SOCIETY
A Dead End for Russia’s War Economy
May 26, 2023
Vadim Grishin
Professorial Lecturer at GWU
Vadim Grishin writes that Russia’s better than expected economic performance over the past year is misleading and describes the grave challenges that lie ahead and the Kremlin’s limited options.
Even though in April 2023, the IMF raised its forecast for Russia's GDP growth from 0.3% to 0.7%, many sources indicate that this projection reflects a low-base effect from the previous year (when the country’s GDP dropped by 2.1%) and could be misleading in a way that camouflages negative economic trends. Meanwhile, Moscow’s “anomaly” – better than expected performance in the face of the most extensive sanctions applied in modern history – has likely come to an end.
Economic miracles and tough reality
Russia’s initial capacity to mitigate the severity of war-related economic imbalances was mostly attributable to favorable market conditions, such as unusually high earnings from energy exports, an accumulation of reserves and the Central Bank’s competent anti-crisis policy. But the present reality is difficult to ignore. No oil and gas price records are expected in 2023, while Moscow’s oil revenues are pressured by an oil cap, and its share in the European gas market continues to drop, from almost 50% at the beginning of 2021 to below 20% in 2022.
A decrease in export revenues by over one third, combined with soaring imports, has dramatically reduced the current account surplus. Meanwhile, growing military spending has created a budget deficit that could exceed 4% of GDP. The widening deficit is forcing the government to spend money from the National Wealth Fund (NWF), to increase borrowing through bond issuance and to consider raising corporate taxes. The situation has also been aggravated by the fact that the West has blocked Russia’s access to almost half of its gold and foreign exchange reserves.
The adjustment that has occurred within the Russian economy, after a year and a half of the war against Ukraine, has come through a swift and painful pivot from Western to Asian markets. The trade turnover between Russia and China in 2022 increased by almost 30% to a record $190 billion.
Almost 75% of all Chinese imports from Russia ($85 billion) came from mineral fuels. The Kremlin would like to pass off that supply diversion as a new economic model based on import substitution, the reduction of regional and social disparities inside Russia, and the rewiring of industries on new technological platforms, as well as a new form of international engagement.
Behind those aspirations, however, some pro-Kremlin experts are seeing Potemkin villages. Referring to a theory of “economic gravity,” they are concerned about the unbalanced bilateral economic cooperation with Beijing, and the high probability that the country’s economy will be "satellited" by China, whose GDP is 10 times bigger than Russia's. They also suggest the emergence of an asymmetric interdependence that would tempt Beijing to demand political concessions from Moscow.
If current trends continue, over the next five years more than 40% of Russia's total foreign trade turnover will likely come from China ($270 billion), with a major part of it fully transferred onto yuan settlement. As of March 2023, half of all NWF liquid assets were already in yuan, which de facto has become a reserve currency for Moscow despite its only partial convertibility.
Although China is interested in acquiring some Russian military and nuclear technology, Russia remains mainly a supplier of raw materials, and on less favorable terms than it had with the West.
Economic miracles and tough reality
Russia’s initial capacity to mitigate the severity of war-related economic imbalances was mostly attributable to favorable market conditions, such as unusually high earnings from energy exports, an accumulation of reserves and the Central Bank’s competent anti-crisis policy. But the present reality is difficult to ignore. No oil and gas price records are expected in 2023, while Moscow’s oil revenues are pressured by an oil cap, and its share in the European gas market continues to drop, from almost 50% at the beginning of 2021 to below 20% in 2022.
A decrease in export revenues by over one third, combined with soaring imports, has dramatically reduced the current account surplus. Meanwhile, growing military spending has created a budget deficit that could exceed 4% of GDP. The widening deficit is forcing the government to spend money from the National Wealth Fund (NWF), to increase borrowing through bond issuance and to consider raising corporate taxes. The situation has also been aggravated by the fact that the West has blocked Russia’s access to almost half of its gold and foreign exchange reserves.
The adjustment that has occurred within the Russian economy, after a year and a half of the war against Ukraine, has come through a swift and painful pivot from Western to Asian markets. The trade turnover between Russia and China in 2022 increased by almost 30% to a record $190 billion.
Almost 75% of all Chinese imports from Russia ($85 billion) came from mineral fuels. The Kremlin would like to pass off that supply diversion as a new economic model based on import substitution, the reduction of regional and social disparities inside Russia, and the rewiring of industries on new technological platforms, as well as a new form of international engagement.
Behind those aspirations, however, some pro-Kremlin experts are seeing Potemkin villages. Referring to a theory of “economic gravity,” they are concerned about the unbalanced bilateral economic cooperation with Beijing, and the high probability that the country’s economy will be "satellited" by China, whose GDP is 10 times bigger than Russia's. They also suggest the emergence of an asymmetric interdependence that would tempt Beijing to demand political concessions from Moscow.
