The war in Ukraine is taking a toll on the Russian economy. Military investments no longer generate growth but instead fuel inflation, and it is becoming increasingly difficult for the government to balance the budget. However, the challenges are not yet unmanageable, according to Emil Wannheden, analyst at FOI.

After three years of war in Ukraine, it is clear that the Russian economy can no longer convert the stimulus from the government’s substantial investments in the military and the rest of the economy into growth. So argues Emil Wannheden, analyst at FOI’s Russia and Eurasia Programme.

“The economy is overheated. This means that even if the government spends more money, it does not lead to growth, only inflation. The economy has reached a limit in terms of what it can produce, which is due to constraints in labour, technology, and so on,” says Emil Wannheden.

He has reviewed economic statistics from 2021 onward, using original Russian sources. Russian authorities collect statistics on matters such as production, growth, and unemployment in the same way as in Sweden.

Ambiguous Risks

However, it is difficult to determine how reliable Russian statistics actually are. Emil Wannheden has searched for contradictions and consistency across the various sources and has concluded that, overall, the figures are reliable—even if they should be taken with a pinch of salt.

He has also reviewed analyses by Russian think tanks and by the Russian central bank, which rely on these statistics to produce their own assessments.

“I have also read what other analysts and experts, both inside and outside Russia, have concluded about the Russian economy. Based on that, I have made an overall assessment,” says Emil Wannheden.

One of his conclusions is that the economy is overheated. The other is that it is becoming increasingly difficult for the Russian government to balance the budget.

“Last year, for the first time, the government was forced to raise taxes and cut welfare spending in order to afford continuing the war in Ukraine.”

According to Emil Wannheden, the Russian leadership’s communication about the economic situation is generally positive, though not excessively sugar-coated. Low unemployment and the partnership with China are highlighted, while problems such as inflation are not entirely concealed.

“And the blame is placed on the West, which actually is partly true, since the sanctions and the West’s economic warfare are creating problems,” says Emil Wannheden.

Emil Wannheden argues that the challenges facing the Russian economy are largely linked to various risks that are, in themselves, difficult to assess. Negative developments may occur, but it is hard to determine whether they will happen in the near term—or at all.

“This is a level of uncertainty that the Russian government must account for. The main risk concerns balancing the state budget—securing enough revenue to finance it. Without sufficient income, the government will essentially have to print more money, which contributes to inflation.”

Russia’s economy has become increasingly militarised as a result of the war in Ukraine. The defence industry has taken on a central role, and a significant part of the economy now depends on the state continuing to place orders for defence materiel.

Russian companies are generally heavily indebted at high interest rates, and there is a risk that many will go bankrupt.

“It is very expensive for companies to finance their loans. If they go bankrupt, there is a risk that this will affect the banks. If the banks have difficulty recovering their loans, that will cause problems for them,” says Emil Wannheden.

Possible Solution: Increased Repression

Capacity constraints present another challenge. Shortages of everything from labour and technology to expertise and industrial inputs are limiting how much the economy can grow.

According to Emil Wannheden, it is difficult for analysts or researchers to communicate about the challenges facing the Russian economy, because it is important not to overestimate or underestimate them. Even though the challenges are numerous and substantial, he believes that the Russian leadership will manage to handle them in one way or another.

“It may require more repression or higher taxes—measures that would have a negative impact on the population or businesses in Russia. Naturally, the leadership would have preferred to avoid that. But if necessary, they will do it,” says Emil Wannheden.

He believes that this could probably continue for a longer period—though not indefinitely.

“If we are heading towards a development increasingly based on repression, where some kind of stability exists despite economic decline, the Russian leadership may settle for that. But it does want Russia to be economically strong as well—there is an ambition to be a great power.”

According to Emil Wannheden, this is Russia’s principal economic dilemma: the more money it spends on the war in Ukraine now, the weaker it is likely to be in the future.

In his view, the difficulties are not so severe that Russia will be forced to scale back its efforts in Ukraine in the near term. Getting the West to ease sanctions is important for Russia, as that would reduce many of its economic problems.

“But it is not so important to them that they are currently prepared to give up their goal of controlling Ukraine.”