Is the Ukraine war boosting or damaging the Russian economy?

This week the International Monetary Fund will assess how well Russia’s economy has held up during the Ukraine war and is expected to estimate it had a mild downturn last year, faces a a small contraction this year and will enjoy a healthy level of growth in 2024.

This seems to contradict the warning from shortly after the invasion that the country faced a contraction of up to 15% and last month’s prediction from the oligarch Oleg Deripaska that international sanctions would drain the Kremlin’s finances by next year.

However, some experts have criticised the IMF’s focus on traditional economic measures such as gross domestic product (GDP) as inappropriate given there is a war on – meaning the figure is inflated by soaring military spending. An analysis from the Centre for Policy Research (CEPR) network of academics has found that when this is stripped out last year’s recession was twice as bad as official figures suggest.

What do the official figures say?

Russia’s GDP dropped in 2022, but not by as much as many expected. In February the International Monetary Fund said it expected final figures to show a mild 2% fall in GDP in 2022, followed by a 0.3% rise in 2023 before a rebound to almost 2% in 2024, sending a message that the economy of 145 million people is robust and able to weather the extra costs of war.

However, this assessment includes military spending – which has soared since the invasion began, particularly after the introduction of conscription for 120,000 civilians last year. The economist Mikhail Mamonov, a sanctions expert based at Princeton and a member of the CEPR, warns against using GDP as a guide to any country directly involved in a war, and especially Russia where the official figures are likely to be massaged. Spending in shops has fallen 10%, he said, showing that the real economy has suffered a dramatic contraction.

What about other parts of the economy?

A CEPR study by the economists Adrian Schmith of the European Central Bank and Hanna Sakhno of the University of Groningen has gone beyond consumer spending to produce a “domestic demand tracker” to measure private sector activity. It draws on 15 separate sources including Google searches, airline ticket purchases and house price data.

The pair concluded that Russia’s recession last year was broader and deeper than the official figures showed once the focus is switched to non-military activity. They said private consumption fell 4% and not the 1.8% in the official numbers, though a definitive assessment stripping out all aspects of military spending was impossible.

Even official measures give a clue to the damage caused to the non-military economy. Russia’s total goods imports in December 2022 were down by about 20% year on year, while technology imports slumped 30%. Last year car production was down 67%, excavation machinery down 53% and television receivers down by 36% with no end to the cut in production likely while sanctions of vital components remain in place.

A dive in retail sales reveals the impact of the war the psychology of the average shopper. A blockade of much-needed and desirable items to buy has also played a part in a fall in spending since last March that is expected to continue this year.

Making matters worse, families fearful of an economic collapse have diverted disposable incomes into savings accounts, leaving Russia with one of the highest deposit savings rates in the developed world at 32%. By contrast the UK savings rate is 9%.

“We don’t know how much money Moscow has left, but it is reasonable to believe there is not much,” says Oleg Itskhoki, a Russian émigré and sanctions expert at the University of California. The payroll bill for recruiting conscripted soldiers and the extra military hardware needed to replace destroyed tanks and spent rockets will have pushed up defence spending from 4.1% of GDP in 2021 towards 7% last year, he adds.

Welfare payments to families who lost loved ones in the conflict add to the bill, while across-the-board benefit payments for those with children have further emptied Russia’s exchequer. The knock-on effect to overall government spending has proved dramatic. In January it jumped 59%, the state statistics office said, and that is likely to be an underestimate.

So is the money running out?

Not only is expenditure up, government income is down and falling fast. Russian workers have low average incomes, pay very little tax, and are few in number relative to the retired population. This dynamic is reflected in World Bank figures for income per head of just $12,200 (£9,875) in 2021 compared with the UK’s $46,510.

The income tax rate on Russian workers is a flat 13%, with a change in 2021 applying a 15% rate for those earning more than 5m roubles a year (£49,000). While this raised an extra 83bn roubles in its first year, such receipts are only a small fraction of those gained from oil and gas sales, which make up the bulk of Russian state revenues.

This reliance paid dividends during the Covid-19 pandemic and last year, when fossil fuel prices were at historic highs. But recent falls are denying Russia the opportunity to replenish funds spent on the war. In January this year, tax revenue from oil and gas plunged 46% from a year earlier, according to the state statistics office.

The combination of higher costs and falling income meant Russia’s public spending deficit hit $25bn (£20.2bn) in January, according to the finance ministry. It means the annual deficit is likely to soar from the current level of 2.5%, while the current account surplus of $250bn at the end of 2022 is at risk of being wiped out by the end of 2023.

What action is Putin taking to bolster his war chest?

Putin has reacted by telling Russian oil companies that he will be taxing them as if they sold their oil at the high price paid for Brent crude, and not the cheaper price paid for Urals crude.

A study by a group of economists, including Elina Ribakova, deputy chief economist at the Institute of International Finance, found that the sale price per barrel achieved by some Russian oil companies was better than the Urals benchmark, but not by much. “The EU embargo on oil products, which took effect on 5 February 2023, will prove to be a powerful additional tool to further curb Russian export and fiscal revenues,” the report said.

Sales of gas are hampered by a lack of gas pipelines heading east and south, forcing the industry to keep much of it in the ground. It is understood that mining companies and fertiliser firms that have made windfall profits from a spike in the world price of commodities over the last two years have paid one-off tax surcharges.

Other measures under consideration include a further rise in income tax, and a tax on savings. Armenia and Turkey are often cited as conduits for Russia funds to bypass the block on using the Swift payments system to move money internationally, but the EU and US are seeking to close down this route.

What about borrowing more money?

Putin wanted the Russian central bank to cut interest rates in February to make it easier for households and businesses to spend using credit and reflate an ailing economy, Bloomberg reported, but he was thwarted. The bank’s governor, Elvira Nabiullina, said a cut in the cost of borrowing would spark an increase in inflation, which is already close to 12%, and the key interest rate was maintained at 7.5% at the central bank’s last meeting last month.

High inflation and high interest rates are likely to stay as more of Russia’s manpower and resources are dedicated to the war effort, denying other parts of the economy the capacity to grow. In response the rouble, which soared last year on the back of bumper oil and gas revenues, has slumped back, adding to the cost of imports. Last week the currency hit lows unseen since April 2022, and on Monday it continued that decline.

Analysts like Mamonov and Itskhoki suggest this combination of falling oil revenues, a sliding rouble, restrictions on borrowing from foreign banks and a fearful Russian public creates a financial shortfall this year that will be difficult to replenish, supporting Deripaska’s prediction that by 2024, the funds to fight the war will already be spent.