ECONOMY
‘Russia is Squandering the Last Remaining Reserves and Savings Accrued in the Pre-War Period’
July 19, 2024
- Igor Lipsits
Professor, Dr.Sci. (Economics)
- Yevgeny Senshin
Journalist
Economist Igor Lipsits analyzes official statements claiming a healthy Russian economy and explains the hidden eddies in the steady flow of soothing governmental rhetoric.
The original text in Russian was an interview published in Republic. A fragment is being republished here with their permission.
Within the country as a whole, the following picture emerges: problems are growing, and the economy is increasingly dependent on oil exports. There are imbalances in many different areas—at least four. Primarily, in the increasing share of military spending and funding to the military economy to the detriment of the civilian economy, on the one hand. “Industrial growth is concentrated on a rather narrow front: mining, oil refining, and metal parts production. The production of consumer goods is expanding at an uncertain rate,” admits the Center for Macroeconomic Analysis and Short-Term Forecasting (TsMAKP), which works closely with the Russian government.
Growing Inflation
This is why the second imbalance arises—the population’s income is growing faster than the supply of consumer goods. And this causes inflation, which continues to rise to levels more than two times higher than the target values previously set by the Bank of Russia (June, estimate: 8.75% year-on-year against the target 4%).
Thirdly, government spending is growing faster than its revenue (even considering the high oil prices). Thus, over the three years of the special military operation, federal budget expenditures grew by 71.8%, while the growth in revenue was only 51.7%. Moreover, domestic revenue sources have been virtually cleaned out. Even the National Welfare Fund has shrunk to an absolutely miniscule sum. By the end of the year, it seems, there will only be about 3 trillion rubles of liquid funds left, compared to the 8.3 trillion rubles as of July 1, 2021.
The growth of non-oil and gas revenue has also stagnated. In the first quarter of 2024, the growth rate of this sector slowed significantly (to 13.1% year-on-year), but government expenses increased by 24.8% y/y. The budget was saved by the fact that oil and gas revenues grew by as much as 58.6% y/y.
Within the country as a whole, the following picture emerges: problems are growing, and the economy is increasingly dependent on oil exports. There are imbalances in many different areas—at least four. Primarily, in the increasing share of military spending and funding to the military economy to the detriment of the civilian economy, on the one hand. “Industrial growth is concentrated on a rather narrow front: mining, oil refining, and metal parts production. The production of consumer goods is expanding at an uncertain rate,” admits the Center for Macroeconomic Analysis and Short-Term Forecasting (TsMAKP), which works closely with the Russian government.
Growing Inflation
This is why the second imbalance arises—the population’s income is growing faster than the supply of consumer goods. And this causes inflation, which continues to rise to levels more than two times higher than the target values previously set by the Bank of Russia (June, estimate: 8.75% year-on-year against the target 4%).
Thirdly, government spending is growing faster than its revenue (even considering the high oil prices). Thus, over the three years of the special military operation, federal budget expenditures grew by 71.8%, while the growth in revenue was only 51.7%. Moreover, domestic revenue sources have been virtually cleaned out. Even the National Welfare Fund has shrunk to an absolutely miniscule sum. By the end of the year, it seems, there will only be about 3 trillion rubles of liquid funds left, compared to the 8.3 trillion rubles as of July 1, 2021.
The growth of non-oil and gas revenue has also stagnated. In the first quarter of 2024, the growth rate of this sector slowed significantly (to 13.1% year-on-year), but government expenses increased by 24.8% y/y. The budget was saved by the fact that oil and gas revenues grew by as much as 58.6% y/y.
“In other words, Russia is once again almost completely dependent on the oil market.”
Major Russian oil basins. Source: Wiki Commons
It is still somehow supporting the economy, but there are a few nuances. For example, this growth in oil and gas revenues is achieved due to the already high and continuously growing rate of expropriation from oil and gas revenues as a share of the revenue of companies within this industry.
Such a high fiscal burden can affect investment projects, and for oil companies, this includes the exploration and development of new fields. Gazprom has already been pillaged and made unprofitable; oil companies should prepare themselves. And oil prices are ever changing…
Fourthly, the Russian economy’s dependence on China is growing across all fronts, from the consumer market to the country’s foreign-exchange reserves (currently, the State Duma only allows them to be held in yuan). These four imbalances form the face, or more precisely, the grimace of the Russian economy.
Consequently, this means that the economy as a whole is unstable. It has not yet fallen into a crisis, but it could—recovery growth is slowing down, with growth rates of 1.5–1.7% on the horizon. And this forms the grounds for conflict between different government departments.
