Latest / The Fourcast / Booming or breaking? The truth about Russia’s war economy

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Booming or breaking? The truth about Russia’s war economy · The Fourcast

0:00
A lot of people got it wrong in the first years of the war that
0:03
Russian economy would collapse. And now I think the pendulum
0:06
swung the other way. You could ask, you know, is
0:09
Putin running out of money? Well, he's already run out of.
0:11
Money. It is now almost like a bubble
0:14
of the war economy. So the only sectors that they
0:17
have recovered to the pre crisis levels and actually have grown
0:21
some are the sectors related to the war economy.
0:23
Is there an argument that Putin needs the war to go on because
0:26
of the way that the Russian economy has now been oriented?
0:33
Hello and welcome to the forecast.
0:35
For months after Putin's invasion of Ukraine, Western
0:38
leaders said Russia was on the brink of collapse under
0:40
sanctions. And yet it didn't.
0:43
It transformed into a wartime economy fuelled by military
0:46
production, redirected trade routes and deeper ties with
0:49
China and India. But now there are signs this may
0:53
be changing, with industrial output slowing, inflation rising
0:57
and severe labour shortages as hundreds of thousands of working
1:00
age men have either died, emigrated or been mobilized.
1:04
And Western leaders are once again questioning how long Putin
1:07
can bankroll his war machine. So is Russia's economy finally
1:11
starting to buckle or is this still wishful thinking from
1:15
Ukraine's allies? With me today, Arkady Ostrovsky,
1:18
Russia editor at The Economist, and Elina Ribakova, one of the
1:22
world's leading experts on sanctions and Russian macro
1:26
economics. Let's begin with the sort of the
1:29
simple question, if you like, of whether Putin really wants a
1:33
deal right now, Arkady, I mean, is he under economic pressure
1:37
that is pushing him towards wanting an end?
1:39
I don't think he wants to suddenly leave Ukraine alone.
1:44
I don't think he suddenly wants to stop, stop his bigger
1:49
offensive against Europe and against transatlantic security
1:54
system which he he is set to, you know, he wants to undermine.
1:58
So I don't think we should look at the deal sort of separately.
2:00
Now, is he under pressure? Yes, he is under some pressure.
2:03
Does that mean that the war is going to end?
2:06
That doesn't necessarily follow. Alina what would?
2:10
You say, I would say indeed, I fully agree with our career that
2:13
we need to separate the two and I think that's where the biggest
2:16
mistake we in Europe and in the West make.
2:19
Visiting Russia, they have separated the two at the very
2:22
beginning of the 2022 invasion. They went into this head on
2:26
understanding what kind of sanctions can be implemented.
2:28
There were some surprises, but not not many.
2:31
They prepared for the sanctions since 2014 and they were willing
2:35
to take the cost. However, what they didn't plan
2:38
for, for the fact that it would take so long.
2:41
And it is indeed incredible that size matters, you know, economy,
2:44
number of people, but yet Ukraine still holds four years
2:47
on, right? Russia wasn't entirely prepared
2:50
for that. They were hoping for either
2:51
blitzkrieg of maybe 2 days or maybe a couple of years.
2:55
And now we're in the situation where instead of producing more
2:58
tanks, tanks got more expensive. And therefore we've seen the
3:01
central Bank of Russia trying to slow down the economy.
3:04
And that is also affecting the production of the military
3:07
industrial complex. Right.
3:09
So, so, So what extent is Russia's economy dependent on
3:13
the war, and to what extent is the war dependent on the
3:16
economy? I think it goes both ways
3:20
indeed, right. It is now almost like a bubble
3:24
of the war economy. So the only sectors that they
3:27
have recovered to the pre crisis levels and actually have grown,
3:31
some other sectors related to the war economy, they have
3:34
slowed down recently, but not really fully to negative
3:37
territory. Most of other sectors have not
3:40
recovered their losses. So it is almost like pricking
3:43
the bubble, right? We talked a lot about it before
3:45
the global financial crisis that it is very hard to do
3:49
politically and economically. At the same time, it is also
3:52
giving opportunities for people that have not had a social lift
3:56
in decades. You know, weaker regions, you
3:58
know, they're getting contractual payments for
4:00
participation in the war or regions where there is military
4:03
production. So this is on the one hand.
