The growth in fixed investment in the first quarter of 2023 was down to just 0.7% year-on-year, kept in positive territory only by the government and defense sectors, with private investments significantly down. (For a more detailed analysis, see the author’s report
.)Dearth of investment
Investors from the Global South are not coming to Russia: zero new investment from Chinese, Indian or Middle Eastern companies has been recorded since February 2022. The reason is that since the beginning of the war, Putin's government has introduced draconian capital controls and ownership right restrictions for foreign investors, keeping away businesses from "friendly" countries from the Global South.
While investors are not coming, an economic recovery depends chiefly on the state's ability to fund the economy – as well as defense spending and social commitments.
How much money does the government still have? Well, the deficit of the federal budget for the first six months of 2023 (RUB 2.6 trillion) comprised 38% of the remaining “liquid part” of the National Wealth Fund (RUB 6.8 trillion), according to the Ministry of Finance
The liquid part – cash on MinFin's accounts at the Central Bank – makes up about 54% of total National Wealth Fund money; the other part (RUB 5.9 trillion) is invested into various shares and bonds, mostly of state-affiliated companies ($3 billion was even invested in Ukrainian bonds while Viktor Yanukovych was president), and are not instantly liquid.
Russia has tried hard to push up the discounted prices of oil sold to Asian markets, but to little avail: the Urals oil price average in the first half of 2023 was hardly above $50 per barrel. To raise budget oil revenues significantly, Urals needs to be at least at the level of $70-80 per barrel, which can hardly be expected in the coming years, with the Central Bank keeping its forecast for Urals flat at $55 per barrel in 2023-25. Exports of liquefied natural gas to Europe and piped gas to China via the Power of Siberia gas pipeline do not generate significant revenues, as LNG exports and gas shipments to China are largely tax-exempt.
Another way to control the budget deficit would be to raise taxes – an option widely discussed by top economic officials at the St Petersburg Economic Forum in June. Partially it is already happening, with the imposition of a windfall tax on fertilizer exporters and other businesses and creeping increases of some other taxes. But the government seems concerned that tax hikes, together with Central Bank rate hikes, would kill any possible economic recovery, which is why the MinFin is currently opting for budget cuts as the key measure to keep the deficit under control.
Yet that has its downsides as well, given the extent to which current economic performance is supported by state spending. According to Rosstat
, in the first quarter of 2023 government final consumption expenditure surged by 13.5% year-on-year, while other components of GDP – household final consumption expenditure, gross fixed capital formation – were either in decline or stagnating.
Another indicator is the outstripping growth of military-related sectors in industrial production. According to Rosstat
, in January-June 2023, year-on-year output in sectors such as "finished metal products other than machinery and equipment” (weapons and ammunition), "computers, electronic and optical products" (radar devices, radio electronics) and "other transport facilities and equipment" (military aircraft, tanks and armored vehicles) was up 20-30%, and in uniforms it was up 76%, whereas overall output in manufacturing industries during the first six months was up just 6.2% year-on-year.
In July, as she explained
the decision to raise rates, Russian Central Bank head Elvira Nabiullina said that "during the period of the recovery growth in the economy, demand was predominantly driven by the public sector."
Faced with a stark choice whether to spend the remaining reserves to continue financing the deficit, economic recovery and the war or to raise taxes, the government has opted to cut “non-essential” spending, as the MinFin is afraid both of the negative impact of tax hikes on the economic recovery and of the shrinking room for maneuver should reserves keep being depleted.
However, cutting spending will have a major negative impact on the current economic model, since, in the absence of private and foreign investment, the economy almost totally relies on budget spending. We should assume that the MinFin announcement about major spending cuts is not the end of the story: key industrial and military lobbyists will likely put up fierce opposition to spending cuts in the coming months, with the outcome unpredictable for the MinFin.
It is also worth noting that the current fiscal situation puts major constraints on Russia's ability to wage war, which is why