If current trends continue, over the next five years more than 40% of Russia's total foreign trade turnover will likely come from China ($270 billion), with a major part of it fully transferred onto yuan settlement. As of March 2023, half of all NWF liquid assets were already in yuan, which de facto has become a reserve currency for Moscow despite its only partial convertibility.
Although China is interested in acquiring some Russian military and nuclear technology, Russia remains mainly a supplier of raw materials, and on less favorable terms than it had with the West.
“At the same time, the tectonic shift toward the East has reinforced the rental nature of the Russian economy, which appears to suit both Moscow and Beijing.”
Economic and financial “satellization” will determine Russia’s transition to Chinese technological platforms (6G, artificial intelligence, etc.) with an inevitable reduction of “technological sovereignty.” А currently circulating vision of Russia as that of a floating technological island that can dock to any platform is obviously an illusion, akin to the claim popular among Russian officials back in 2008 that Russia was an island of stability in an ocean of global financial crisis.
Limits of ‘khaki capitalism’
The Russian economy is currently driven – to the detriment of other industries – by the soaring military spending, which has increased the share of the defense sector in the overall structure of the national economy. Awkwardly but irrevocably, Russia has been shifting onto a war footing. According to Rosstat, industrial production in March 2023 rose 1.2% versus a year earlier, well ahead of the 1.4% decline expected in a Bloomberg survey of economists.
The unexpected rebound was due to a double-digit surge in the industrial output of the defense sector: finished metal products (including weapons and ammunition) grew above 30%; the production of computers, electronic and optical products (including military electronics) rose 22.5%; and so-called "other transports" (including the manufacture of various combat vehicles, from armored cars to aircraft) climbed 13.0%.
The workforce in defense plants has been significantly enlarged to pump out more weapons and military equipment faster and get them directly to the troops. The Russian state-owned defense conglomerate Rostec alone recruited more than 30,000 new employees and has switched its enterprises to a three- and even four-shift daily work schedule.
It is also worth looking at what is going on with tank production, since tanks appear to play a significant role in the conflict. According to the Russian Defense Ministry, the output of tanks in 2023 will quadruple and almost reach the level of production for the whole USSR.
Limits of ‘khaki capitalism’
The Russian economy is currently driven – to the detriment of other industries – by the soaring military spending, which has increased the share of the defense sector in the overall structure of the national economy. Awkwardly but irrevocably, Russia has been shifting onto a war footing. According to Rosstat, industrial production in March 2023 rose 1.2% versus a year earlier, well ahead of the 1.4% decline expected in a Bloomberg survey of economists.
The unexpected rebound was due to a double-digit surge in the industrial output of the defense sector: finished metal products (including weapons and ammunition) grew above 30%; the production of computers, electronic and optical products (including military electronics) rose 22.5%; and so-called "other transports" (including the manufacture of various combat vehicles, from armored cars to aircraft) climbed 13.0%.
The workforce in defense plants has been significantly enlarged to pump out more weapons and military equipment faster and get them directly to the troops. The Russian state-owned defense conglomerate Rostec alone recruited more than 30,000 new employees and has switched its enterprises to a three- and even four-shift daily work schedule.
It is also worth looking at what is going on with tank production, since tanks appear to play a significant role in the conflict. According to the Russian Defense Ministry, the output of tanks in 2023 will quadruple and almost reach the level of production for the whole USSR.
According to the Russian Defense Ministry, the output of tanks in 2023 will quadruple and almost reach the level of production for the whole USSR (the photo shows a T-72). Source: Wiki Commons
In the post-Soviet period, the highest number of tanks produced was in the 2000s (about 200-300 per year) thanks to export deliveries to India and Algeria; meanwhile, the total output of new tanks for the Russian Armed Forces is actually planned at around 1,500 units this year. Still, that figure is tricky because it includes not only several hundred new T-90M and T-14 tanks, but also T-80, T-72 and even older, T-62 models that will be taken out of deep military storage and upgraded. Nevertheless, that quantity of new and modernized Russian tanks will hardly balance out the announced deliveries of third-generation Western tanks to Ukraine, including the Leopard 2, Challenger 2, and M1 Abrams.
The lone, ancient tank that was shown at the Moscow Victory Day Parade on May 9 has become a symbol of Russia’s military weakness, underscoring how significant Russia’s losses have been since Moscow’s invasion in Ukraine. Open sources have documented that Russia lost nearly 2,000 tanks in 2022. The situation is no better with most other types of arms, which has pushed Moscow to buy artillery shells from North Korea and drones from Iran.
Tellingly enough, the so-called voenkory – “milbloggers” – and an oligarch-turned-warlord Yevgeny Prigozhin, the head of the mercenary group Wagner, have constantly complained about the shortage of ammunition on the battlefield. Prigozhin's video messages and social media posts have political goals, though he is daring to voice what is forbidden by Russian military censorship.