4:05
On the other hand, of course, for Russia to be able to
4:08
continue at this pace is challenging.
4:11
And that's where they're looking for new sources of investment.
4:13
And that's what they're trying to negotiate, whether with the
4:16
US or with countries in Asia, for some sort of sort of blink
4:20
for less forceful enforcement of sanctions.
4:23
Katie, do you think the West misunderstood this at the
4:25
beginning? I think the West did
4:27
misunderstand it. I think the West misunderstood a
4:29
lot of things and I think the West continues to make a lot of
4:31
mistakes towards Russia. We can talk about it in terms of
4:36
public opinion and the links between public opinion, economy
4:40
and politics of it. But in terms of economy, yes, as
4:43
you said rightly, everybody was expecting Russia to collapse.
4:48
It did not. But the pressures are catching
4:52
on. The divide between the civil
4:54
economy and the military economy, part of the economy is
4:58
growing. Now this the source of, you
5:02
know, income for Russia is shrinking, which is why Russia
5:05
has the biggest budget deficit I think it's had in modern
5:09
history. And you know, and very high
5:14
inflation and 40% of Russian budget goes towards the
5:20
military, towards the war, both in terms of production of
5:24
weapons and in payments of of contracts and the payout death
5:29
payouts. So I think the pressures are
5:31
building up. I think the West misunderstood
5:33
at the time when they expected it to to collapse.
5:36
I think it's misunderstanding what game Putin is playing now
5:40
and actually how complicated that relationship between the
5:44
economy and the society and the politics really is.
5:48
Yes. I mean, I again, I think at the
5:49
beginning there was this assumption or a lot of
5:52
commentary that this would not be sustainable for long, that
5:56
the impact of the war would be felt by ordinary Russians and
5:59
that this would dramatically affect the popularity of Putin.
6:04
Why hasn't that happened? He made it a commercial war.
6:07
It's most extraordinary things. You know, people don't talk
6:11
about war, but partly because of that and partly to great degree
6:16
is because of repression. I mean, Russia is highly
6:19
repressive, almost a totalitarian regime where
6:23
speaking out will will land you in jail.
6:26
So you have a certain living standard which is maintained
6:30
across the population. You have the army, which is most
6:34
people think, OK, well that, you know, they're getting paid so we
6:37
don't need to feel sorry for them.
6:40
And you have a repressive system which basically punishes
6:44
speaking, speaking out against the war.
6:46
And that creates a false idea of homogeneous support.
6:51
And that is, I think the biggest mistake the West has made in in
6:55
recent months is basically completely accepting and
6:59
embracing Putin's propaganda that all Russians support the
7:02
war or the majority of Russians support the war.
7:05
And the picture is much more nuanced.
7:07
But the the the Western policy towards Russia and the Western
7:10
rhetoric towards Russia has reinforced Putin's propaganda
7:15
rather than confronted it. Right.
7:18
But I mean, accepting the fact that he's commercialized the war
7:24
and the people are not being dragged off against their will,
7:28
the numbers surely at this point are so enormous that everybody
7:34
must be touched by it. You're right.
7:37
I mean, the numbers are huge. I mean Russia's losses are in
7:41
dead and wounded. You know, some say, you know,
7:45
it's it's a million around 1,000,000, which is, which is
7:50
enormous. And yes, it is contractual.
7:55
And I wouldn't say it's all, you know, there is a lot of
7:58
deception. There is a lot of pressure.
8:00
You know, to what extent it's voluntary, it's another matter.
8:03
I don't think it is. You know, a lot of it is not
8:05
voluntary. A lot of it is actually people
8:08
who are drafted into the Army by law and then pressured to sign
8:13
contracts. So there is lots of lots of
8:16
deception. But yes, you're right,
8:18
ultimately everybody now knows that the, the losses are, are
8:24
huge and people see it and they're the cities and towns and
8:27
the villages because the, the size of cemeteries is growing
8:31
and everybody particularly in a small place where you know,
8:35
people have been taken from mostly it's not large cities
8:39
like Moscow and Saint Petersburg.
8:41
It's disadvantaged economically. Poorer regions of, of Russia.
8:46
Of course people see it. It is having an impact.
8:49
If you ask people what they would like, they say they want
8:53
the stop of the war, they don't want mobilization, they do not
8:57
want to participate in it, and they want 60% want improvement
9:00
in the relationship with the West.
