ECONOMY
How Government Policies are Weakening the Stability of the Russian Economy
January 10, 2025
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Yuri Danilov
PhD, independent scholar
The report written by these three authors has generated considerable debate in the Russian expert community, with a number of critics dismissing it as untenable (see, for instance, Russia.Post’s article on the subject).
Strengths and weaknesses of the arguments presented
In my opinion, this report deserves serious attention, in particular because it generates political signaling. There are many theses that must be agreed with; two seem to be the most important:
In criticizing experts who view the current Russian regime as the USSR 2.0, the authors rightly point out the market nature of the Russian economy. Note, however, that they themselves pay no heed to the regime’s drift toward a more rigid mobilization model, in which the place of the market sector will be significantly reduced and, accordingly, the market nature of the economy will weaken.
It is also fair to say that the current system of Western sanctions is not very effective. Let us note that this ineffectiveness is largely a consequence of the stubbornness of the “architects” of these sanctions, who continue to “pound on the fortress wall” at its thickest point, ignoring alternative possibilities.
At the same time, there are already many voices that have convincingly proven the failure of these sanctions, first and foremost Alexander Libman (see his argument in Russia.Post here). However, the politicians who decided on this configuration of sanctions are doing nothing to change it, apparently trying to “save face.”
That being said, the authors of the report make three key mistakes. First, they ignore certain risks, primarily the risk of price and financial instability, as well as default risk.
Secondly, they underestimate the growing resource deficit (primarily in labor and finances).
Moreover, they talk about the possibility of a significant redistribution of resources between the market and military sectors in favor of the latter, but they do not assume that if this happens, there is the risk of destabilizing the economy, which relies on the market sector (which, as stated above, will shrink significantly).
Strengths and weaknesses of the arguments presented
In my opinion, this report deserves serious attention, in particular because it generates political signaling. There are many theses that must be agreed with; two seem to be the most important:
In criticizing experts who view the current Russian regime as the USSR 2.0, the authors rightly point out the market nature of the Russian economy. Note, however, that they themselves pay no heed to the regime’s drift toward a more rigid mobilization model, in which the place of the market sector will be significantly reduced and, accordingly, the market nature of the economy will weaken.
It is also fair to say that the current system of Western sanctions is not very effective. Let us note that this ineffectiveness is largely a consequence of the stubbornness of the “architects” of these sanctions, who continue to “pound on the fortress wall” at its thickest point, ignoring alternative possibilities.
At the same time, there are already many voices that have convincingly proven the failure of these sanctions, first and foremost Alexander Libman (see his argument in Russia.Post here). However, the politicians who decided on this configuration of sanctions are doing nothing to change it, apparently trying to “save face.”
That being said, the authors of the report make three key mistakes. First, they ignore certain risks, primarily the risk of price and financial instability, as well as default risk.
Secondly, they underestimate the growing resource deficit (primarily in labor and finances).
Moreover, they talk about the possibility of a significant redistribution of resources between the market and military sectors in favor of the latter, but they do not assume that if this happens, there is the risk of destabilizing the economy, which relies on the market sector (which, as stated above, will shrink significantly).
Source: Statista
Consider the risks!
In evaluating the stability of the Russian economic system, the authors operate mainly on performance indicators, primarily gross domestic product, military spending, real incomes of the population, and the dynamics of these indicators over time.
Here is their reasoning: “…the military spending has increased, the geography of foreign trade has changed, and the citizens’ real disposable incomes has grown. Together, all this provides the Russian economy with strength and stability…”.
Those who are more familiar with how the market economy works (and the Russian economy is still a market economy—the authors of the report are right about this) usually use other indicators to gauge sustainability (stability), primarily ones that characterize risks. This is where my opinion diverges from that of my colleagues: I believe the risks of instability in the Russian economy are exceedingly high.
Just over a year ago I wrote that macroeconomic stability has been significantly undermined. Over the past year, the risk of financial instability has increased drastically; price stability has been lost; in recent months, the reserve of enterprise stability, which was previously formed by a sufficient profit margin, has been declining. In addition, the positive economic impact created by the introduction of preferential mortgages has died out, while the risks (primarily, inflation) remain.
