Despite the ongoing war in Ukraine and crippling Western sanctions, Russia's economy is showing surprising resilience. The country recorded a robust 3.6% GDP growth last year, while the unemployment rate hit a record low of 2.6% in April. This apparent economic prosperity, however, comes at a cost â rampant inflation fuelled by a combination of strong government spending and a tight labour market.
The surge in military expenditure, amounting to approximately 7% of GDP, coupled with substantial subsidies, has significantly boosted economic activity. However, this war-time spending has also created significant macroeconomic imbalances. The resulting labour shortages, exacerbated by a brain drain of skilled workers leaving the country, have driven up wages, pushing inflation above the official target of 4% and reaching over 9% annually.
This inflationary pressure has prompted the Russian central bank to take action. On Friday, the bank announced a sharp interest rate hike, raising rates from 16% to 18% in an attempt to tame the runaway price increases. The bank warned of an overheating economy, highlighting that GDP growth remains high despite the escalating inflation.
Despite the economic headwinds, Russians are indulging in a spending boom, with consumption per capita increasing by more than 20% from 2021 to 2023. This trend is particularly evident in tourism, where spending has surged by over 90%. Spending on culture, hotels, transport, and personal services has also seen significant growth.
This apparent economic prosperity has led some, like Sergei Ishkov, a Moscow investor and entrepreneur, to observe a buoyant upper-middle class enjoying a "really good life." However, experts like Bartosz Sawicki, a market analyst at Conotoxia, caution that this boom is fuelled by unsustainable factors like massive government spending and labour shortages.
The Russian central bank is committed to tackling the inflation challenge and maintaining economic stability. Despite projecting a slowdown in GDP growth to 0.5% to 1.5% in 2025, the bank has signalled that it will maintain its high interest rates until inflation returns to its target. Further rate hikes are also a possibility to mitigate economic risks.
The bank acknowledges the exhaustion of labour and production reserves, warning that further attempts to stimulate demand could exacerbate inflation, potentially leading to stagflation. To avoid this scenario, the bank emphasizes the necessity of a deep recession.
With the next central bank meeting scheduled for September 13th, all eyes will be on the bank's continued efforts to navigate the delicate balance between controlling inflation and maintaining economic stability in the face of a war-torn economy.