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Putin’s War-Financing Boom Masks Ominous Economic Future

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Russian Economy Booms Amid Ukraine Conflict, but Challenges Loom Ahead

President Vladimir Putin may tout the Russian economy’s performance as “better than previously expected,” but a closer look reveals that the current boom is temporary and foreshadows a challenging economic future. With a tight labor market and persistent inflation, the Russian economy is overheating, despite Putin’s claims.

The International Monetary Fund (IMF) predicts that Russia’s GDP will expand by 2.2% this year, outpacing the expected growth of the eurozone. This surprising boom can be attributed to the government’s unprecedented spending spree to finance the ongoing war in Ukraine, which Russia invaded in February 2022.

The defense budget has risen significantly, reaching 3.9% of GDP this year, up from 2.7% in the year before the invasion. Furthermore, it is expected to surge even more in 2024, reaching approximately 6% of GDP. These figures, however, likely underestimate the true extent of war-related spending, as other expenses are hidden within different sections of the budget.

This massive war effort diverts public resources to a military-industrial sector plagued by corruption and inefficiency. Additionally, military priorities have caused a shortage of skilled labor, with the unemployment rate falling to a record low of 3%. More than 300,000 Russian men have been mobilized for the war, exacerbating labor shortages even in industries unrelated to the conflict.

Despite these economic challenges, Russia has managed to adapt to Western sanctions by finding alternative trade routes and exploiting loopholes to import banned components. The recent surge in oil prices has also provided some relief and much-needed revenue for the government. Putin now projects a budget deficit of just 1% of GDP this year, half of previous estimates, thanks to increased oil and gas taxes.

However, the long-term outlook for the Russian economy is grim. The exodus of talented workers since the invasion of Ukraine poses a significant threat to future economic growth. An estimated 800,000 to 900,000 Russians, including highly skilled tech industry professionals and employees of foreign-based organizations, have left the country since February 2022.

Another challenge lies in the weakening Russian ruble, which has depreciated by 30% since its peak in January. Despite the central bank’s efforts to stabilize the currency, including raising the key rate, inflation is running at an annual rate of 6% and could reach 7% in the coming months. To boost the currency’s demand, the government recently implemented measures forcing big exporters to deposit a significant portion of their foreign currency earnings with Russian banks and convert a large portion into rubles.

As Russia becomes increasingly isolated due to sanctions and other barriers, the government is tightening its control over the economy. It has seized assets of foreign companies leaving the country and aims to reclaim a series of previously privatized Russian companies. These actions, combined with rampant corruption, raise concerns about inefficiencies in the industrial and banking sectors.

Furthermore, the Russian economy will face dire consequences when military spending eventually decreases. The country’s partial circumvention of sanctions cannot compensate for the loss of technology transfers from Europe and the United States. Reduced public investment in education and healthcare, prioritizing the military, will also negatively impact productivity and exacerbate the country’s already poor demographics.

Moreover, Russia’s economic boom comes at the price of increasing financial dependence on China. Trade between the two countries has surged, with Beijing purchasing much of the oil that Russia can no longer sell to Europe. Russia now favors the yuan over the dollar as its currency of choice, further cementing its reliance on another government-managed currency.

The IMF predicts that GDP growth will halve to 1.1% next year, and strains on the economy are already evident. Despite these challenges, Putin may be tempted to continue spending as he seeks re-election in 2024. However, sustaining the current pace will only exacerbate existing problems and delay an inevitable economic downturn.

In conclusion, while the Russian economy appears to be booming in the short term, underlying challenges related to the ongoing conflict in Ukraine, talent exodus, currency depreciation, and increasing dependence on China pose significant threats to its long-term stability.

More detail via Reuters here… ( Image via Reuters )

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