In the two Years since Vladimir Putin’s invasion of Ukraine, the Russian economy has repeatedly defied the doomsayers. A financial collapse, widely predicted in the spring of 2022, never materialized. The economy entered a recession, but it was less severe than expected and passed quickly. Inflation was the most recent fear. Last year, prices accelerated rapidly; Economists thought the situation could get out of hand. Even Putin was concerned. In February, he urged officials to pay “special attention” to rising prices.
But once again the Russian economy appears to be proving the pessimists wrong. Data published on March 13 expects prices to have risen 0.6% month-on-month in February, compared to 1.1% at the end of last year. On an annual basis, inflation is unlikely to increase again, after reaching 7.5% in November (see Chart 1). Many forecasters expect interest rates will soon fall to as low as 4%, and household expectations for future inflation have leveled off. The outcome of the Russian presidential elections, which start on March 15, is a foregone conclusion. If it were competitive, these numbers would not hurt Mr. Putin.
Russian inflation soared last year due to higher budget spending than during the Covid-19 pandemic. As Putin doubled down on his invasion of Ukraine, he increased spending on everything from transportation equipment and weapons to soldiers’ salaries. Total government expenditure increased by 8% in real terms. Demand for goods and services increased beyond the economy’s capacity to supply them, causing sellers to raise prices. Workers became extremely difficult to find, not least as hundreds of thousands were drafted and tens of thousands fled the country. In October last year, nominal wages rose at an annual rate of 18%, up from 11% at the start of the year. This caused price inflation in labor-intensive services such as healthcare and hospitality.
Who deserves credit for the turnaround? The Ministry of Finance is advancing its claim. Last year, its officials successfully lobbied for exchange controls, which force exporters to pour foreign currency into Russia’s financial system. The wheezing has likely supported the ruble, which has appreciated in recent months, pushing down the price of imports.
Central bank officials think their colleagues at the Treasury Department are economic ignoramuses who tamper with the markets at their peril. They believe that their policies – of more than doubling interest rates since July 2023 – should take credit for the inflation slowdown, and they are probably right. Higher interest rates have pushed Russians to put money in savings accounts rather than spend it. Tighter monetary policy has also restricted lending. In December, retail lending grew 0.6% month-on-month, down from 2% for most of 2023.
Few other central banks have been so tough. Yet Russia still appears to be heading for a “soft landing,” in which inflation slows without crushing the economy. The performance of the economy is now in line with the pre-invasion trend; gdp grew by more than 3% in real terms last year (see Chart 2). Unemployment remains at record lows. And there is little evidence of problems in the business community; The number of business closures recently reached an eight-year low. The Moscow Stock Exchange hopes to see more than 20 IPOs this year, up from nine last year. The latest ‘real-time’ data on economic activity is quite strong. Consensus forecasts for GDP The growth of 1.7% this year seems too pessimistic.
Russia’s economic resilience is partly the result of past stimulus measures. In recent years, businesses and households have built up large cash balances, allowing them to continue spending even in the face of high inflation, and avoid bankruptcies due to high financing costs. As in other parts of the world, the declining demand for labor has mainly resulted in a decrease in the number of open vacancies, rather than in a lower number of people working. Figures from HeadHunter, a recruitment site, show that the ratio between vacancies and job seekers is no longer increasing. Having struggled to find workers in recent months, bosses are reluctant to let people go unless absolutely necessary.
Breaking sanctions has also put pressure on the economy. Russian production facilities previously owned by Westerners have reopened under new management, the central bank said in a recent report. At the beginning of the war, sanctions made it difficult for Russian companies to obtain raw materials, slowing down production. But now companies have established sustainable supply chains with ‘friendly’ countries. More than half of goods imports come from China, twice as much as before the invasion.
As new trade relationships have been established, Russian exporters have dared to raise prices, supporting revenues and profits. For example, the discount on oil that Russia offers to Chinese customers has fallen from more than 10% in early 2022 to around 5% today. And it’s not just oil. Putin boasts about rising ice cream exports to China and noted last week that he was treating “my friend, President Xi Jinping,” with a lick.
As every Russian knows, inflation is never truly defeated. Central bank officials remain concerned that inflation expectations remain too high. The biggest concern is that the ruble could depreciate, either due to lower oil prices, a new round of severe sanctions or if China loses interest in supporting Putin. These are serious concerns. Nevertheless, the world’s pariah economy is back on track. ■