Economic outlook

Russia had a better than expected first half of 2024, defying earlier forecasts and was on course to end the year with 3.8-4% growth. However, that is coming to an end. 

“Despite its best efforts, the Kremlin has not been able to simultaneously fight its war in Ukraine, fund social and infrastructure projects, and keep inflation and the ruble under control. The economy hit a wall this year: there is no spare industrial capacity; there are no more workers; and exports are being squeezed by Western sanctions,” says Alexandra Prokopenko, a political economy analyst.

 

 

The CBR posted a pessimistic medium-term macroeconomic outlook at the start of August that predicts the economy will hit a brick wall in the first half of 2025. Growth will fall to 0.5-1%. Consumption growth will fall to zero. And inflation and interest rates will stay high. If the liberal macro team trying to rescue the situation fails then Russia faces stagflation for several years.

As 2024 came to an end a debate was raging over what comes next. Many were predicting a wave of bankruptcies due to unsustainable borrowing costs, while others argued that Russia’s economy is more robust than it looks.

"Those who have lost most economically in Russia this year are Putin’s core supporters: state employees. That means doctors, teachers, emergency service workers and pensioners. Their salaries, pensions and subsidies are all indexed to inflation – so will rise only by 9% (even though inflation for individuals has long cleared 20%)," says Prokopenko. “The Russian economy in 2025 will be a fragile economy. There is money available to keep fighting the war for another 12 months: it has already been earmarked. And despite worsening expectations, business generally remains optimistic. The projected 0.5% budget deficit is manageable, albeit expensive at current rates.”

Nonetheless, significant risks are looming, warns Prokopenko. Stagflation – characterised by rising prices and economic slowdown – is becoming increasingly apparent. The weakening ruble and accelerating inflation are eroding household incomes, while the growing demand for military expenditure diverts resources from other sectors, exacerbating imbalances and stifling opportunities for modernisation.

The Kremlin appears intent on downplaying these challenges, but structural economic problems cannot be masked indefinitely by expanded state spending or deeper government intervention. “​Slowly but surely, Russia is heading for stagnation and economic degradation that increasingly look unavoidable even if the fighting ends in Ukraine,” says Prokopenko. 

CBR Governor Elvia Nabiullina had been hiking rates since the second quarter of 2023 to two-decade highs, without having any impact on inflation, which was around 9% at the end of 2024, and eventually teamed up with the Ministry of Finance (MinFin) to use non-monetary policy methods to try to cool parts of the economy to lower inflation, while MinFin increased military spending by a quarter to keep the war machine going, in what is a very unusual macroeconomic experiment.

In the second half of 2024, a slowdown in economic growth began due to Russia’s stretched labour supply and production capacity constraints.

Stagnation in 2025 

Russia’s economy is cooling as the military Keynesian effects wear off. Russian economic growth should decelerate further in 2025 and 2026 to around 1%, a level close to the economy’s long-term potential growth rate, says the Bank of Finland institute for Emerging Economies (BOFIT). In 2025, the economy may be on the verge of stagnation with GDP increasing by only 0.5-1%, and growth rates for investment and private consumption may drop to zero.

A race has begun that will determine the health of the Russian economy in the next few years. On the one hand, the sky-high inflation and interest rates threaten to crush growth and investment; on the other, the CBR was promising a “breakthrough” in inflation in December and promised to be able to lower interest rates in early 2025 to return the economy to a more sustainable path.

The danger is if the CBR loses control over inflation then Russia could be plunged into a protracted period of so-called stagflation, which is very hard to escape from once it begins.

The rate hikes to date have had little effect so far. In an effort to slow growth and cool the economy mortgage subsidies have been nixed, consumer borrowing curtailed and taxes added to corporate deposits to encourage companies to invest. At the same time, corporate borrowing started to slow in December as state-backed guarantees for debt were curtailed. At the time of writing none of these measures had produced visible results, which are expected to appear in the first quarter of 2025.

Higher growth would require a substantial increase in productivity, which seems unlikely given that a considerable share of investment is already dedicated to branches serving the war effort either directly or indirectly. Russian President Vladimir Putin is well aware of the problems and has called for an increase in production and more growth, but the limitations are on the supply side with capacity utilisation at over 80% – already at its practical maximum – and a chronic labour shortage means production cannot easily be expanded even if demand increases.