The Central Bank still effectively manages macro risks, but seems increasingly like a late-level Tetris player, unable to react in time as the pieces fall faster and faster. For the past year, Elvira Nabiullina has only been able to make bad decisions. For example, just recently the Central Bank was forced to make the poor, inflationary decision to return to repo auctions, in order to avoid the even worse, catastrophic decision to freeze deposits by converting them into “war bonds.”
In evaluating the stability of the Russian economic system, the authors operate mainly on performance indicators, primarily gross domestic product, military spending, real incomes of the population, and the dynamics of these indicators over time.
Here is their reasoning: “…the military spending has increased, the geography of foreign trade has changed, and the citizens’ real disposable incomes has grown. Together, all this provides the Russian economy with strength and stability…”.
Those who are more familiar with how the market economy works (and the Russian economy is still a market economy—the authors of the report are right about this) usually use other indicators to gauge sustainability (stability), primarily ones that characterize risks. This is where my opinion diverges from that of my colleagues: I believe the risks of instability in the Russian economy are exceedingly high.
Just over a year ago I wrote that macroeconomic stability has been significantly undermined. Over the past year, the risk of financial instability has increased drastically; price stability has been lost; in recent months, the reserve of enterprise stability, which was previously formed by a sufficient profit margin, has been declining. In addition, the positive economic impact created by the introduction of preferential mortgages has died out, while the risks (primarily, inflation) remain.
The Central Bank still effectively manages macro risks, but seems increasingly like a late-level Tetris player, unable to react in time as the pieces fall faster and faster. For the past year, Elvira Nabiullina has only been able to make bad decisions. For example, just recently the Central Bank was forced to make the poor, inflationary decision to return to repo auctions, in order to avoid the even worse, catastrophic decision to freeze deposits by converting them into “war bonds.”
“Based on the positive Russian economic indicators and real incomes of the population, as well as the way the economy has adapted to the sanctions regime, the authors of the report conclude that: ‘Russian economic stability is not at serious risk,’ while in fact completely overlooking the actual risk analysis.”
The fact that the risk to the country’s economy is high is indicated by the high degree of volatility—of the national currency exchange rate, interest rates, commodity prices, and stock indices (all of which can be seen first-hand in Russia in recent months).
This is also indicated by the difficulties observed in recent months with businesses unable to make payments, including debt repayments, as well as issues raising money on the government bond market.
The non-payment crisis is returning: in a survey of entrepreneurs conducted by the Russian Union of Industrialists and Entrepreneurs, 37% of respondents mentioned the problem of non-payments by counterparties as by far the most common among all possible constraints on a company’s operations.
It is worth recalling that back in the late 1990s, the runaway growth in government bond yields led to a non-payment crisis that ended in the 1998 default.
According to the SPARK-Interfax system, in the third quarter of 2024, the share of companies delaying payments to suppliers by an average of more than 60 days increased significantly. For large businesses, it rose to 5.2%, for medium-sized businesses—6.2%, and for small businesses—12.1%.
The authors of the report seriously underestimate the risk of falling into hyperinflation. They claim that “the pass-through effect of devaluation on consumer prices is constrained to a coefficient of 0.1,” but this is only an estimate of the short-term (a 3–6 month perspective) impact of the ruble’s depreciation on prices. In the Russian expert community, such estimates vary from a 5–6% change in the exchange rate (Bank of Russia) and 5–10% (Development Center) to 25–30%(VTB).
But Bank of Russia employees also point to the long-term consequences of the ruble’s devaluation: “Empirical studies show that…the exchange rate pass-through to prices…in the base case estimate is 98.5% in the long term (more than five years).”
In recent months, financial authorities have managed to fill the budget, largely due to the further acceleration of inflation and the growth of inflation expectations.
This is also indicated by the difficulties observed in recent months with businesses unable to make payments, including debt repayments, as well as issues raising money on the government bond market.
The non-payment crisis is returning: in a survey of entrepreneurs conducted by the Russian Union of Industrialists and Entrepreneurs, 37% of respondents mentioned the problem of non-payments by counterparties as by far the most common among all possible constraints on a company’s operations.