The Challenge of Import Substitution
One part of the government apparatus (represented by the Central Bank) is interested in somehow suppressing inflation. But so far, these efforts have not been very successful. Now the only real tool that the Central Bank has—theoretically—to combat inflation is the key rate. When it is increased, deposits naturally become more profitable and consumer loans become more expensive, which should reduce the pressure of the excess supply of money on the market.
But business loans are also becoming more expensive. And consequently, it becomes more difficult for domestic production to develop, especially among the civilian population, as loans now cost 17.0–17.5% per annum (and the Central Bank threatens to raise the key rate even higher!). It is very difficult to stay above water, let alone make a profit, when borrowing is so expensive. Meanwhile, the state will take more and more of this earned profit by increasing the corporate tax rates by a quarter starting from 2025. How can we solve the problem of import substitution under these conditions?
In addition, raising taxes will reduce demand, which in Russia is already too small to continue profitably producing many goods.
Such a high fiscal burden can affect investment projects, and for oil companies, this includes the exploration and development of new fields. Gazprom has already been pillaged and made unprofitable; oil companies should prepare themselves. And oil prices are ever changing…
Fourthly, the Russian economy’s dependence on China is growing across all fronts, from the consumer market to the country’s foreign-exchange reserves (currently, the State Duma only allows them to be held in yuan). These four imbalances form the face, or more precisely, the grimace of the Russian economy.
Consequently, this means that the economy as a whole is unstable. It has not yet fallen into a crisis, but it could—recovery growth is slowing down, with growth rates of 1.5–1.7% on the horizon. And this forms the grounds for conflict between different government departments.
The Challenge of Import Substitution
One part of the government apparatus (represented by the Central Bank) is interested in somehow suppressing inflation. But so far, these efforts have not been very successful. Now the only real tool that the Central Bank has—theoretically—to combat inflation is the key rate. When it is increased, deposits naturally become more profitable and consumer loans become more expensive, which should reduce the pressure of the excess supply of money on the market.
But business loans are also becoming more expensive. And consequently, it becomes more difficult for domestic production to develop, especially among the civilian population, as loans now cost 17.0–17.5% per annum (and the Central Bank threatens to raise the key rate even higher!). It is very difficult to stay above water, let alone make a profit, when borrowing is so expensive. Meanwhile, the state will take more and more of this earned profit by increasing the corporate tax rates by a quarter starting from 2025. How can we solve the problem of import substitution under these conditions?
In addition, raising taxes will reduce demand, which in Russia is already too small to continue profitably producing many goods.
“Thus, 10 years after setting a course for import substitution, Deputy Head of the Ministry of Industry and Trade of the Russian Federation Vasily Osmakov came to the conclusion that import substitution is impossible without exporting one’s products to foreign markets.”
“This thesis only seems counterintuitive at first glance. Let's take the auto industry again as an example. We can only manufacture a fully locally made Russian car if it has export potential, due to the limited domestic market. And this rule applies to any product,” Osmakov said.
That is, a situation arises where the Central Bank is pulling in one direction, trying to suppress inflation and inevitably destroying opportunities for economic growth, while the government is pulling in another, trying to accelerate economic growth with injections of government money so that the growth of the military-industrial complex does not devastate the consumer market.
As a result, an acute conflict is growing between the Central Bank and the government. And the essence of the government’s claims is quite clearly stated in the most recent report by the Stolypin Institute, with Oleg Deripaska acting as chairman of the supervisory board:
“By maintaining high rates, the Bank of Russia, in essence, is suggesting that the economy take a break in investments, where all investment projects that have been started will be suspended indefinitely, and new projects simply will not be launched. This is primarily due to the fact that the key rate (16%) already exceeds the level of return on sales in the economy as a whole (13.5% at the end of 2023), not to mention the return on assets (7.5% in 2023).
The cost-benefit ratio in many industries is significantly lower, and for them, attracting loans at current rates actually means committing oneself to financial servitude. The longer rates remain high, the more companies will have to turn away from investments.”
Nabiullina’s stratagem
In light of this reality, during the Financial Congress of the Bank of Russia, held on July 3–4, 2024 in St. Petersburg, the bank’s governor Elvira Nabiullina employed an interesting stratagem. In the presence of all the leading bankers of the country, Andrei Kostin and Herman Gref, she posed the question: “If the Central Bank lowered the key rate to 4-5%, would that be good for economic development?” And all the state bankers stood behind Nabiullina and said: “It would be catastrophic, it would be a disaster, under no circumstances should it be reduced, we can only increase it.”