9:02
Interestingly, the argument you hear a lot is that, well, none
9:06
of it matters because public opinion in Russia doesn't matter
9:08
because people don't have any agency.
9:10
But actually it does not in the direct way that everybody
9:14
expects that people will just come out in the streets and
9:16
overthrow Putin. People can't do that if there
9:18
are tanks and people with guns. But in terms of the why the
9:25
Kremlin cares about public opinion and it does, it measures
9:29
it all the time, is that it creates a merely in which it can
9:33
operate. It needs to have this picture.
9:36
Putin from the very beginning, from the moment he came to
9:39
power, he came out with this idea of super majority of people
9:43
supporting him. That is the source of
9:45
legitimacy. Let's let's turn to the economy.
9:47
To what extent did sanctions backfire and and how much was
9:51
Russia able to turn itself towards China, towards India and
9:55
adapt? Well, you know, I think first we
9:57
need to think about objectives of sanctions.
10:00
Sanctions do not create World Peace.
10:02
You know, they don't change regimes.
10:04
They don't resolve your educational reform at home,
10:06
right? I think we're just loaded too
10:08
many things on this magic tool that is supposed to be like a
10:11
magic wand and then Putin disappears and will live happily
10:14
ever after. So I think first we needed to
10:16
have realistic expectations. In terms of realistic
10:19
expectations, should we give foreign exchange to Russia in
10:21
exchange for their oil? Probably not Should we sell the
10:24
missile and components of missiles?
10:26
Probably not, right. This is the extent of sanctions
10:29
that I would like to see with clear targets and clear
10:32
measurable objectives to to check against them, right.
10:35
So this is first whether Russians get luxury goods or
10:38
not, frankly, I don't really care, right?
10:40
And most people in Ukraine that getting their Shahid's to their
10:43
house also don't really care. So this is the first part.
10:46
In terms of what backfired, I think what backfired is our poor
10:50
enforcement and implementation of sanctions.
10:53
We gave the huge window for China to drive through with the
10:57
truck and more than 90% of various sanctions evasion
11:02
schemes happen via China. It may be Western produced the
11:05
Western owned goods that ship through China or maybe are
11:09
produced in joint venture ventures in China or licensing
11:12
and then go to Russia. Of course, other border states
11:15
are also at fault and I think that's has created a special
11:19
relationship and it's also allowing China to test drive
11:23
sanctions evasion techniques for against possible sanctions that
11:26
they might experience in the future.
11:29
So. So are you saying that pretty
11:30
much everything gets through anyway?
11:33
Not everything gets through. Things spend longer time
11:37
travelling to Russia, they're more expensive, but a lot of
11:40
things still get through. And we can see that from the
11:42
disassembled components, parts that the Ukrainian authorities
11:46
are disassembling and putting online.
11:48
You can see that Russia still acts has access to Western
11:52
components, albeit more expensively and with the longest
11:55
production times. What about the the US
11:57
administration's approach to trying to to tackle this?
12:01
I mean, they've been terribly fierce on India, but not
12:06
terribly fierce towards China. Well, there is this panda in the
12:10
room that they're very afraid of addressing, right.
12:13
And I think it is also characteristic to this
12:15
administration as well as the previous one.
12:17
If you look at the statistics, China started supplying this
12:20
components already in autumn 2022 and it's almost sort of
12:24
went to the pre war levels, the volumes thanks to China.
12:28
And we sort of closed the blind into that and we try to have
12:31
behind the closed door conversations with China and
12:34
didn't quite really work out right.
12:36
So I think here the current administration seems to be
12:39
following the same strategy. Maybe they would like to have a
12:41
grand deal on trade and they do not want to have the the pesky
12:45
Russia, Ukraine war issue getting in the way of that.
12:49
In specifically in terms of India, I would like to see more
12:53
the decisive action. Yes, they've been some good
12:55
announcements, but let's see if there will be enforcement.
13:00
Right. But how does how is all this fed
13:02
through to Russia's domestic economy and to what extent is it
13:07
under pressure? I mean, you know, the question
13:10
kind of feels, is there an argument that Putin needs the
13:13
war to go on because of the way that the Russian economy has now
13:17
been orientated? Once you have driven into the
13:21
bubble, you know, and we all remember, Greenspan, that nobody
13:24
likes to prick the bubble, right?
