Russia’s war-fueled economic boom faces a reckoning

Russia’s economic machine, once turbocharged by war and government spending, is now running out of steam. Nearly three years after the Ukraine invasion, Moscow’s upbeat mood — with its packed restaurants and buzzing luxury stores — feels like a thin veil over a much more fragile reality.

Inflation is way up, interest rates are at a shocking 21%, and cracks are forming in quite literally every sector of the economy. “A relatively good period for the Russian economy, which was based on previously accumulated resources, is over,” said Oleg Vyugin, a respected economist and former central bank official.

Inflation and high rates are hitting everyone

Russia’s central bank is facing an impossible task. Inflation is running at more than double the bank’s target, and its answer — hiking interest rates to levels not seen since the early days of the war — is backfiring. Businesses are groaning under the weight of record borrowing costs.

Car dealerships are among the first casualties. Autostat, a research group, warns that bankruptcy waves could wipe out large parts of the industry. Farmers are next in line. With spring planting season around the corner, they’ll need loans to survive, but these rates have made borrowing a gamble.

Even state-controlled giants aren’t immune. Pipeline operator Transneft and Russian Railways have slashed investment programs, citing the high cost of borrowing. Private players like steelmaker Severstal and aluminum producer Rusal are scaling back too. Rusal, one of the world’s top aluminum producers, is considering cutting its output by 10%.

But the pain doesn’t stop there. For regular Russians, high prices are eating into their pockets. The middle class, buoyed by a tight labor market that pushed up wages, is managing. But for lower-income households, it’s a different story. They’re struggling to keep up as inflation erodes what little purchasing power they have.

Energy exports and currency troubles add pressure

Energy isn’t the safety net it used to be. Oil prices, already unpredictable, pose one of the biggest risks for 2025. If they drop some more, the government will be forced to make tough sacrifices, warned economist Sofya Donets. And Ukraine’s recent decision to end natural gas transit across its territory will chip away another 0.2% to 0.3% of GDP, according to analysts.

The ruble is also under pressure. It has weakened way too much against the dollar, and cross-border payment issues stemming from U.S. sanctions are adding insult to injury. Import-reliant sectors are feeling the heat.

Sanctions have made borrowing abroad a logistical nightmare. Yuan-denominated bonds, which were once a lifeline, have slowed in issuance due to payment delays and currency shortages. This leaves businesses strapped for cash and short on options.

A risky economic future

And now the Bank of Russia has a new monster to fight: stagflation. It’s the worst of both worlds — high inflation coupled with sluggish growth. This overheating economy, fueled by war spending in the first half of 2024, is now running headfirst into supply-side constraints, including a labor shortage.

Governor Elvira Nabiullina said avoiding stagflation is critical, emphasizing that this is every central bank’s nightmare scenario. But whether Russia can dodge the bullet is another question. Domestic demand is showing early signs of slowing, which could eventually help ease inflation.

But for now, prices remain painfully high. And growth forecasts are grim. The central bank predicts GDP growth could plummet to as low as 0.5% in 2025, a drop from last year’s estimated 3.5%-4%. Inflation, the bank hopes, will return to its 4% target by 2026.

Meanwhile, the Economy Ministry is a little more optimistic, projecting a 2.5% growth rate for this year. President Vladimir Putin has downplayed the concerns, framing the slowdown as part of a broader plan to “stabilize” inflation.

Consumer confidence remains surprisingly resilient. A December poll by the Levada Center found two-thirds of Russians optimistic about the future. While confidence has dipped from wartime peaks earlier this year, it’s still higher than in 2022.

For now, high wages and a tight labor market have softened the blow for many. But as borrowing costs stay high and prices continue to climb, that optimism may not last.

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