Strange things are happening in Russia these days. In early October, the country inked a deal to sell chickpeas to Pakistan in exchange for mandarin oranges. A few weeks later, the Russian government advised international participants traveling to the southwestern city of Kazan for the BRICS summit to bring cash in U.S. dollars or euros, as major credit card companies such as Visa and Mastercard have suspended operations on Russian soil since the full-scale invasion of Ukraine began in 2022.
During the BRICS summit, a Chinese official mentioned that Russia is facing “serious difficulties” with paying its membership fees to the Shanghai Cooperation Organisation; the official blamed Western sanctions. As if this were not enough, the comment came on the same day that the Kremlin had to cancel bond auctions to issue nearly 600 billion Russian rubles (around $6 billion) in sovereign debt for lack of buyers.
Strange things are happening in Russia these days. In early October, the country inked a deal to sell chickpeas to Pakistan in exchange for mandarin oranges. A few weeks later, the Russian government advised international participants traveling to the southwestern city of Kazan for the BRICS summit to bring cash in U.S. dollars or euros, as major credit card companies such as Visa and Mastercard have suspended operations on Russian soil since the full-scale invasion of Ukraine began in 2022.
During the BRICS summit, a Chinese official mentioned that Russia is facing “serious difficulties” with paying its membership fees to the Shanghai Cooperation Organisation; the official blamed Western sanctions. As if this were not enough, the comment came on the same day that the Kremlin had to cancel bond auctions to issue nearly 600 billion Russian rubles (around $6 billion) in sovereign debt for lack of buyers.
These examples might sound trivial, but taken together, they highlight how all might not be going hunky-dory for the Russian economy—contrary to the Kremlin’s claims that Western sanctions are ineffective and Russian GDP growth is booming. Like a cash-strapped household pretending that all is well while quietly burning through emergency savings, Moscow is trying to project economic normalcy by tapping into its vast financial buffers.
This is not a sustainable strategy: Without fresh inflows of cash, even the largest of savings only last for a while. Russia could soon struggle to preserve costly social stability at home while waging its expensive war against Ukraine.
To understand Russia’s economic troubles, looking at inflation is a good starting point. Official statistics are fishy, but even without consulting them, it’s easy to see that price growth is an issue in Russia. First, the ruble has lost one-third of its value against the U.S. dollar since early 2022, inflating the price of imports and therefore fueling inflation.
Second, Russian firms are struggling to hire because of the combined impact of a shrinking population; a high death toll from the COVID-19 pandemic; and the war in Ukraine, which has killed or seriously wounded 2 percent of Russian men between the ages of 20 and 50, and is causing an exodus of highly skilled workers. To attract workers, Russian companies are raising wages, again fueling inflation. Third, the Kremlin believes that it can buy social stability by showering people with generous handouts—another inflationary factor.
Central bankers like to raise interest rates when inflation is high, seeking to tame price growth by weighing on demand. The Central Bank of Russia has applied these principles to the letter; since mid-2023, it has gradually increased its key rate to a whopping 21 percent. Russian companies are feeling the pinch. This week, Sergei Chemezov, the CEO of state-owned defense conglomerate Rostec, declared that high interest rates are eating into profits so much that most Russian industrial firms could soon go bankrupt. But there is a catch: Because of its obsession with social stability, Moscow is working to negate the impact of high interest rates on the population.
A recent scheme for subsidized loans provides an example of this. Since 2020, millions of Russians have signed up for real estate loans at a cheap rate of 8 percent, while the government has reimbursed banks for the difference between that face rate and the 20 percent or more that higher central bank rates should command. That policy might well boost economic growth in the short term, but it comes with high costs: Home prices in Russia have tripled since 2020, suggesting a real estate bubble that could soon burst. The scheme also comes with a roughly $5 billion price tag for the Kremlin.