13:25
It's very hard for you to stop to stop that.
13:28
And we've seen all this musical chairs let them continue from
13:31
the bankers, you know, before the global financial crisis.
13:34
And there is something very similar here because Russia has
13:37
been writing five year plans of diversification from commodities
13:41
of productivity growth improvements.
13:43
And at some point they just started rewriting the same plan
13:46
because they struggled to find the new sort of results that
13:50
hope or productivity growth apart from just being a
13:53
commodity economy. And this war economy has given
13:56
this temporarily boost. And I think that is very hard to
14:00
stop. You know, even as Arkady was
14:02
describing even an autocratic regime, people still worry about
14:05
the opinion of the people. And specifically in autocratic
14:09
regimes, the regime change is more painful than in a
14:12
democratic economy, I think. That's absolutely right what
14:15
Lena is saying. And I I think we should be
14:18
slightly humble in that we got it.
14:23
I mean, a lot of people got it wrong in the first months and,
14:26
you know, years of the war that Russian economy would collapse.
14:30
And now I think the pendulum swung the other way is, oh, no,
14:35
it's fine. You know, it's so resilient.
14:37
It will, you know, nothing will actually happen and, and Putin
14:41
can carry on for three, 5-7 years.
14:44
The truth is we don't know. We haven't been to this
14:48
position. I mean, Lenny is absolutely
14:49
right that it's very hard. Even if the world were, even if
14:53
the war was to freeze, let's say, even if you imagine, which
14:58
is very hard to imagine, some of the sanctions would get lifted.
15:02
Basically, I can't see any sources of growth or investment
15:07
in Russia. I can't see Russian economy
15:09
getting back, getting back on track.
15:12
So in a way, the deterioration, the degradation of Russian
15:17
economy will continue. How people will respond, how the
15:21
politics will respond, we simply don't know.
15:24
But we do know that in a way you could ask, you know, is Putin
15:28
running out of money? Well, he's already run out of
15:30
money. If he didn't run out of money,
15:31
there wouldn't be a budget deficit, which is five times I
15:34
think, or Lenny will correct me larger than that what what they
15:38
forecast. So in that sense, he's already
15:41
run out of money. And so the fact that the economy
15:44
will, you know, suffer is already suffering, is under
15:48
pressure that doesn't necessarily again mean that that
15:51
Putin will stop. So we are we're in uncharted
15:55
territory. We simply don't know how things
15:58
are going to to form. And it will be a function of
16:01
many things of where the war is going or where the economy is
16:04
going, whether there are any black Swans, what the, you know,
16:08
what would if the war was to freeze, what would happen to the
16:12
soldiers who return home? What would happen to the levels
16:15
of violence and aggression. There are just too many factors
16:18
which we have to be, as I said, humble and so, so.
16:21
Alina, to what extent is sanctions relief, you know,
16:25
needed by Russia and attractive in the peace process?
16:28
You know, how much of A priority will it be?
16:31
I think we've seen already from the person whom I call the
16:34
sanctions lifting envoy Dmitriev, that sanctions are a
16:38
priority in this negotiations. Why are they priority, As I kind
16:42
of exactly explained, not because it's going to boost the
16:45
economy dramatically, but it's going to think change things on
16:47
the margin. And let's think about investors
16:50
domestically, third country investors and then Western
16:53
investors. Russia doesn't necessarily hold
16:56
or need the Western investors to come back.
16:59
They need to have this sort of multiple equilibrium domestic to
17:02
be resolved where domestic investors was extra cash or
17:05
maybe third country investors feel, oh, wait a second, this is
17:07
maybe a normalising situation. I'm more ready to invest at this
17:11
levels into Russia. And I think this is a critical
17:14
moment for Russia. The signalling of normalisation
17:17
would give them space to invest more.
17:19
And the question is whether they invest more in something
17:21
productive for civilian use or something more military related.
17:25
And the big risk, it will be something that is definitely
17:28
military related. Yes, and and why would anybody
17:31
trust that Russia won't get into further entanglements in the
17:34
future when it's it, it's whole foreign policy approach seems to
17:39
be based on that? Well, I can comment on the
17:42
macroeconomic side of it is we have done a lot of studies at
17:46
the Kiev School of Economics where we're trying to use data
17:49
to track supply chains and the shipments among different parts
17:53
of the Russian industrial base, military industrial base.