It is worth recalling that back in the late 1990s, the runaway growth in government bond yields led to a non-payment crisis that ended in the 1998 default.
According to the SPARK-Interfax system, in the third quarter of 2024, the share of companies delaying payments to suppliers by an average of more than 60 days increased significantly. For large businesses, it rose to 5.2%, for medium-sized businesses—6.2%, and for small businesses—12.1%.
The authors of the report seriously underestimate the risk of falling into hyperinflation. They claim that “the pass-through effect of devaluation on consumer prices is constrained to a coefficient of 0.1,” but this is only an estimate of the short-term (a 3–6 month perspective) impact of the ruble’s depreciation on prices. In the Russian expert community, such estimates vary from a 5–6% change in the exchange rate (Bank of Russia) and 5–10% (Development Center) to 25–30%(VTB).
But Bank of Russia employees also point to the long-term consequences of the ruble’s devaluation: “Empirical studies show that…the exchange rate pass-through to prices…in the base case estimate is 98.5% in the long term (more than five years).”
In recent months, financial authorities have managed to fill the budget, largely due to the further acceleration of inflation and the growth of inflation expectations.
“The budget impulse itself creates an increasingly dangerous gap between the supply and the demand of goods and services.”
Budgets for the coming years and the rising key rate are prompting businesses to change prices in response to their expectations for the future. Growing the primary market of government bonds is impossible without the use of inflationary methods of pumping liquidity into the banking sector.
Russia is already quite close to hyperinflation. One must take into account that this term is not tied to any specific level of inflation, but rather is a characteristic of the uncontrollability of inflationary processes, and the current crackpot budget policy is certainly leading the country in this direction.
The collapse into hyperinflation can occur at lower levels than it might usually, simply due to the adoption of a fundamentally new model of behavior among businesses and the general population: buyers strive to buy more and faster, and entrepreneurs take future price increases into account when setting prices. These behavior models themselves begin to influence the acceleration of price growth.
Remember the law of conservation of matter!
It is difficult to share the optimism expressed by the authors of the report regarding available resources.
One of them claims in another publication that the regime has a reserve of several million people potentially ready to go to the front, and that the available financial resources “more than exceed” the sum needed to provide them with starting and monthly payments.
But in a country with almost no unemployment, finding “several million people” is not possible without damaging the economy. And finding a spare 2% of the budget (according to the same author’s calculations, an additional 1% of the budget is required to recruit 700,000 people into the army), as events at the end of this year show, is impossible without taking measures that would be fraught with extremely serious consequences. After 8 months of failing to successfully enact their plan to raise funds on the federal loan bond (OFZ) market, the Ministry of Finance was forced to accept extremely unfavorable conditions in order to finance the budget deficit, which could greatly increase the volume of coupon payments in the future. To ensure the success of these auctions, the Bank of Russia, as stated above, resumed repo auctions.
It appears that there were non-public agreements between the state and the largest banks to finance the budget deficit through OFZs (although it is clear that in this case the OFZs act as the “middle man,” while in reality we are talking about the Central Bank financing the Government).
The Ministry of Finance “squeezing” money from the bond market creates a powerful crowding out effect, further redistributing resources from the market sector to the non-market (in fact, to the military) sector. The same crowding out effect creates the preconditions for mass corporate defaults, which will begin, according to even the most loyal experts, in the first or second quarter of 2025.
This is still an isolated episode, but this “raking in” of resources to finance the military sector has long been to the detriment of the market sector, which (and in this, we agree with the authors of the report) is the main factor in maintaining the stability of the entire Russian economy. In turn, undermining the market sector reduces its stability. Further redistribution of resources in favor of military needs is tantamount to sawing off the branch on which the Russian economy hangs.
The authors of the report make an unforgivable mistake for professionals, claiming that “the Russian government’s debt is insignificant by modern standards—it is expected to reach 18.1 percent of GDP by the end of 2024—which leaves a huge space for domestic borrowing.”
When speaking about the country’s “insignificant national debt,” they try to compare Russia with North America or Western Europe, while according to the objective characteristics of the debt market, Russia’s place is among the countries of Latin America and Eastern Europe. And by the standards of these regions, the ratio of domestic national debt to GDP at 18% can hardly be called low. This ratio for Bulgaria is 6%, for Croatia 13%, for Peru 14%, for Romania 18%, and for the more prosperous Chile—25%.