Russia’s bigger fiscal picture looks dire. On the expenses side, war is costly, and defense spending keeps rising to record highs: Military expenses will make up 40 percent of Russia’s public spending in 2025, for an eye-popping $142 billion. (National security and “classified” expenses will absorb another 30 percent of Russia’s federal budget.) Russia is also splurging to preserve social stability. In the next six years, the Kremlin plans to spend $431 billion on all sorts of social projects, including sending children to summer camps in occupied Crimea, building brand-new student campuses across Russia, and raising the minimum wage by no less than 10 percent per year.
The revenue side of the fiscal balance does not look any better. Excluding dividends, Russia’s state-owned gas giant Gazprom used to provide around 10 percent of the Kremlin’s fiscal revenues. Such largesse is over: After losing access to the European market, Gazprom recorded a $6.8 billion loss in 2023, making it impossible for the company to transfer money to state coffers. (Gazprom sent $40 billion to the Russian Ministry of Finance in 2022.)
Things could soon get even worse. In a few weeks, a deal allowing the transit of Russian gas to Europe via Ukraine will expire, cutting down Moscow’s remaining gas exports to the European Union by half and Russian total gas sales by one-third—for an expected loss of $6.5 billion per year for Gazprom.
Russia only has a few options to find new income streams. Sustained economic growth would raise fiscal revenues through higher taxes, but labor shortages mean that this is not a credible plan. A few weeks ago, the deputy governor of Russia’s central bank acknowledged that “available production capacity is depleted.” With social stability a constraining factor, Moscow can only apply fiscal Band-Aids.
Current plans include imposing higher taxes on wealthy households—for a mere $1.5 billion a year, or less than 3 percent of total income tax receipts—and raising tariffs on Chinese electric vehicles. It is not clear what Beijing will think of these protectionist measures in light of the supposedly unlimited friendship that binds Russia and China; Russian President Vladimir Putin has previously called U.S. tariffs on Chinese electric vehicles “unfair.”
With ever-rising expenses and dwindling revenues, Russia is now posting an annual fiscal deficit of nearly 2 percent of its GDP. For most economies, this is not an issue. Such a small shortfall can typically easily be financed through debt issuance. But Western sanctions have turned Russia into a pariah on the global financial scene, making it impossible for it to tap global debt markets. Moscow’s plan B was to tap domestic bond markets, but things are not going well on this front, either. Despite having to cancel auctions this month for lack of buyers, the Kremlin has penciled in issuing $25 billion in domestic bonds by the end of the year. So far, it is not getting anywhere.
With debt issuance out of the equation, Russia is now forced to turn to plan C: tapping into its savings. On paper, such a strategy could work for a while thanks to the vast holdings that Moscow accumulated in its National Wealth Fund (NWF) in the 2010s. However, these savings are now drying up: The liquid part of the fund has shrunk by more than half since the start of the war in Ukraine, to just $54 billion in September. Last year, the government stopped saving money in its NWF. Moscow is now resorting to selling the portion of its NWF reserves that it holds in gold; the fund’s gold reserves have shrunk by around half, or about 262 tons of gold, since early 2022.
Russia is depleting its rainy-day holdings, and this cannot last forever. Even assuming high global oil prices, the Kremlin’s 2024 budget includes a further $13 billion drop in NWF holdings this year, or about a quarter of the fund’s liquid reserves. Looking ahead, the NWF’s liquid reserves cover just around a year and a half of budget deficit. This assessment might prove optimistic: It assumes that official fiscal data is trustworthy—some experts believe that Russia’s fiscal deficit could be closer to 5 percent of its GDP—and that the global economy won’t suffer from major shocks. If global growth were to tank, the Central Bank of Russia estimates that the NWF’s liquid reserves could vanish in less than a year.
In September, Kyrylo Budanov, Ukraine’s defense intelligence chief, told attendees at a conference in Kyiv that Russia will try to force an end to the war in 2025, when the Kremlin could start facing genuine economic problems. This analysis might not be too far from the truth—and it will be useful to keep it in mind as calls for negotiations between Kyiv and Moscow grow louder every day.
The post Russia Can’t Keep Spending Like This for Long appeared first on Foreign Policy.
