No one knows what Russian President Vladimir Putin was hoping to achieve when he embarked on a nine-hour flight from Moscow to Alaska to meet U.S. President Donald Trump last month. But it’s a safe bet that he was looking to avoid the additional sanctions on the Russian economy that Trump had vaguely threatened a number of times—and perhaps get relief from existing sanctions or even some lucrative U.S. investment deals.
Putin has every reason to seek a lifeline for the Russian economy. In recent weeks, a flurry of signs has shown Russia’s war-drained, sanctions-constrained economy to be at an inflection point. For the first time since the start of the war, nonmilitary economic activity has been contracting, bankers are making plans to weather a financial crisis, and energy firms are worrying about losing their largest customer for seaborne oil exports.
Putin’s intensifying economic troubles have important implications for Western policymakers as they begin negotiating with Moscow about the future of Ukraine. Unlike the impression the Russian leader tries to make, time is far from being on his side. In fact, economic pressure remains the best leverage that Ukraine’s supporters have over the Kremlin. It remains to be seen whether Europe and the United States will choose to play the economic ace they still have up their sleeves.
Understanding the true state of the Russian economy requires some serious sleuthing. It is usually useless to look at official growth statistics, which are fishy and tend to undergo frequent revisions. Yet the latest GDP release does contain an interesting nugget: The economy narrowly escaped a technical recession (defined as two consecutive quarters of GDP contraction) in the second quarter, with reported growth of just 0.1 percent after a 0.6 percent drop in the first quarter—the first such fall since the start of the war. Stripping out the booming military sector, the rest of the Russian economy is in a recession.
A quick look at the automotive sector underlines the bleak state of the civilian economy. Typically a reliable indicator of the mood of households, new car sales dropped by nearly 30 percent during the first half of the year compared with the same period last year—a sure sign of trouble for consumer demand. The contraction of business activity goes far beyond carmakers. In July, S&P Global’s purchasing managers’ index for Russian manufacturing—which tracks corporate orders from their suppliers and where anything below 50 indicates a contraction—stood at just 47, the lowest reading since March 2022.
The troubles faced by households and firms are now threatening to spread to the Russian banking sector, a particularly alarming sign for Moscow. The rate of nonpayment on all loans to individuals (such as mortgages, car loans, and credit cards) is rising fast, shooting up by 32 percent at VTB, Russia’s second-largest bank, since the start of this year. Overall delinquency rates remain low, but they are deceptive: In Russia, households struggling to repay loans often negotiate a grace period with their banks instead of defaulting outright.
The contagion could soon spread to real estate, too. In May, the Russian Central Bank warned that the risk of a real estate crash had reached its highest level since the institution began monitoring it nearly 10 years ago. The central bank has good reason to worry about the potential bursting of a housing bubble. In the year to July, real estate prices for new homes rose by nearly a quarter in central Moscow, close to three times inflation over the same period—raising fears that such rises could be unsustainable. In parallel, Russian households are contracting loans for a record-high average term of 26 years. In the Russian context, stretching loan repayment over such previously unheard-of terms is a sure sign of rising indebtedness and financial strain.
Bankers are also worrying about shaky corporate loans, telling Bloomberg that they have discussed bailout options with the Russian government. The central bank reported that 13 out of the 78 largest Russian nonbank firms cannot service their debt—more than double the figure from last year. The central bank expects to add two additional firms to that list later this year. With interest rates unlikely to drop much from their current 18 percent amid persistently high inflation, it is hard to imagine how firms can both service debts and stay afloat.
With households and firms in dire financial straits, VTB saw its net interest income drop by about half in the first half of this year from a year earlier. This data is probably ringing alarm bells in the Kremlin, since Russian policymakers no longer have much of a fiscal pot to recapitalize banks. The last such operation came with a huge price tag; in 2017, the recapitalization of three small banks—Otkritie, B&N, and Promsvyazbank—cost more than $24 billion, around half the current size of the remaining liquid reserves of the National Welfare Fund. Printing money is not an option because it would further fuel inflation. Besides, mere hints that the Russian banking sector could be going through a rough patch would be a public relations disaster for Moscow: Such a situation would undermine the Kremlin’s narrative that Western sanctions have no bite.
Trump’s recent sanctions salvos on third countries are also a worry for the Kremlin. In August, the Trump administration imposed an additional 25 percent tariff on India to punish the country for its purchases of Russian oil. Since European countries curtailed Russian oil imports beginning in 2022, India has become the largest buyer of Russian seaborne oil shipments. Indian oil refineries absorb roughly 1.8 million barrels per day of Russian crude, making the Indian market worth around $40 billion per year for Russian oil firms.
So far, Indian refiners are continuing to import Russian oil at a small discount. However, the Kremlin is probably planning for a worst-case scenario where New Delhi orders a halt to these imports for fear of seeing its dispute with the United States escalate. This would be a nightmare for Russian oil exporters. China, the other major buyer of Russian oil, appears unwilling to raise imports in order to avoid overreliance on Russian firms. With China out of the equation, it is hard to spot other major alternative customers for Russian oil shipments should the Indian lifeline be lost. As Ukraine ramps up its long-range attacks on Russian oil refineries and pipelines, taking as much as 20 percent of Russian fuel production offline, Russian energy executives are probably not sleeping very soundly these days.
On top of this, the Russian oil sector is facing two other hits—a serious situation for a sector that typically provides around one-third of the Kremlin’s budget and is thus crucial for the war effort. First, Russia’s Urals benchmark oil price has dropped by more than 20 percent since peaking in early January, a major weight on oil revenues. Second, the Russian ruble has appreciated by 41 percent against the dollar since the start of the year, further weighing on oil revenues once they are converted to local currency. To help replenish Russian state coffers, the central bank is desperately trying to stem any further appreciation. In order to limit demand for the ruble, the bank abolished regulations last month that had required Russian exporters to repatriate and convert foreign currency earnings.
To solve its intractable fiscal dilemma, the Kremlin is now resorting to old tactics. The value of private assets seized from firms and individuals by the government tripled over the past 12 months and has now reached a total of $50 billion since the start of the war. A spectacular such seizure took place in June, when a Moscow court ruled that the Russian state could nationalize Russia’s second-largest airport, Moscow Domodedovo. To back the case, the prosecutor-general argued that the airport’s owners were conspiring against the country by holding foreign passports. The move sent a chill through Russian business circles, where European and U.S. passports are common.
It is hard to make any sorts of predictions regarding the shape and outcome of potential negotiations on the future of Ukraine. As Western diplomats ponder next steps, they should remember that economic pressure could well have been the one thing that pushed Putin to travel all the way from Moscow to Alaska. Now is not the time for Western leaders to make concessions on the sanctions front and give Putin his much-needed economic breathing room. If Europe and the United States manage to stay patient and united on this topic, Putin’s growing fear of a humiliating economic crisis could get him to the negotiating table.
The post Putin’s Fear of a Humiliating Economic Crisis appeared first on Foreign Policy.