Under strain and at a crossroads
Russia’s vulnerability to Western sanctions, along with the limited growth capacity of its military-industrial complex, is forcing the Kremlin to forego full mobilization scenarios and instead opt for various palliative ways to increase recruitment (such as expanding the age range for conscription). These economic obstacles to total war are an irritating reality to the country’s war-mоngering propagandists and to siloviki calling for further militarization of the economy.
Opinions differ as to how that could be done.
The lone, ancient tank that was shown at the Moscow Victory Day Parade on May 9 has become a symbol of Russia’s military weakness, underscoring how significant Russia’s losses have been since Moscow’s invasion in Ukraine. Open sources have documented that Russia lost nearly 2,000 tanks in 2022. The situation is no better with most other types of arms, which has pushed Moscow to buy artillery shells from North Korea and drones from Iran.
Tellingly enough, the so-called voenkory – “milbloggers” – and an oligarch-turned-warlord Yevgeny Prigozhin, the head of the mercenary group Wagner, have constantly complained about the shortage of ammunition on the battlefield. Prigozhin's video messages and social media posts have political goals, though he is daring to voice what is forbidden by Russian military censorship.
Under strain and at a crossroads
Russia’s vulnerability to Western sanctions, along with the limited growth capacity of its military-industrial complex, is forcing the Kremlin to forego full mobilization scenarios and instead opt for various palliative ways to increase recruitment (such as expanding the age range for conscription). These economic obstacles to total war are an irritating reality to the country’s war-mоngering propagandists and to siloviki calling for further militarization of the economy.
Opinions differ as to how that could be done.
“Russian Investigative Committee Chairman Alexander Bastrykin proposed a complete nationalization of the country's main industries, calling it as a necessary step to preserve economic security amid the war.”
Investigative Committee Chairman Alexander Bastrykin advocates a nationalization of the Russian industries. Source: Wiki Commons
VTB Chairman Andrei Kostin put forward an alternative approach for building a new growth model based on domestic resources: he suggested launching a new privatization to raise the money Russia needs to conduct the war. In Kostin’s list of assets to be sold by the government are major state monopolies, such as Transneft, Russian Railways and Russian Post, as well as non-core companies that are part of Rostec and Rosatom. President Putin’s pressman Dmitri Peskov, commenting on these ideas, called them “interesting.” Their attractiveness is natural, since the war has accelerated the reconfiguration of resources, wealth and power at the federal and regional levels. A new privatization could institutionalize the ongoing redistribution of property in favor of Putin’s cronies and law enforcement elites, and consolidate Russian military capitalism.
The opposite option – a full-fledged nationalization – cannot be ruled out either, though it would require a radical restructuring of the entire bureaucracy and economic management system, which the Kremlin does not seem ready to implement at this stage.
New political cycle and black swans
In the current conditions, according to both demographic and economic estimates, Putin appears to have enough financial resources and manpower to continue a medium-intensity war for at least three more years. This means that all critical decisions regarding further reshaping of Russia’s economic and political system could be postponed until at least after Putin’s assured reelection in 2024, when a new political cycle will be launched – not only in Russia, but also in the US.
In this context, some political observers have suggested that Putin is expecting “radical changes in the West and in Ukraine,” with a “split of the elites” in Ukraine followed by “the West decreasing its military and political support to Kyiv.” Putin’s problem, however, is that his personalistic autocratic regime cannot be shielded from his own mistakes and miscalculations (for instance, a “rise in political ambitions of other powerful actors”), or from “black swans” – unexpected developments that would be destructive to Moscow’s geostrategic aspirations, such as radical changes on the battlefield, a new global economic crisis and/or shifts in China's foreign policy.
The opposite option – a full-fledged nationalization – cannot be ruled out either, though it would require a radical restructuring of the entire bureaucracy and economic management system, which the Kremlin does not seem ready to implement at this stage.
New political cycle and black swans
In the current conditions, according to both demographic and economic estimates, Putin appears to have enough financial resources and manpower to continue a medium-intensity war for at least three more years. This means that all critical decisions regarding further reshaping of Russia’s economic and political system could be postponed until at least after Putin’s assured reelection in 2024, when a new political cycle will be launched – not only in Russia, but also in the US.
In this context, some political observers have suggested that Putin is expecting “radical changes in the West and in Ukraine,” with a “split of the elites” in Ukraine followed by “the West decreasing its military and political support to Kyiv.” Putin’s problem, however, is that his personalistic autocratic regime cannot be shielded from his own mistakes and miscalculations (for instance, a “rise in political ambitions of other powerful actors”), or from “black swans” – unexpected developments that would be destructive to Moscow’s geostrategic aspirations, such as radical changes on the battlefield, a new global economic crisis and/or shifts in China's foreign policy.
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