17:56
And we're seeing production of some of the types of weaponry
17:59
that is not currently needed in Ukraine.
18:01
So we've seen that activity, whether it's naval warfare
18:05
related or maybe the airplanes. And that raises questions, what
18:08
are they using that output for? What are they planning to use it
18:12
for? Akadi.
18:15
Yeah, I think there is also one very big factor in all of this,
18:20
which Elena mentioned the a few minutes ago, which is China.
18:29
Russia would not have been able to conduct this war economically
18:34
without China's lifeline. Now China's got deep pockets.
18:41
It's not going anything away for free.
18:43
We know that Chinese actually investment in Russian economy
18:46
and the private economy is very low.
18:49
But China needs Russia to be stable with the biggest mistake
18:54
I think the West has made at the beginning of the war.
18:58
And it was sort of almost contemptuous to think that you
19:01
could isolate Russia simply by imposing Western sanctions.
19:08
The world is bigger than the worst.
19:10
You know, if you have India, if you have China, if you have
19:14
global S which do not isolate Russia, you cannot isolate its
19:19
com. You cannot cut the sources of
19:21
revenue. The Indian companies, Chinese
19:25
companies will buy Russian oil. Physically restricting Russian
19:29
volumes of oil export is probably the best thing.
19:33
And and the best thing of all would be take bringing down the
19:37
oil price. And I think that is actually the
19:39
probably the biggest unknown factor is you know, there are
19:42
predictions in the market out there.
19:44
Ilina probably knows more that you know, the oil is already $50
19:48
a barrel that it will get to $30, it will get to $30 a
19:55
dollars a barrel by by the end of 2027.
19:59
Now Russia is going next year is going to be the hardest year
20:03
economically Russia has had. If the oil price continues to go
20:06
down, that's a very different dynamic.
20:09
You know, Russian cost of extraction I from the top of my
20:13
mind, I think is about $2025 a barrel.
20:17
So you only get $5. I mean that you can't conduct a
20:20
big war, you can't continue to pay those contracts given that
20:25
your army is contractual at $30 a barrel of the same.
20:30
And keep the the army of the same size.
20:32
So it just becomes impractical. It just he, Putin will stop when
20:36
either he has stopped or when he's unable to go any further in
20:41
terms of his intentions. The intentions are not going to
20:44
change. The capacity and capability
20:47
could change. And Alina, are Russian consumers
20:50
happy to be this reliance on China in the future?
20:56
And I suppose in terms of labour force, you know the increasing
20:59
number of imported workers from Africa and you know where, where
21:03
else, wherever else they may be coming.
21:07
Well, on China, I think the consumer is definitely sort of
21:10
getting concerned, but it's a bit too early days.
21:13
Let's look at the car imports. Russia actually imposed tariffs
21:17
on its big friend China for car imports because they realized
21:20
that the Western producers used to put some of the production
21:23
domestically and it led to some positive spillovers and
21:26
agglomeration effects in the economy, while China just
21:29
aggressively dumping the oversupply into Russia.
21:32
And that has allowed China to continue one of the biggest
21:35
producers in the world in cars because they were dumping into
21:38
Russia. So Russia actually put in a
21:39
tariff on that, right. So you see already some of the
21:42
concerns, but I think also the big concern or maybe
21:46
embarrassment is the big flip in terms of Russia's export to
21:50
China. Russia used to export to China
21:52
mostly manufacturing products, more complex machinery sometime
21:56
in 2000. Now 80% is energy and metals,
22:00
you know, so it's truly like a pump, you know, that is that is
22:04
sending goods to China. And it's definitely not a good
22:07
look for Russian authorities or the consumer.
22:11
OK. And what about Labour just going
22:13
on into the future? I mean, you know, if Russia has
22:15
lost quarter of a million dead or somewhere between that and a
22:18
million, that's enough to have quite an effect, isn't it?
22:20
Yes, I mean we see it already in unemployment numbers.
22:23
The unemployment numbers are around 2%.
22:25
You know, this is an emerging market, right?
22:27
In any emerging market there are more frictions that would keep
22:30
your natural rate of unemployment, meaning non
22:32
inflation generating rate of unemployment somewhat elevated.
