The markup in the International Monetary Fund’s 2024 Russian growth forecast from 1.1% to 2.6% has elicited stories about Russian economic ‘resilience’.
For decades, Russia ran highly orthodox and prudent macroeconomic policies, accumulating wealth amid extremely low debt levels. The strength of these orthodox ‘Fortress Russia’ policies created substantial fiscal space, which is now helping Russia finance highly stimulative fiscal policies to support its war against Ukraine and weather the associated economic stresses.
Economic policy-makers can support growth in the short run with large fiscal stimulus or credit expansion and post good growth numbers. Given strong buffers and the populace’s seeming ability to tolerate hardship, Russia may well be able to sustain such performance for several years.
But ‘resilience’ is a misnomer. Russia is masking a process of significant economic degradation that will continue well into the future and further marginalise its global footprint.
Don’t overestimate the size of Russia’s economy
Russia’s war footing and the associated fiscal expansion is a clear driver of the economy’s current solid activity. According to draft plans from the government, Russia is increasing real military spending this year by almost one-third, accounting for over a third of spending and around 7% of gross domestic product.
But one should not overstate the economy’s size and vigour. As a share of the global economy, Russia has fallen in purchasing power terms from nearly 4% before the 2008 financial crisis to under 3% (and using market exchange rates to now well under 2%).
Oil proceeds are a crucial revenue source. Russian officials have indicated that Brent crude should be $85 per barrel in 2024. However, Brent has traded below that level so far this year. Moreover, Urals oil trades at a significant discount to Brent, and there is enormous opacity surrounding the discounted price Russia receives as it is highly dependent on deals with China and India.
US and G7 efforts to reinforce the oil price cap and curtail sanctions evasion (for example by Greek tankers) will also impact revenue. They unfortunately have not hurt the Russian economy anywhere near as much as desired.
While Russia should be able to easily finance its deficit, several costly macro factors come into play. Inflation is elevated and the central bank is maintaining high interest rates in the light of the outlook for prices. That will erode real incomes and crimp investment. The ruble will on average weaken as currency depreciation generates more rubles for the budget. The currency would in all probability weaken much further were it not for capital controls. Russia also will presumably draw down on the National Wealth Fund.
More generally, the Russian economy can be increasingly characterised as a system of energy production financing surging military spending, with little innovation elsewhere in a society already well behind others on the technological frontier. But, of course, the reliability of economic data should always be taken with a pinch of salt, and especially Russian economic data in the current circ*mstances.
Geopolitical vulnerability
Russia’s growing dependence on China, India, Iran and others is a vulnerability beyond energy market developments. India is strengthening relations with the US. China wishes to maintain strong export ties to the US and Europe. Notwithstanding cheap energy, China and its firms will be cautious in their Russia dealings, fearing that they might run afoul of US sanctions, especially those that could block access to the US financial system.
In the meantime, Russia’s human capital is being sharply eroded. The death of soldiers (estimates suggest over 300,000 soldiers killed or badly wounded) and an enormous brain drain (estimated up to 1m, the bulk of whom are young and well educated) are imposing a huge loss of human capital and reportedly straining labour markets. These factors will harm Russian productivity well into the future.
Western sanctions on technology, even if significantly circumvented because of transshipments and other leakages, are hurting the economy. Reports abound about the lack of spare parts – for example, the difficulties in fully keeping Russian airplanes afloat. Russia will also face difficulties developing many energy fields without western services.
The opportunity cost of the war footing is also seen in the numerous reports of burst pipes and the loss of winter heating throughout Russia as basic infrastructure needs go unmet.
Western firms have been withdrawing from the Russian market, often with their assets seized. They surely will not be coming back soon.
Around $300bn of sovereign Russian assets have been frozen in the West, and considerable income on them has been forgone. Russia faces the risk of never seeing this patrimony again, and certainly a major portion will most likely be used to finance Ukraine’s reconstruction.
A cursory examination of current Russian data – such as growth and inflation– might suggest that the economy is ‘resilient’ in the face of the costs of Russia continuing its ruthless invasion. That view may contain elements of validity in the short term. But even that overlooks weaknesses and realities. Significantly greater isolation and economic degradation is baked in the cake for the Russian economy and people.
Mark Sobel is US Chair of OMFIF.