In this way, Nabiullina built an alliance of those who support high rates and showed the government that Russia's leading bankers were behind her. This means that she feels a lot of pressure in her position.
That is, a situation arises where the Central Bank is pulling in one direction, trying to suppress inflation and inevitably destroying opportunities for economic growth, while the government is pulling in another, trying to accelerate economic growth with injections of government money so that the growth of the military-industrial complex does not devastate the consumer market.
As a result, an acute conflict is growing between the Central Bank and the government. And the essence of the government’s claims is quite clearly stated in the most recent report by the Stolypin Institute, with Oleg Deripaska acting as chairman of the supervisory board:
“By maintaining high rates, the Bank of Russia, in essence, is suggesting that the economy take a break in investments, where all investment projects that have been started will be suspended indefinitely, and new projects simply will not be launched. This is primarily due to the fact that the key rate (16%) already exceeds the level of return on sales in the economy as a whole (13.5% at the end of 2023), not to mention the return on assets (7.5% in 2023).
The cost-benefit ratio in many industries is significantly lower, and for them, attracting loans at current rates actually means committing oneself to financial servitude. The longer rates remain high, the more companies will have to turn away from investments.”
Nabiullina’s stratagem
In light of this reality, during the Financial Congress of the Bank of Russia, held on July 3–4, 2024 in St. Petersburg, the bank’s governor Elvira Nabiullina employed an interesting stratagem. In the presence of all the leading bankers of the country, Andrei Kostin and Herman Gref, she posed the question: “If the Central Bank lowered the key rate to 4-5%, would that be good for economic development?” And all the state bankers stood behind Nabiullina and said: “It would be catastrophic, it would be a disaster, under no circumstances should it be reduced, we can only increase it.”
In this way, Nabiullina built an alliance of those who support high rates and showed the government that Russia's leading bankers were behind her. This means that she feels a lot of pressure in her position.
“They demand a low key rate from Nabiullina, but she knows that she will have to answer for the inevitable high inflation that follows.”
Consider the recent article published by the TsMAKP, which we already mentioned above. It already talks about a “silent crisis,” caused by the fact that Russian businesses have taken out loans (at a variable rate, which is growing in conjunction with the Bank of Russia’s key rate). Companies will not be able to refinance loans, since new loans are now so prohibitively expensive. This means that old loans are beginning to drag large companies (including state-owned companies) and the banks that lent them toward bankruptcy.
The current state of the Russian economy is generating more and more conflict.
Each of the conflicts on their own could not cause an acute crisis. But when there are so many of them, they can lead the economy into a state of instability and crisis. And moreover, this instability may last for a long time.
It’s possible that this will become more noticeable in the upcoming year, when the state will have to further cut spending on the country’s civil needs. Thus, TsMAKP sees a significant risk of recession (economic decline) only after May 2025.
It can be assumed that in the third year of the special operation, Russia is squandering the last remaining reserves and savings accrued in the pre-war period. Gold and foreign exchange reserves have been lost, the National Welfare Fund is being used up, and the remaining funds in the treasury accounts were long ago drained to finance the military-industrial complex.
The current state of the Russian economy is generating more and more conflict.
Each of the conflicts on their own could not cause an acute crisis. But when there are so many of them, they can lead the economy into a state of instability and crisis. And moreover, this instability may last for a long time.
It’s possible that this will become more noticeable in the upcoming year, when the state will have to further cut spending on the country’s civil needs. Thus, TsMAKP sees a significant risk of recession (economic decline) only after May 2025.
It can be assumed that in the third year of the special operation, Russia is squandering the last remaining reserves and savings accrued in the pre-war period. Gold and foreign exchange reserves have been lost, the National Welfare Fund is being used up, and the remaining funds in the treasury accounts were long ago drained to finance the military-industrial complex.
Oleg Vyugin, a Russian economist and Professor at the National Research University Higher School of Economics. Source: Wiki Commons
As Oleg Vyugin, a professor at the Higher School of Economics, who previously held a number of high positions both in the government and in big business, explained in his speech at the Bank of Russia Financial Forum, the source of economic growth in 2022–2023 came primarily from using all the resources accumulated by the government over many years.
However, both the financial and labor resources are almost exhausted, says Vyugin: “We’ve already heard the first alarm bells in the form of tax increases: in order to maintain the achieved level of budget expenditures, we have to redistribute domestic resources.”