It is hardly pertinent to talk about Russia attracting external loans today. Quite recently, RANEPA employees calculated that for countries with average income levels, safe debt burden thresholds are equal to 24% of GDP, while for Russia, the safe debt threshold should not exceed 20% of GDP.
Russia is already quite close to hyperinflation. One must take into account that this term is not tied to any specific level of inflation, but rather is a characteristic of the uncontrollability of inflationary processes, and the current crackpot budget policy is certainly leading the country in this direction.
The collapse into hyperinflation can occur at lower levels than it might usually, simply due to the adoption of a fundamentally new model of behavior among businesses and the general population: buyers strive to buy more and faster, and entrepreneurs take future price increases into account when setting prices. These behavior models themselves begin to influence the acceleration of price growth.
Remember the law of conservation of matter!
It is difficult to share the optimism expressed by the authors of the report regarding available resources.
One of them claims in another publication that the regime has a reserve of several million people potentially ready to go to the front, and that the available financial resources “more than exceed” the sum needed to provide them with starting and monthly payments.
But in a country with almost no unemployment, finding “several million people” is not possible without damaging the economy. And finding a spare 2% of the budget (according to the same author’s calculations, an additional 1% of the budget is required to recruit 700,000 people into the army), as events at the end of this year show, is impossible without taking measures that would be fraught with extremely serious consequences. After 8 months of failing to successfully enact their plan to raise funds on the federal loan bond (OFZ) market, the Ministry of Finance was forced to accept extremely unfavorable conditions in order to finance the budget deficit, which could greatly increase the volume of coupon payments in the future. To ensure the success of these auctions, the Bank of Russia, as stated above, resumed repo auctions.
It appears that there were non-public agreements between the state and the largest banks to finance the budget deficit through OFZs (although it is clear that in this case the OFZs act as the “middle man,” while in reality we are talking about the Central Bank financing the Government).
The Ministry of Finance “squeezing” money from the bond market creates a powerful crowding out effect, further redistributing resources from the market sector to the non-market (in fact, to the military) sector. The same crowding out effect creates the preconditions for mass corporate defaults, which will begin, according to even the most loyal experts, in the first or second quarter of 2025.
This is still an isolated episode, but this “raking in” of resources to finance the military sector has long been to the detriment of the market sector, which (and in this, we agree with the authors of the report) is the main factor in maintaining the stability of the entire Russian economy. In turn, undermining the market sector reduces its stability. Further redistribution of resources in favor of military needs is tantamount to sawing off the branch on which the Russian economy hangs.
The authors of the report make an unforgivable mistake for professionals, claiming that “the Russian government’s debt is insignificant by modern standards—it is expected to reach 18.1 percent of GDP by the end of 2024—which leaves a huge space for domestic borrowing.”
When speaking about the country’s “insignificant national debt,” they try to compare Russia with North America or Western Europe, while according to the objective characteristics of the debt market, Russia’s place is among the countries of Latin America and Eastern Europe. And by the standards of these regions, the ratio of domestic national debt to GDP at 18% can hardly be called low. This ratio for Bulgaria is 6%, for Croatia 13%, for Peru 14%, for Romania 18%, and for the more prosperous Chile—25%.
It is hardly pertinent to talk about Russia attracting external loans today. Quite recently, RANEPA employees calculated that for countries with average income levels, safe debt burden thresholds are equal to 24% of GDP, while for Russia, the safe debt threshold should not exceed 20% of GDP.
“Russia is already feeling an acute shortage of labor and financial resources. There is nowhere to get these resources from.”
The Sarmat intercontinental ballistic missile. Source: Wiki Commons According to official data, military expenditures, excluding “disguised” costs, comprise 32.5% of the 2025 budget. Source: Wiki Commons
They cannot be redistributed as simply as was done in the USSR. It will not even work the way it was done in Germany in the 1930s, where compulsory labor service was introduced in 1935, when the unemployment rate was just over 4%, and the share of military spending was 18% of the budget. In Russia today, unemployment is 2.3%, and the share of military spending in the 2025 budget is 32.5% (this is according to official data, without taking into account “disguised” costs).
