There are still options to sustain Russia’s war economy

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Production of vehicles, trailers and semi-trailers was 50 percent higher in June than the same month in 2022, according to Russia’s official statistics agency. Meanwhile, the central bank reported a deficit in the first quarter of the year. The number of workers employed in industrial establishments was the sharpest since records began in 1998. The central bank estimates annual inflation at 7.6 percent over the past three months, more than 4 percent above its annual target.

Naturally, we should treat official economic data in President Vladimir Putin’s Russia with considerable caution. But the picture painted by these three indicators is not far from the truth. Eighteen months after the full-scale invasion of Ukraine, Russia is showing many of the classic symptoms of a wartime economy, such as inflation, labor shortages, rising government spending and deficit financing.

For Kyiv and its Western backers, the question is whether pressures on the Russian economy will, at some point in the future, be serious enough to derail the Kremlin’s annexation war in Ukraine. Western sanctions undoubtedly add to these pressures, particularly by reducing Russia’s oil and gas export revenues. However, Kremlin policymakers still have measures to stabilize the militarized economy.

For example, it is possible to increase withdrawals from Russia’s National Welfare Fund, a rainy-day reserve of liquid assets including gold and the Chinese renminbi. Authorities may also expand domestic bond issuance.

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Other options that could address the problems of capital flight and a falling ruble include imposing capital controls and requiring exporters to convert foreign exchange earnings into Russian currency. Last but not least, the government can increase taxes, or reduce non-military government spending, or both.

The latter two measures seem unattractive to the Kremlin, which has sought to maintain the illusion for citizens that life can go on more or less as usual after the war. This illusion has been punctured to some extent by events such as the now-deceased warlord Yevgeny Prigozhin’s abortion riot, the partial mobilization of the public, and the fact that the war has been going on for so long.

On economic grounds, however, the Kremlin wants to reduce or avoid measures that would crush living standards and alienate the public ahead of next year’s presidential election. Although this will be strictly an organized political ritual rather than a real contest, officials still want to hand Putin a huge victory. The higher the turnout, the more tightly ordinary Russians are locked into the regime’s embrace — at least so goes official thinking.

Time is of the essence for the Kremlin. Its apparent calculation is that the Russian economy should survive until the tide of political opinion turns, above all else, in the West. Next year’s US elections are less than 15 months away, and Moscow surely hopes they will produce a president and Congress less interested in paying for Ukraine’s defensive war.

To eliminate or reduce U.S. and allied military and budgetary support for Ukraine, the prospects for its resistance to Russian aggression would be bleak indeed. Even with this support, Ukraine’s GDP fell by 10.5 percent in the first quarter of this year from the first quarter of 2022.

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Hundreds of thousands of refugees have fled Ukraine. Much of the south and east of the country is under Russian occupation. Moscow has greatly disrupted Ukrainian industrial and agricultural exports, and its physical destruction of cities, infrastructure and other assets has caused hundreds of billions of dollars in damage. Whatever difficulties Russia’s economy is experiencing, they are nothing compared to Ukraine’s.

They were not as intense as some of the earlier Russian wars. Hyperinflation in World War I was a factor behind the civil unrest that precipitated the fall of Tsarism in the February Revolution of 1917. In World War II, the Nazi invasion caused huge economic and human losses in the Soviet Union, turning the war into an existential struggle for survival.

For Ukrainians, the current war is a struggle for survival as an independent state and as a nation with its own distinct, non-Russian identity. For Russians, war is not about national survival. One day it may be about the survival of Putin’s regime – but, from a purely economic point of view, that day is still some way off.

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