Chelsey Dulaney
The Russian central bank’s jumbo interest-rate increase to halt a tumbling ruble this week points to a new reality for the Kremlin: Russia’s economy has reached its speed limit.
The government has flooded the Russian economy with money to keep its troops in Ukraine supplied and insulate its businesses and citizens from the war. Thanks to the state’s largess, demand in the economy is rising, helping it recover from last year’s sanctions-induced recession. Supply—increasingly constrained by Russia’s isolation and widespread labor shortages—isn’t.
That growing imbalance of Russia’s wartime economy was thrust into focus this week as the ruble fell to its lowest level since the early days of the war. A senior Kremlin official blamed the currency drop on loose monetary policy. A day later, Russia’s central bank hiked interest rates by 3.5 percentage points at an emergency meeting, citing the need to stabilize the currency and bring down inflation, which it said has been growing at an annualized rate of 7.6% over the last three months.
The ruble has staged a rebound, with $1 now buying roughly 94 rubles compared with as much as 102 on Monday. Economists see this week’s volatility not as the beginning of an imminent financial crisis but rather as a symptom of Russia’s sclerotic economic prospects.
In another bid to support the currency, the Russian government struck an informal agreement with exporters to convert more of their foreign earnings back into rubles, according to Russian business newspaper Vedomosti. The central bank implemented a stricter version of that policy shortly after the war began to help prop up the battered ruble
One step Russia’s central bank is now considering to boost the currency would reimpose requirements—used earlier in the war—on exporters to convert foreign earnings back into rubles, according to media reports.
“Russia is one of the few countries that could sustain for the longest. I don’t think they’re necessarily going to run out of money or whatnot,” said Erik Meyersson, chief emerging-market strategist at Swedish bank SEB.
But the level at which the Russian economy can grow without stoking inflation is now much lower than before Western sanctions. The decline of this so-called potential growth rate sets up a dilemma for President Vladimir Putin as he needs to both boost military production and placate the domestic population ahead of the coming presidential elections in March.
Government spending as part of gross domestic product has jumped by 13.5% in the first quarter compared with the same period last year, the highest growth rate in data going back to 1996.
The International Monetary Fund has estimated that Russia’s potential growth rate was around 3.5% before 2014, the year it seized Crimea from Ukraine.
Analysts at Raiffeisenbank Russia estimate the long-term potential growth of the economy now stands at 0.9%. In the years running up to the 2008 financial crisis, Russia’s economy averaged growth of more than 7% a year.
“The devaluation of the ruble shows that the economic fireworks of booming public spending are not sustainable,” said Janis Kluge, an expert on the Russian economy at the German Institute for International and Security Affairs. “The speed limit is not what the government can finance, but what the economy can produce.”
Russia’s ability to increase production at its own factories is already stretched to the limit. In sectors supplying the military, plants are working multiple shifts to cope with orders. Statistical categories associated with military output, such as metal goods, optical products and special clothing, boomed in the first half of the year.
Nonmilitary industrial sectors, meanwhile, have languished, weighed down by the lack of access to Western parts, inefficiency and a history of weak investment in upkeep of machines and equipment. Auto output is down more than 10% year-over-year. As a result, Russia’s economy has become increasingly centered on its vast natural resources, with profits from energy and metals filling the government’s coffers.
WSJ explains how Chinese car brands profited from Moscow’s invasion of Ukraine and Western sanctions. Illustration: Kalvin Ng
Russia has tried to become more self-sufficient since it invaded Ukraine last February and was cut off from Western supply networks. Those efforts are slow-moving and so far having mixed success. Some 65% of industrial enterprises in Russia are dependent on imported equipment, according to a poll published in June by Moscow’s Higher School of Economics.
“Building up capacity in new sectors takes time,” said Iikka Korhonen, the head of the Bank of Finland Institute for Emerging Economies. “You need machinery, you need qualified technicians. All that takes resources and it takes time.”
Russia has turned abroad to fill the gap. Imports of goods were up 18% this year through July, according to data from the finance ministry. Imports from China have surged and Russia’s defense minister recently visited North Korea to view weapons systems.
Russia’s growing dependence on imports has major implications for its economic stability. The economy still runs a current-account surplus, broadly meaning it receives more from exports than it spends on imports. But that surplus has fallen 85% this year, which means less money is flowing into the economy and a lower demand for rubles. A weakening ruble also makes imports more expensive in ruble terms, driving up inflation.
Russia has been less successful at finding new suppliers for mid-tech and high-tech products such as aircraft parts that have been hit by Western sanctions. Those imports were down $7 billion in the final quarter of 2022 compared with a year earlier, according to an analysis published by the Centre for Economic Policy Research.
Russia’s growing technological isolation is expected to reduce its long-term growth prospects, which were bleak even before the war. The country’s labor force has been shrinking for more than a decade as its population ages. Productivity has been weak owing to a lack of investment and a business climate rife with corruption and bureaucracy.
Those trends have only worsened over the past year. Russia is facing its worst labor shortage since the 1990s as hundreds of thousands are mobilized for the front or have fled the country.
“There’s almost no supply left in Russia’s economy, and the inevitable result of that is going to be inflation,” said Liam Peach, senior emerging-market economist at Capital Economics.
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