia. The Chinese have factories, for example, automobile factories, where you just change the nameplates. But there is not a single large Chinese enterprise you can see where the Chinese have brought their technology and equipment, thanks to which the Russian economy can manufacture its own products.
It is the same case in the debt market, not to mention the equity market. As far as I know, not a single Russian company has raised serious money on the Shanghai or Hong Kong stock exchanges. There are some secondary listings of shares, but no one has managed to raise equity capital there. Meanwhile, placing bonds in large volumes with Chinese banks is possible only if allowed by the Chinese Communist Party Politburo.
Sure, we have pivoted to the East. But only because we stopped talking to the West. What Russia was getting from the West, it is not getting from China.
