Russia faces stagflation threat as GDP slows and inflation rises

Business Insider discloses that Russia is facing an increasingly dire economic situation as its GDP and inflation figures move in the wrong direction.

As Russia grapples with declining GDP and rising inflation, the prospect of an economic worst-case scenario looms ominously over Moscow. The central bank's recent policy meeting summary noted signs of weakening domestic demand, yet inflationary pressures persist. This troubling combination, commonly referred to as stagflation, is a situation that policymakers aim to avoid at all costs. Stagflation presents a more complex challenge than a standard recession. In typical downturns, central banks can lower interest rates to stimulate growth.

However, when inflation continues to escalate during an economic slowdown, the situation becomes much more complicated. High interest rates must remain in place to control price increases, leaving governments effectively immobilized. While the Bank of Russia did not explicitly mention stagflation, the conditions it outlined suggest a genuine concern. In a separate report this month, the bank warned of a significant GDP slowdown expected next year. Although the Russian economy has thrived during wartime, ongoing sanctions, production constraints, and a severe labor shortage are likely to take their toll by 2025. Additionally, OPEC+ oil production cuts are further impacting Russian growth. 

Despite these challenges, inflation remains high, prompting the central bank to raise interest rates to 19 per cent this month, as previous measures have failed to curb it. This inflationary pressure is partly driven by Russia's aggressive defence spending, which is projected to remain at unprecedented levels through 2025, although spending may slightly decrease in the following two years. Labour shortages are another contributing factor, with businesses raising wages to attract workers as the ongoing conflict strains the labour market, leading to an estimated shortfall of nearly 5 million workers by the end of last year. 

There is, however, a glimmer of hope regarding stagflation: if domestic demand continues to decline, the central bank anticipates that inflation may also decrease. Nevertheless, the current situation is concerning for Russia. The last time stagflation plagued the US in the 1970s, the Federal Reserve had to trigger a deep recession to stabilise the economy.

By Naila Huseynova