Almost all the available Russian economic resources have already been used, says Nabiullina, and the country finds itself in an unprecedented situation.

The unemployment rate fell to a historic low of 2.4% in 2024, and the personnel shortage continues to grow, the head of the Russian Central Bank said. Three quarters (73%) of Russia’s enterprises are suffering from personnel shortages.

At the same time, due to increasingly effective US financial sanctions, the official exchange rate against the dollar and the euro exceeded RUB100 for the first time since October 10, 2023 as the currency weakened, further hurting consumption and fuelling inflation.

Is the new budget sustainable? 

MinFin clearly thinks that the higher military spending is sustainable and it has managed to contain the federal budget deficit, which was 1.9% of GDP in 2023 and is forecast to be closer to 0.8% in 2024, before falling to zero in 2025.

Despite the heavy military spending, part of MinFin’s calculations is that because a third of this goes on wages, that money is recouped by personal income taxes and VAT, which together make up two thirds of Russia’s tax take, compared to oil and gas revenues, which accounted for 33% in 9M24.

While borrowing has increased, it remains modest. MinFin planned to raise RUB4 trillion on the domestic OFZ market, up from a pre-war average of RUB2.5 trillion, but government debt remains very modest and a pool of some RUB19 trillion of liquidity is still in the banking sector that can be tapped if needed.

Funds in the National Welfare Fund (NWF) halved in 2023 to some RUB4.8 trillion, which could have been used to fund a deficit of the order of RUB3.3 trillion in 2023, but in 2024 it appears MinFin has not needed to dip into the fund again.

The budget remains dependent on oil export tax revenues, but this dependence is also falling. While oil prices in 2025 are expected to soften, MinFin is also working hard to reduce the share of these revenues in Russia’s tax revenue to between 23% and 25% in 2025 from 33% in 2024 to further diversify Russia income away from its dependence on hydrocarbons. One of the ironies of the war in Ukraine is that it has forced the Kremlin to carry many long-overdue structural reforms.

While sanctions have failed as a tool to directly hurt the Russian economy, they have caused constraints that are fuelling deeper problems.

War outlook

The Russian economy is starting to feel the strains of the war in Ukraine, but the war itself is going well. In November The Armed Forces of Russia (AFR) took more territory in a month than at any time since the invasion began in 2022. Hundreds of square kilometres were captured after the front line had been largely static for almost two years during what Ukrainian General Valery Zaluzhnyi described as a stalemate.

However, these advances are coming at a great cost. In December the AFR was reportedly losing as many as 1,500 men a day, wounded or killed – five times more than the Armed Forces of Ukraine (AFU) defenders were losing.

The losses have put pressure on the Kremlin to raise fresh fighters through its voluntary recruitment programme. For most of 2024 the campaign has been going well, with between 30,000 and 40,000 new recruits a month – enough to replenish the losses at the front. However, as autumn arrived the number of fresh volunteers was starting to slow, with multiple regions reporting they were failing to meet their quotas. That has led to a dramatic inflation in the sign-up bonuses paid to soldiers, which have reached the extraordinary level of RUB3mn ($30,000) in some regions – enough to buy a nice car. Russian President Vladimir Putin said in December Russia recruited just over 430,000 soldiers in 2024, up from 300,000 in 2023.

But Russia is not going to run out of men anytime soon, as it has a population that is three times larger than Ukraine’s, and Putin has in reserve the option of a general mobilisation, a card he remains very reluctant to play.

Conversely, the AFU is facing a severe manpower shortage and is losing men even faster than Russia. First, some 7.5mn people have fled, with an estimated 2mn military aged males sheltering in Poland alone. Secondly, a significant proportion of potential recruits refuse to fight and have escaped conscription by buying exemptions from corrupt recruiters and doctors. And thirdly, morale in the AFU is collapsing, with the number of deserters rising steadily in the last months of the year. And while the AFU is taking less casualties than the AFR, the attrition from death and injury is continuous.

Most of those serving on the Ukrainian front line also complain they are so understaffed that there has been few rotations home for a rest and mothers of soldiers are actively campaigning for service limits and rotations out of the front line, but to little effect. At the same time, public opinion towards the government is souring thanks to the increasingly aggressive press gangs that are snatching military-aged men from the streets throughout Ukraine.

