The Russian economy is not in a state of collapse. Not yet, at least. GDP still grows. The wages have increased.
Western sanctions did not deliver the devastating blow that many expected. Appearances can be deceptive.
Structures that hold this war economy are becoming increasingly fragile, and there is mounting evidence that Vladimir Putin may be reaching a point he can no longer ignore.
In the last few weeks, seven key events have shown a system that is in motion but also under pressure.
Putin’s model of wartime has allowed Russia to function through money, firepower and narrative control.
It’s getting to the point that he might have to decide between funding the war or maintaining internal peace.
This choice could define more the future of this conflict than any victory on the battlefield.
Transfers, not productivity, is the basis of a war economy that relies on transfer payments
Massive spending is used to create the illusion of strength. The state’s budget is now devoted to defense at a rate of approximately 40%.
According to other studies, the military spending of this country is close to 7 percent of GDP. This represents a 40-percent increase from year to year.
Reports claim that Russian soldiers receive bonuses of up to 1,5 million rubles and their family members get “coffin-money” payments between 12-15 million rubles in the event they die.
The transfers fueled booms locally in regions such as Tuva, Buryatia and Dagestan where deposits rose 151%, 81% respectively.
Defense industry factories are open 24 hours per day. Many former civil firms have been forced to convert into military production.
Now, drones are assembled in bread factories. Shipyards now make stoves. This reindustrialization has benefited some.
Severstal, the Russian steel giant, has negative cash flow of 33 billion rubles despite being profitable one year ago.
The Kremlin has been aggressively supporting this system. The cost of this system is high.
The oil and gas revenue is down partly because of the falling prices in global markets and due to a stronger Russian ruble. However, inflation continues to be above 10%.
High interest rates (21%), imposed by the government to control inflation, are hampering private sector investments.
The banking system is in trouble
The financial stability of the model is also being examined.
The Kremlin-linked Center for Macroeconomic Analysis and Short-Term Forecasting, or CMASF (Centre for Macroeconomic Analysis and Short-Term Forecasting), warned in late May of an impending “systemic bank crisis”.
The report outlined three possible triggers, including a run on the banks, bad debts exceeding 10% or requiring a recapitalization of more than 2% GDP. All three triggers are now closer to happening than ever before.
The liquidity is decreasing. Money supply to monetary base has risen, suggesting banks are heavily leveraged.
The MOEX index volatility has risen, indicating investor anxiety.
Due to declining profits and increasing borrowing costs, major corporations such as Gazprom and Norilsk Nickel have cancelled dividend payments.
Rosstat has reported that corporate earnings will decline by 6.9% in 2024 or 15% if inflation is adjusted.
The Bank of Russia’s policy rate of 21%, initially intended to contain inflation is now stifling the lending process, delaying project completion and slowing growth in areas outside of war economies.
Diplomacy is frozen, and this is part of the plan
Diplomatic paralysis is parallel to economic tension. The two rounds of talks held in Istanbul between Russia and Ukraine ended without much progress.
The latest Russian demands are near total: Ukraine has to withdraw from all the occupied areas, give up NATO, reduce its military and lift martial law within 100 days.
No reparations or sanctions should be requested.
Ukraine rejected the term, calling it political fiction. Western officials agree in private.
After Russia’s latest strikes against Ukrainian cities, even US President Donald Trump – who has staked his foreign policy for the second term on ending this war – called Putin, “absolutely MAD”.
Senator Richard Blumenthal warned that the Kremlin is “playing America as fools” by “mocking Russia’s peace efforts”.
But Russia’s refusal of compromise is calculated. Dmitry Medvedev is now an important security official and he says that the goal of Moscow is not peace. It’s victory.
Diplomacy is now a new front of the conflict, with the aim to wear down Ukraine’s partners, pressurize US mediators and delay progress on battlefields.
Russia is playing with fire
Under the Russian people’s silence, there is a state-led surveillance system. The Kremlin presidential administration is the largest user of data on polling in Russia.
The “coordination centre” of Prime Minister Mishustin tracks unhappiness in real-time, using AI, data from social media, and reports on regional issues to create “satisfaction map” updates daily.
It isn’t paranoia. This is survival instinct. Putin has seen two regimes fall around him, and he knows even the most authoritarian of systems can collapse quickly when public opinion changes.
The illusion of stability cannot be achieved by force alone, but also through the provision of income and service.
It is for this reason that he refused to continue mobilizing, in spite of military pressure. This is also the reason why government has continued to spend on consumer protection and mortgage subsides until very recently.
Most of these programs have been reduced. The majority of subsidies have been eliminated. The growth is slowing. The wages of new employees have stagnated. It is getting harder and harder to make the internal choice between stability in America and wars abroad.
Which breaks first, the social contract or the war machine?
It’s not just a story about survival. The story is one of excessive compression. All settings have been tightened up to their maximum. Finances, politics, military.
The real incomes remain higher today than they were before World War II, but are now slowing down. Interest rates and inflation are still high. This is stifling real investment.
It is not possible for the Kremlin to continue writing checks in large amounts of money every year, both to regional governments and soldiers’ families.
Ukraine has not been defeated on the battlefield. The long-range attacks by Ukraine on strategic Russian aircraft in Siberia, the Arctic and Siberia show that it can attack beyond the front line.
The small victories show a technical and resilient depth which complicates Russia’s path towards escalation.
Putin does not face collapse. Putin faces choices. Continue to spend on war, and you risk an economic crash. Reduce spending to avoid public discontent. Try another mobilization at the risk of losing his grip on power.
Russia will fight as long as necessary. External powers are the only ones who can bring about peace.
How long can Russia afford the costs of Putin’s war-economy gamble? This post may change as new information is revealed.
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