22:35
This is not even a normal rate for UK or the US, right.
22:39
So that's one of the reasons why the central bank was forced to
22:42
hike rates. So this employment issue will be
22:45
very sort of unemployed or employment or labour force issue
22:49
will be pervasive. For now, it seems that the, the,
22:53
the, the block of secure security block has won out,
22:58
especially after the terrorist attack on, on I think in Crocus
23:02
City Mall where they are not letting a lot of migrant workers
23:07
to come back. On top of that, you had some of
23:10
the racism nation issues and also not adding to the
23:13
willingness of this work is to come back.
23:15
And then finally, you mentioned some of them African countries
23:19
sort of coming, including from South Africa and others being
23:22
lured to Russia. And the issue is there that
23:25
integration is very hard. And also many of them have to
23:28
come under pretense of working. And then the end of the day,
23:32
they end up either on the highly toxic, poisonous production or
23:35
the some of them end up on the frontline.
23:38
And then of course, they let their people home know that,
23:40
well, this is not a great way to to, to earn your money.
23:43
So finally, Arkady, I mean, it doesn't sound like you think the
23:47
economy is is going to force Putin into anything imminently.
23:53
I think so. I don't think there is anything
23:55
to force, unfortunately, there is anything to force Putin into
23:59
into any sort of a deal. Now that is not to say that he
24:05
doesn't have pressures. There are pressures in terms of
24:09
the expenditure. There is pressures on the
24:11
economy. There is a pressure, you know,
24:13
he can't obviously, you know, they've been fighting for four
24:17
years in January. This war will be longer than
24:20
than the Soviet participation in the Second World War, the in the
24:26
Great Patriotic War. So the the pressures are
24:30
building up. Russia is not in a, you know, in
24:34
a healthy position at all. But remember, it's, you know, in
24:38
a war, it's always about the other side as well.
24:41
It's who's got more resources. That's why the war of attrition
24:47
is so dangerous. You know, he's he can't deal
24:50
with sort of a military final military blow to Ukraine.
24:54
But if he ties Ukraine to degree that the number of desertions
24:59
is, you know, is very, very high now, you know, Russia spends 8%
25:04
on, on, on, on the war on the military.
25:07
Ukraine spends 30% of the military, you know, corruption
25:10
scandals, everything else. You know, it only needs to be it
25:13
doesn't need to be strong. It only needs to be slightly
25:16
stronger than Ukraine talked about mistakes in the West.
25:19
But the fact that, you know, four years into this war,
25:23
European military production is nowhere near the fact that that
25:26
Europe still has not passed the frozen assets to Ukraine.
25:30
And it's still, you know, there is more talk than action.
25:34
I think that's the biggest LED down for Ukrainians.
25:38
And they know this. I mean, you know, the, the
25:40
opinion in Ukraine is already becoming very resentful of
25:43
certainly of America and now will be towards Europe because
25:46
they feel LED down because all this talk about, you know, for
25:49
as long as it takes, whatever it takes is the talk.
25:53
And, and, and finally to you, Alina, I mean, if you were an
25:56
economic adviser to Putin, might you be tempted to say the lesson
26:01
of the Ukraine war is that this works for Russian growth and
26:04
that Russia has shown that it can, it can pivot to this kind
26:08
of existence and that in the medium term, it suits us to keep
26:13
agitating at Europe because it works for us too.
26:18
If I were a great cardinal in Kremlin administration, I would
26:22
definitely say that it's gives us the social lift for many
26:27
people in the regions that would wouldn't have it otherwise.
26:30
It keeps people calm. We also don't want to have this
26:33
people back at home trying to reintegrate into the society
26:37
after being at war. And some of them are also
26:40
criminals, right? That also creates a lot of
26:43
challenges. I would probably advise to find
26:46
ways to freeze the contract conflict, the war temporarily to
26:51
be able to invest and rearm more skilfully and then think what
26:55
kind of levers will have vis A vis Europe if we can put more
26:59
pressure on Europe. So that would be unfortunately
27:01
my advice for if I were great Cardinal in Putin's
27:05
administration. Elina Arcadi, thank you so much
27:08
indeed for your time. It's been fascinating talking to
27:11
you both. That's the forecast.
27:12
Until next time, bye bye.