(Bloomberg) — President Vladimir Putin’s invasion of Ukraine triggered an economic boom in Russia built on the back of government stimulus. Almost three years on, there are gathering signs the bill is about to come due.
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The mood in Moscow and other cities remains upbeat with packed restaurants and busy luxury stores, but a combination of record-high interest rates and persistent inflation is increasingly threatening forecasts for another year of slower, but still war-fueled growth.
“A relatively good period for the Russian economy, which was based on previously accumulated resources, is over,” said Oleg Vyugin, an economist and former top central bank official. “High inflation eats away at all that seemingly short-lived success.”
On top of that, Russia is confronted with sanctions, a recently weakened currency, a muddied outlook for oil prices and the prospect that its biggest trading partner, China, won’t shake off significant economic troubles of its own.
The central bank is forecasting a sharp decline in growth in 2025 to as low as 0.5%, down from an estimated 3.5%-4% last year, and sees inflation returning to its 4% target only in 2026.
While the Economy Ministry’s outlook is more rosy at 2.5% growth this year, Putin said last month that a cooling economy was part of the government’s plan as it aims to “stabilize” inflation.
The economy so far has managed to churn on despite efforts to hobble it from the outside, and along with high wages, that has helped dampen public opposition to the war. Two thirds of Russians remain confident in the future, according to a December poll by the Moscow-based Levada Center. Consumer sentiment, while down from its wartime peak earlier this year, remains higher than at any point during 2022.
Any pain from rising prices is being felt unevenly among Russians in part because a labor shortage has pushed up wages.
“If we talk about the middle class, it feels fine now,” said Sergey Dmitrieyev, an IT specialist from Moscow. “Less well-off people are feeling more stressed.”
The high interest rates have failed to quell price growth running at more than twice the goal. Nevertheless, the Bank of Russia in December held its key interest rate at 21%, higher than in the immediate aftermath of the invasion.
The decision not to increase borrowing costs again came after heightened criticism from the business community that the bank’s cure for inflation had become more harmful than the disease itself, and could provoke a wave of bankruptcies.
The record borrowing costs have started to take a toll. Russian car dealerships are facing a potential wave of bankruptcies, according to the Autostat research group.
The agriculture sector is also feeling the squeeze. “The risk of bankruptcies is rising along with the key rate,” said Eduard Zernin, who served as the head of the Russian Union of Grain Exporters. “When farmers need to fund the sowing in the spring, we will see if those risks materialized.”
Even the largest companies are reviewing their strategies. State-controlled pipeline operator Transneft PJSC and Russian Railways JSC sharply cut investment programs partly due to borrowing costs.
Private businesses like steelmaker Severstal PJSC and miner MMC Norilsk Nickel PJSC are also trimming expenditures, while United Co. Rusal International PJSC, a top aluminum producer, is considering cutting output by more than 10%, citing the economic situation as one of the reasons.
Still, the two biggest hardships in the economy — inflation and high borrowing costs — are forecast to decline this year. The central bank projects inflation at 4.5%-5% by year end, and the key rate at an average of 17%-20% for 2025.
It will be “a year of belt tightening,” said Sofya Donets, an economist at T-Investments. “Creditors win, and borrowers can hardly imagine how they will live.”
For consumers and businesses, that means less credit for purchases and investments.
A collapse in the cost of crude is one of the biggest risks to the economy in 2025, according to Donets. If the price goes any lower, the state will have to make sacrifices, she said.
Meanwhile, Ukraine ended transit of natural gas across its territory, and while the economic effect will likely be muted, it could still cost Russia about 0.2% to 0.3% of gross domestic product, according to various analyst estimates.
Another unknown is the war itself. Analysts at Promsvyazbank said a rapid end to the conflict, as incoming US President Donald Trump has vowed to make happen, could help the ruble strengthen and bring back foreign investors and export revenue to Russia.
If talks drag out, inflation and tight policy are likely to persist, leading to slower growth, they said.
A significantly weakened ruble against the dollar and issues with cross-border payments arising from US sanctions threats are also taking a toll.
“Working in delivery service with my own car, the cost of new automobiles is important, and it’s constantly rising,” said Evgeny Goryachev, 50, in Moscow, adding that one bright side has been the appearance of cheaper Chinese automobiles.
Disruptions in cross-border payments have slowed the transport of goods like coal and aluminum.
“The main risks for Russia are problems with payments,” said Alexey Vedev, a former deputy economy minister.
Payment problems and a foreign currency deficit have made it more difficult for Russian business to avail themselves of a relatively cheap borrowing option — yuan-denominated bonds — issuance of which slowed in the second half of the year.
What Bloomberg Economics Says…
“Moscow is still miles from making the yuan work as well as dollars and euros for its trade settlement, with costly inefficiencies in its exchange-rate market. Still, Russia’s experience shows that a large economy, if forced, can at least partially ditch the dollar and continue to function.”
— Alex Isakov, Russia Economist. Click here to read more.
Even as constrained investment is likely to lead to several quarters with small increases in output, “there is no reason to expect a recession,” said Nikita Kulagin, the head of macroeconomic analysis at Sovcombank.
Not everyone is so sanguine. “The risk of a recession is also the highest in the last three years,” Donets said. “In some quarters, growth may be negative next year. For now, our main forecast is still growth by the end of next year, slightly below 1%.”