Stability Under Threat
It will become increasingly difficult to not only ensure growth, but to simply maintain stable living conditions within the country. And there are three main reasons behind this disaster:
1) It is becoming increasingly difficult to find funds for state support of the “peacetime economy” and citizens who do not work in the special military operation
2) It is becoming increasingly difficult to obtain equipment to replace failing equipment in many sectors of the economy
3) The labor shortage issue is getting worse
However, both the financial and labor resources are almost exhausted, says Vyugin: “We’ve already heard the first alarm bells in the form of tax increases: in order to maintain the achieved level of budget expenditures, we have to redistribute domestic resources.”
Stability Under Threat
It will become increasingly difficult to not only ensure growth, but to simply maintain stable living conditions within the country. And there are three main reasons behind this disaster:
1) It is becoming increasingly difficult to find funds for state support of the “peacetime economy” and citizens who do not work in the special military operation
2) It is becoming increasingly difficult to obtain equipment to replace failing equipment in many sectors of the economy
3) The labor shortage issue is getting worse
“More and more equipment will begin to fail, and this portends not just a decline in output, but also an increase in the scale of industrial accidents in Russia.”
Experts note that: “At hazardous production facilities (HIFs) alone, 60–70% of the equipment has already exceeded its standard service life, and the annual socio-economic damage from accidents is estimated at 0.6–0.7 trillion rubles.”
It is increasingly difficult to replace worn-out equipment—the supply of new equipment is simply insufficient: “Based on the results from the first half of 2024, the decrease in imports of equipment and machinery in Russia amounted to 4.9%. According to Federal Customs Service data published yesterday for the first five months of 2024, imports in January-May decreased by 8.5% y/y.”
To top it off, the investment climate (a term that now seems laughable when referring to the Russian economy) is being completely ruined by law enforcement agencies, which are now routinely seizing business assets for a variety of reasons (see RP’s article on the topic).
In other words, there are a number of conditions that have arisen which not only prevent business from flourishing, but also make it difficult for companies to survive. They are trying to fight back however they can, but it’s becoming more and more difficult.
“For our export- and import-dependent country, this spells ruin”
Add to this the problems in foreign trade. For example, Vladimir Chistyukhin, First Deputy Chairman of the Bank of Russia, made a previously unthinkable statement at a session of the St. Petersburg International Legal Forum: “One smaller, but currently important thing to consider is our international settlements. We must do everything to keep the wheels spinning. Things that were unpopular yesterday—swaps (including with central banks), some clearing systems, the use of cryptocurrency—everything needs to be tested, tried, and as quickly as possible. Because if there is no way to ensure payments for products in foreign economic activity, for our export- and import-dependent country, that’s it, this spells ruin!”
These words from government officials indicate the same thing that we, scientists, have said earlier: the Russian economy is in danger. It’s just that the dangers are manifesting more slowly, the safety net proved somewhat larger, and the price of oil turned out to be higher than anticipated. And oil sanctions were not as effective as expected.
It is increasingly difficult to replace worn-out equipment—the supply of new equipment is simply insufficient: “Based on the results from the first half of 2024, the decrease in imports of equipment and machinery in Russia amounted to 4.9%. According to Federal Customs Service data published yesterday for the first five months of 2024, imports in January-May decreased by 8.5% y/y.”
To top it off, the investment climate (a term that now seems laughable when referring to the Russian economy) is being completely ruined by law enforcement agencies, which are now routinely seizing business assets for a variety of reasons (see RP’s article on the topic).
In other words, there are a number of conditions that have arisen which not only prevent business from flourishing, but also make it difficult for companies to survive. They are trying to fight back however they can, but it’s becoming more and more difficult.
“For our export- and import-dependent country, this spells ruin”
Add to this the problems in foreign trade. For example, Vladimir Chistyukhin, First Deputy Chairman of the Bank of Russia, made a previously unthinkable statement at a session of the St. Petersburg International Legal Forum: “One smaller, but currently important thing to consider is our international settlements. We must do everything to keep the wheels spinning. Things that were unpopular yesterday—swaps (including with central banks), some clearing systems, the use of cryptocurrency—everything needs to be tested, tried, and as quickly as possible. Because if there is no way to ensure payments for products in foreign economic activity, for our export- and import-dependent country, that’s it, this spells ruin!”
These words from government officials indicate the same thing that we, scientists, have said earlier: the Russian economy is in danger. It’s just that the dangers are manifesting more slowly, the safety net proved somewhat larger, and the price of oil turned out to be higher than anticipated. And oil sanctions were not as effective as expected.
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