According to SIPRI, in the USSR, the share of military spending in the late 1980s reached 28%, and this proved critical for the Soviet economy. The authors of the report rightly state that the modern Russian economy is much more stable than the Soviet one, precisely because of its market nature.
But it seems that the critical level of military spending at which the modern economy will cease to be sustainable also differs from the USSR: it is lower due to the fact that to ensure the sustainability of the economy (and, accordingly, the survival of business), certain resources are needed that must remain at the disposal of the private sector. The withdrawal of these resources from the market sector will tank the stability of the Russian economy.
The main contradiction in the report
The report contains a glaring internal contradiction. On the one hand, the authors agree with the existing consensus that the market nature of the Russian economy has become the most important factor in its stability.
On the other hand, they say that the government can pool all of its resources together (if banks do not want to buy OFZs, the government will force them) and thus plug any holes in the budget. At the same time, the authors of the report do not recognize that this picture provides less and less room for the market sector, and that it will not be able to stabilize the economy as effectively. Nevertheless, in their analysis, for some reason the economy remains stable even without the market sector. But if all resources go to buying OFZs or producing military equipment, who will support the production of consumer goods and services?
According to SIPRI, in the USSR, the share of military spending in the late 1980s reached 28%, and this proved critical for the Soviet economy. The authors of the report rightly state that the modern Russian economy is much more stable than the Soviet one, precisely because of its market nature.
But it seems that the critical level of military spending at which the modern economy will cease to be sustainable also differs from the USSR: it is lower due to the fact that to ensure the sustainability of the economy (and, accordingly, the survival of business), certain resources are needed that must remain at the disposal of the private sector. The withdrawal of these resources from the market sector will tank the stability of the Russian economy.
The main contradiction in the report
The report contains a glaring internal contradiction. On the one hand, the authors agree with the existing consensus that the market nature of the Russian economy has become the most important factor in its stability.
On the other hand, they say that the government can pool all of its resources together (if banks do not want to buy OFZs, the government will force them) and thus plug any holes in the budget. At the same time, the authors of the report do not recognize that this picture provides less and less room for the market sector, and that it will not be able to stabilize the economy as effectively. Nevertheless, in their analysis, for some reason the economy remains stable even without the market sector. But if all resources go to buying OFZs or producing military equipment, who will support the production of consumer goods and services?
“The state is steadily encroaching on the market sector, reducing its ability to ensure the sustainability of the entire economy.”
Flyer for contract service in the "special operation." Text on the flyer: "Join the army of victory. One-time payment of 4 million rubles (over $37,000 USD), salaries starting at 260,000 rubles per month (about $2,400 USD). Guaranteed by the state. Source: VK
Tax hikes; rising interest rates on loans; sharp increases in wages; the crowding out effect on the bond market--all of this directly reduces the market sector’s ability to develop. Of course, Western sanctions also contribute to this, but the effect is much weaker than, for example, the consequences of an extremely risky budget policy.
Methodologically and politically erroneous conclusions
The conclusion formulated in the report that “5-6 years is the minimum projected sustainability of the current economic model” contradicts the methodology of crisis prediction. It is already impossible to estimate the time that a crisis will occur, but forecasting maintained stability is even stranger, as if to say that since this stability currently exists, it has every opportunity to continue multiplying.
Macroeconomic stability, which had already been undermined in 2023, was practically destroyed by the implementation of the 2024 budget. The Russian economy is extremely fragile today, and a collapse into a crisis is becoming increasingly likely. But such a collapse will only occur at a trigger point, i.e. an event (usually sudden) that critically disrupts the normal (stationary) mode of functioning of the economic system. The emergence of such a trigger is probabilistic, which is why there is no way to scientifically substantiate the terms of “the end of stability.”
The political signaling that can be seen in the report seems rather strange. The report’s conclusion about the economic stability of the regime suggests that, politically, it would be expedient for the Russian “opposition” not to try to change the regime today, and for Russian business and bureaucracy not to take risks and remain loyal to the regime. The West is being sent a signal about the inevitability of long-term coexistence with an unchanged, not very dangerous regime.
