The Davis Center, part of Havard University, released a comment yesterday on a report it has done that warns that in addition to pumping the economy full of money to fund the war – just over RUB10 trillion or $100bn and rising – the Kremlin has been ordering banks to make soft state-directed loans to defence industry companies. A lot of loans: some RUB21-25 trillion.

This is off the books money. In 2024 defence ate up 6% of GDP (and is due to rise to 8% this year) but if you add in the bank loans then you get to 18% of GDP, which is huge (but a bit less than Ukraine’s 20% of GDP).

The point is that Russian President Vladimir Putin has been selling a “we can afford this war and not even break a sweat” to the people. If this take on the lending is correct, that is a lie and Russia is pouring way more money into a war to little effect. Yes, Russia is “winning” insomuch as the Armed Forces of Ukraine (AFU) is under pressure and losing ground, but still, Russia has only captured 20% of Ukrainian territory and won’t get much more – a few hundred kilometres perhaps in the coming months. That is hardly a “victory”.

I was already following the corporate loans thing as a banking/inflation story. It’s a hell of a lot of money and moreover, it is unusual for Russia as companies typically do all their investment out of retained earnings – loans remain very expensive, and credit is not a favourite way of raising investment capital. Companies prefer bonds for investment projects, as yields on bonds are more predictable, or better to say banking interest rates in Russia are very unpredictable – as we have seen with bells on over the last three years.

And sure enough, last year, issuers placed debt securities for a total of RUB6.86 trillion, which is a third higher than the 2023 record of RUB5.2 trillion.

Central Bank of Russia (CBR) governor Elvia Nabiullina was saying last summer that corporate borrowing was accelerating and running much faster than retail loans, and that was fuelling more inflation. So are the corporate loans as another source of cash flooding the already overheated economy.

Nabiullina has successfully cooled consumer borrowing (mostly credit cards as part of a consumer boom) but struggled to cool corporate borrowing.

Previously the explanation for the booming corporate loans was that as a result of the mass exodus of international companies, local entrepreneurs and former Russian country managers were taking over these companies in what has been amongst the largest transfer of property in Russia’s history. The international franchises were worth up to 40% of GDP – billions of dollars. And as people are not companies, but largely former employees, they don’t have any retained earnings to invest so they have to borrow.

And the banks were happy to lend. If you show up to see your bank manager and tell him: “I’m the former country manager for Mothercare and I have been offered the business for kopeks on the ruble, so can I borrow a billion rubles?” he is going to say yes isn’t he?

This made complete sense to me. But Kennedy, in his report, is suggesting a far bigger share of the borrowing is for the defence sector and indeed, in its last sector report from November, the CBR also said that industry was responsible for a large share of the borrowing, but it didn’t give a breakdown.

Is a credit crisis coming? No. Not yet.

Firstly Nabiullina is well aware of the problem and already teamed up with Russian Finance Minister Anton Siluanov in the autumn to squash the soft corporate lending using non-monetary policy methods, as we reported. She has also introduced a corporate tax on deposits, as companies that had cash were simply plonking it in deposit accounts as a 21% return on your cash when inflation is only 9% is a much better return that you can get from investing it.

And it seems to be working as corporate borrowing starts to slow in the last couple of months of 2024.

Nabiullina also pointed out to the Duma in a meeting in December that non-performing loans (NPLs) were only 4% in 2024, and had fallen from 6% in 2022 and 5% in 2023. These are very low levels of bad debt and the bank sector started this year with NPLs closer to 3%.

Moreover, of the small amount of overdue debt, three quarters is already provisioned. That is key. In Ukraine NPLs are just under half the outstanding loan portfolio which is a massive amount, left over from the 2008 crisis, but thanks to the banking sector clean up carried out by former NBU governor Valeria Gontareva, 90% of that debt was provisioned for, before the war started, which is why Ukraine should have had a bank crisis due to bad debt and didn’t. Nabiullina knows her onions and she also had already finished her clean up in 2018. Russia's banking sector is rock solid and extremely well managed.

Still, injecting an extra RUB25 trillion into the economy via corporate loans is not a good thing. Most of these loans have been taken out with floating rates, on the assumption that rates will fall as they were so high in 2022 when Nabiullina hiked rates to 20% after the start of the war. She did then rapidly put through a series of rate cuts back to normal levels, but in the second quarter of 2023 inflation started to take off and she reversed, and has been hiking rates aggressively until she finally paused – probably too early – in December. That makes the cost of borrowing increasingly painful.

Will the cost of borrowing burden cause the “wave of bankruptcies” some are predicting? No one agrees on this as others have argued that the Russian economy is more robust than first appears and the chance of a crisis remains low.

While interest payments are eating into profits, that doesn’t seem to be accelerating. During the first half of 2024 corporate profits were indeed falling, down 5.8% y/y to RUB13,9 trillion, according to Rosstat. However, they began to recover in the second half of the year and were up to RUB24.2 trillion in October from RUB21.4 trillion in September. But the jury is still out on future profits as the Ministry of Finance is intending to hike taxes and economic growth is expected to fall to a mere 0.5% this year from 4% in 2024.

The thing with credit crises is they are unpredictable and come suddenly and quickly.

Currently, the main effect of the corporate borrowing is to add to the cash in circulation and so to keep inflation high. Nabiullina now has a 12% spread of real interest rates (the prime rate minus inflation). That is unheard of. It shows that rate hikes are totally ineffective in bringing down rates. But that is because the economy is not working normally: usually high rates suck cash out of the economy and bring inflation down. But in the war economy, the government continues to pour money in, and the corporates were adding to the torrent by borrowing more.

Now Nabiullina is trying to bring the borrowing down by artificial means and special taxes. And I have every confidence that it will work. But the problem is that it won’t work very fast.

Putin has unhelpfully suggested that companies invest and produce more goods and services. And that would bring inflation down too; inflation is caused by too much cash chasing too few goods, so instead of reducing the cash (via traditional monetary policy) you can also just increase the amount of goods. But that too takes time – years.

The upshot is that Kennedy's report is correct in the essentials, but its alarmist tone is overdone in my book if you dig into the details. Kennedy’s big takeaway is that to solve all these problems, Putin needs to stop the war and get some sanctions relief and so Ukraine actually has more leverage in the mooted talks than first appears.