Russia also has the advantage in materiel. Putin put the Russian economy on a war footing early on and the country has dramatically increased the production of arms and ammo. In the manufacturing of drones, Russia has boosted its output from 1.7mn a year to around 3mn. This is the one area where Ukraine is holding its own, but in the manufacture of artillery shells or long-range missiles, Russia retains a clear advantage.

Nevertheless, Russia’s stocks of arms are reportedly starting to run low, so the Kremlin is turning to allies such as North Korea and Iran for supplies. China remains wary of secondary sanctions and has refrained from supplying Russia with arms, but has delivered dual-use equipment.

One of Russia’s biggest advantages is its massive stocks of FAB glide bombs, a Soviet-era gravity bomb to which wings are strapped and a crude GPS guidance system added. These heavy bombs can carry 1,000kg of explosive and as they are next to impossible to shoot down, as they fall more than fly, they have proved devastating against Ukraine’s defences. Russia has tens of thousands of these in stock and has been firing up to 500 per day.

Ukraine has been resupplied recently as the Biden administration surged deliveries before President Donald Trump took over, and has received armaments such as long-range missiles. At the same time, the EU finally delivered the promised 1mn artillery shells nine months late that have given Ukraine parity in artillery fire again for the first time since 2022, but all this help is too little, too late.

At the time of writing, the prospects for a ceasefire deal have been improving as Ukraine’s allies have begun to talk about sending peacekeepers to police a mooted demilitarised zone that is widely assumed to be part of any deal. However, the prospects of talks remain very uncertain, as neither Putin nor Zelenskiy appear willing to soften their maximalist demands. Everyone is waiting to see what Trump will do.

Vladimir Putin and Defence Minister Andrei Belousov spoke at an expanded meeting of the Defence Ministry with a report on the situation at the front and in the rear on December 16, and for the first time Belousov warned that Russia would prepare for a military conflict with Nato.

According to Belousov, only 1% of the territory of Luhansk and 25-30% of the territory of the Donetsk, Zaporizhia and Kherson regions remain under the control of the AFU.

National defence spending "already today" has reached 6.3% of GDP and 32.5% of the federal budget, Belousov said. In connection with this, the Defence Ministry will need to "bring order" to the property complex in 2025. "We cannot increase these expenses indefinitely either," Putin admitted, noting that the Russians are already giving "everything they can."

Domestic politics 

Putin’s political repressions intensified in 2024 as “justification of terrorism” overtook “defaming the Russian army” as the main charge. Most of those arrested had posted negative comments on social media as the Kremlin attempts to keep a tight control over public opinion.

Russia’s authorities continue to crack down on opposition figures and journalists they have designated “foreign agents.” New measures ban earning income from their Russian assets online such as the sale or rental of property, through dividends or as interest on savings. In short, the authorities continue to come up with new ways to leave the handful of foreign agents still in Russia with fewer and fewer sources of income.

Nevertheless, most Russians, after initial concerns, have thrown themselves behind the Kremlin and support the war. Their attitude can be summed up as: “Starting a war was a stupid idea, but now we are fighting we don’t want to lose.” The Kremlin has effectively sold the war to the general public as an attack on Russia by Nato.

Polls in December showed 82% of Russians trust Putin and a total of 51% of those polled said they approved of the Russian government’s handling of the country (a 7% decrease), while 57% approved of Prime Minister Mikhail Mishustin’s performance (a 4% decrease). Putin’s popularity has actually been boosted by the war from around 60% pre-war as he taps Russian national pride and patriotism, which is at an all-time high.

Perceptions of the quality of life and confidence in the future have also reached new all-time highs, according to a poll by the independent pollster, the Levada Center. Public sentiment in Russia regarding quality of life has rebounded to near-record levels after a slight decline last year, with over half of respondents expressing satisfaction with their lives, according to the Levada Center.

Confidence in the future also surged, with 66% of Russians expressing optimism, a return to the near-maximum levels observed in May 2022 (67%). However, 31% remain uncertain about the future, a figure consistent with spring 2022 lows.

These strong results are associated with the steady increase in real disposable incomes up to a record 9.6% in July that has created a new war middle class. It remains to be seen what happens to these results when the widely expected economic downturn arrives in 2025, but for most, 2024 was a very pleasant year of prosperity, carefully shielded from the war by the Kremlin.

 

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