The fallacy of these signals seems to be linked to an assumption of the regime's immutability. In fact, economic weaknesses are currently creating increased political vulnerability for the regime, and that is why the authorities, who are well aware of the risks, are trying to “skip over” this dangerous stage as quickly as possible.
While publicly declaring their own thesis about the stability of the situation (with which the authors of the report also agreed), the authorities are actively, but quietly working on the transition to a more rigid model, at least in four areas:
1) Attempts to switch out the political elite, which have already begun (see here and here), but have been met with muted resistance and are therefore still barely noticeable
2) Redistribution of property in favor of the president's most loyal supporters (see here and here)
3) Attempts to form a state ideology, combined with declarations of personal loyalty to Putin (see here and here), have replaced the non-ideological spin-dictatorships
4) Restriction of access to alternative information (ceasing operation of YouTube and Viber in Russia, increased funding for blocking VPNs). In addition, in 2024, cases of criminal prosecution for connections to opposition media increased significantly. Today, we can say that the regime is moving from “targeted” repressions to mass intimidation (examples of the most outrageous court decisions can be seen here).
To overcome the vulnerability that still remains, the political regime needs to use those 5-6 years to transform into a more rigid mobilization model (under favorable circumstances, including the absence of obstacles from the opposition and the West).
Under this model, a regime that relies on harsh repression is more likely to cope with internal opposition, perhaps even in the event of economic disasters.
A regime like this would be much more dangerous on a global scale.
Methodologically and politically erroneous conclusions
The conclusion formulated in the report that “5-6 years is the minimum projected sustainability of the current economic model” contradicts the methodology of crisis prediction. It is already impossible to estimate the time that a crisis will occur, but forecasting maintained stability is even stranger, as if to say that since this stability currently exists, it has every opportunity to continue multiplying.
Macroeconomic stability, which had already been undermined in 2023, was practically destroyed by the implementation of the 2024 budget. The Russian economy is extremely fragile today, and a collapse into a crisis is becoming increasingly likely. But such a collapse will only occur at a trigger point, i.e. an event (usually sudden) that critically disrupts the normal (stationary) mode of functioning of the economic system. The emergence of such a trigger is probabilistic, which is why there is no way to scientifically substantiate the terms of “the end of stability.”
The political signaling that can be seen in the report seems rather strange. The report’s conclusion about the economic stability of the regime suggests that, politically, it would be expedient for the Russian “opposition” not to try to change the regime today, and for Russian business and bureaucracy not to take risks and remain loyal to the regime. The West is being sent a signal about the inevitability of long-term coexistence with an unchanged, not very dangerous regime.
The fallacy of these signals seems to be linked to an assumption of the regime's immutability. In fact, economic weaknesses are currently creating increased political vulnerability for the regime, and that is why the authorities, who are well aware of the risks, are trying to “skip over” this dangerous stage as quickly as possible.
While publicly declaring their own thesis about the stability of the situation (with which the authors of the report also agreed), the authorities are actively, but quietly working on the transition to a more rigid model, at least in four areas:
1) Attempts to switch out the political elite, which have already begun (see here and here), but have been met with muted resistance and are therefore still barely noticeable
2) Redistribution of property in favor of the president's most loyal supporters (see here and here)
3) Attempts to form a state ideology, combined with declarations of personal loyalty to Putin (see here and here), have replaced the non-ideological spin-dictatorships
4) Restriction of access to alternative information (ceasing operation of YouTube and Viber in Russia, increased funding for blocking VPNs). In addition, in 2024, cases of criminal prosecution for connections to opposition media increased significantly. Today, we can say that the regime is moving from “targeted” repressions to mass intimidation (examples of the most outrageous court decisions can be seen here).
To overcome the vulnerability that still remains, the political regime needs to use those 5-6 years to transform into a more rigid mobilization model (under favorable circumstances, including the absence of obstacles from the opposition and the West).
Under this model, a regime that relies on harsh repression is more likely to cope with internal opposition, perhaps even in the event of economic disasters.
A regime like this would be much more dangerous on a global scale.
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