Russia's economy thrives despite global isolation

As global economies grapple with rising unemployment, recession fears, and sluggish growth, Russia’s economic landscape presents a surprising anomaly.

Amidst global economic uncertainty, with rising unemployment in the US and Canada, persistent recession fears in Europe, and economic challenges in China, one country stands out for its surprising economic performance: Russia, Caliber.Az reports citing the foreign media.

Despite facing severe international sanctions and being widely regarded as a pariah state, Russia's economy is defying expectations with notable growth.

This year, Russia's GDP is projected to expand by over 3 per cent in real terms, outpacing the majority of wealthy nations. In May and June, economic activity saw a marked increase, according to the central bank, while other real-time indicators, including data from Goldman Sachs, suggest an accelerating economy. Unemployment is near historic lows, and the rouble remains stable. Although inflation is high—rising by 8.6 per cent year on year in June, significantly above the central bank’s 4 per cent target—the robust growth in cash incomes, up 14 per cent year on year, is enhancing the purchasing power of Russians.

Consumer sentiment reflects this positive trend. The official consumer confidence index, as tracked by Russia’s statistical agency, shows levels significantly above the average since Vladimir Putin took office in 2000. Independent polling by the Levada Centre corroborates this, with Russians’ confidence in their financial situation reaching an all-time high. This upbeat sentiment is driving consumer behavior: more Russians are making substantial purchases, such as cars and home furnishings, and dining out is increasingly popular. Notably, Russians imported 18 per cent more cognac and 80 per cent more sparkling wine last year compared to 2019. Sberbank reports a 20 per cent year-on-year increase in overall consumer spending in nominal terms as of June.

In a world grappling with economic difficulties, Russia's economic resilience and consumer confidence present a striking contrast, driven by a unique blend of factors including significant domestic spending and an economy buoyed by state-controlled financial mechanisms.

The latest economic data reveal a striking contrast to the 2010s, a decade marked by sluggish growth and persistent financial difficulties for many Russians. Back then, output and incomes stagnated, and by 2018, real wages had failed to surpass 2012 levels. The discontent was palpable, exacerbated by the 2014 sanctions imposed by the West following Vladimir Putin’s annexation of Crimea, coupled with austere fiscal policies that included tax hikes and spending cuts. The COVID-19 pandemic and a new wave of Western sanctions, triggered by Putin’s full-scale invasion of Ukraine in 2022, further deepened financial hardships.

However, the recent economic turnaround seems counterintuitive. While it's tempting to attribute the recovery to Russian exports, the reality is less rosy. Although Putin has successfully redirected hydrocarbons that once went to Europe to other global markets, Russia's export performance has not been impressive. Oil prices have fallen from their highs, and in the first quarter of 2024, the total value of Russia’s physical exports was 4 per cent lower in dollar terms compared to the same period in 2023, and a third lower than in 2022.

Instead, the key to understanding Russia's economic acceleration lies in its macroeconomic policies. A major shift has occurred in fiscal policy: Putin has abandoned the austerity measures of previous years. In 2024, Russia is expected to run a budget deficit of 2 per cent of GDP—a significant figure by its standards. This deficit is largely funded by drawing on the substantial financial reserves accumulated during the 2010s. Essentially, Russia is leveraging past savings to fuel present growth.

Government spending has surged, with total outlays increasing by an average of 15 per cent in both 2022 and 2023, and a slightly smaller increase planned for this year. A significant portion of this additional spending is directed towards the war effort in Ukraine. Data from the Bank of Finland indicate that military expenditure is set to rise by about 60 per cent this year, which not only enhances Russia's military capabilities but also injects money into the economy, boosting overall economic activity and consumption.

In July, President Vladimir Putin significantly increased federal bonuses for individuals enlisting to fight in Ukraine, raising them from 195,000 roubles ($2,200) to 400,000 roubles. Regional authorities are expected to provide additional funds, and the government is also committing substantial sums to compensate the families of soldiers killed in action. This spending spree extends beyond military needs; Putin has also boosted welfare payments, including a nearly 10 per cent increase in pensions for some recipients. Major infrastructure projects, such as a highway linking Kazan and Yekaterinburg, and even government-funded holidays for children in Crimea, exemplify the broad scope of state spending.

Russia's economic revival is also driven by an unconventional monetary policy. To combat high inflation, the central bank has raised interest rates dramatically from 7.5 per cent to 18 per cent, with potential further increases on the horizon. This strategy strengthens the rouble by attracting investment from “friendly” nations like China and India, reducing import costs and thereby easing inflation. High interest rates typically reduce consumer spending by encouraging savings and increasing debt repayment costs. However, Russia's government has implemented measures to shield the real economy from these effects.

A variety of schemes have been introduced to mitigate the impact of higher interest rates. Consumers facing financial hardships can now more easily suspend loan repayments if they prove a decline in income or an emergency situation. Soldiers in Ukraine benefit from loan holidays, while a recently closed mortgage scheme kept rates fixed at 8 per cent, well below the current policy rate. An "industrial mortgage" program provided businesses with loans at rates as low as 3 per cent annually. Additionally, banks are pressured to keep rates from rising excessively, with the state often covering any resulting financial shortfalls.

This economic intervention is having tangible effects. Official data reveals that in the first quarter of 2024, households allocated 11 per cent of their disposable income to servicing debt—on par with levels in 2021, when interest rates were considerably lower. Despite a significant rise in the central bank's policy rate, the effective interest rates for households and businesses have only increased by about half as much. New borrowing remains robust, with corporate lending expanding over 20 per cent annually and unsecured consumer credit growing in line with nominal wages.

But how sustainable is this economic boom? President Putin’s efforts to mitigate the impact of rising interest rates are likely to lead to higher and more prolonged inflation. Rising living costs could eventually trigger public discontent. Additionally, persistent budget deficits are unsustainable in the long term. At the current rate of expenditure, Russia’s financial reserves could be depleted within five years, and the government faces steep borrowing costs. Yet, with the ongoing war in Ukraine, Putin continues to prioritize immediate military and political objectives, fueling the economic party for now.