Russia’s economy defied all expectations in 2023 by not only not collapsing but was the fastest growing country in Europe by the end of 2023.

The rapid economic growth in 2023 has been fueled by a record RUB32 trillion ($346bn) of state spending, much of which went on defence. Industrial output grew 3.6%; manufacturing expanded at 7.5%; and military-linked production increased at double-digit rates.

The war has changed the structure of Russian industry, with the defence sector increasingly important. Industrial capacity utilisation is at 80.9%, and factories are running three shifts a day. Unemployment figures indicate almost full employment. Double-digit pay rises are fueling a wage-price spiral. As salaries rise, people spend more, and prices go up.

But the Kremlin has used up all the slack in the economy. There are no more reserves to increase supply in the economy. Therefore, growing demand will only lead to higher prices. And overheating may lead to unrealistic optimism – on behalf of households and companies – about future income prospects, resulting in more borrowing. Such a trend is already visible in the mortgage sector.

And in 2024, spending will only increase again, superheating an already hot economy: spending is planned to be RUB36.5 trillion ($395bn), more than a third of which will go on the defence sector and various wartime payments.

The economy in 2023 surpassed its 2021 levels, with GDP registering notable increases. In October alone, GDP exhibited a y/y growth of 5% in November following a 5.6% growth in September, according to official numbers.

Independent assessments from Bloomberg Economics echo these figures. Their analysis suggests that an annual growth rate of 5-5.5% in the total output of non-financial sectors during the fourth quarter is indicative of an overall economic growth rate of 3-3.5% for the entire year, ahead of the official forecast for 2.2% growth for 2023.

“All is not well with the Russian economy and the sanctions imposed by the West after Russia’s full-scale invasion of Ukraine are working – just not as fast as Western politicians would like. The Russian economy is gradually returning to what it looked like in the late Soviet period or even NEP (New economic policy) in 1920s: while the consumer market was dominated by private enterprise, almost everything else – including foreign trade – was largely controlled and calibrated by a Kremlin seeking to boost defence output, and ensure social stability,” says Alexandra Prokopenko, a political economy analyst.

The military Keynesianism boost from putting Russia on a war footing paid dividends that saw industrial production and the PMIs soar. The manufacturing sector, marked by a robust 9.5% growth in October, continues to be driven by the "special military operations," which has contributed to the expansion of industries such as engineering, chemistry, and metallurgy.

Investment activity during the third quarter exceeded expectations, also driven by the war, recording an impressive 13.3% growth rate (compared to 10% from January to October).

The labour shortage caused by the draft led to all-time low unemployment that pushed up both nominal and real wages and that in turn fuelled consumption and more growth. At street level Russia appeared to be booming to most Russians.

A surge in consumer and investment demand has been instrumental in boosting wholesale trade. In October, the total consumer spending of citizens exhibited a remarkable y/y increase of 10.7% (and a 3.3% rise compared to October 2021).

In addition, the external situation rapidly improved as the Kremlin quickly found ways to almost entirely dodge sanctions. Both the oil and technology sanctions have almost completely failed. The oil price cap sanctions that were imposed round the start of 2023 have also failed with the Financial Times reporting that not a single barrel of Russian oil was sold at below the $60 cap.