Putin's economy on the brink: central bank fights rising inflation

Last year, the head of the Russian Central Bank, Elvira Nabiullina, raised the interest rate to 16%, hoping that a strict monetary policy would curb inflation. This did not succeed, as inflation continued to rise. Currently, the head of the CB admits that on 26 July, an interest rate increase to 17% or 18% is likely, said Milov, the pro-democracy opposition Russian economist and former Deputy Minister of Energy (in 2002).

- War, isolation, sanctions, reorientation towards China, and a massive labour shortage are strong pro-inflationary factors, assessed Milov. As he explained, huge amounts of money that go into the Russian defence industry are driving inflationary pressure, but not the economy.

The money put into the defence industry doesn't translate into economic growth because it doesn't generate added value or stimulate new production chains - observed the expert.

As he argued, the Russian model is an economy heated, or even overheated, by state money, but it really doesn't develop.

According to official data, inflation on 1 July stood at 9.13% year over year (yoy). Milov pointed out that a much more realistic picture can be obtained by looking at the research of the Romir Centre, which presents the FMCG (Fast-Moving Consumer Goods) price index, i.e., everyday goods. Annually, they were supposed to have become 34% more expensive in May. Meanwhile, the Kremlin's original goal was 4% inflation by the end of this year.

A high interest rate and strict policy did not help reduce inflation. At the same time, a high interest rate maximally limits the possibility of financing economic development. This is evident from the data. In investments, the share of loans is only 10% because they are simply unavailable for businesses—explained Milov.

The expert notes that Russian authorities boast about wage growth, but no wage increase can outstrip such inflation.

Additionally, because the war needs to be funded, taxes are rising, which will also harm investments and reduce production - he stated.

This is compounded by the lack of trust in the courts, institutions, and the protection of property rights.

The Russian authorities refer to GDP growth figures, but according to Milov, "this means absolutely nothing" because GDP growth itself, detached from other indicators, does not reflect the state of the economy.

- In the USSR, GDP grew until the very end until the country collapsed. There was nothing in the stores anymore, but GDP was growing. Why is it growing now? The authorities took money from reserves and put it into the defence complex. The military part of the economy, yes, shows rapid growth, but precisely because of this money. Everything else - either doesn't grow at all or is shrinking. Overall, it comes to 3% growth. However, it must be remembered that the wartime economy means 5-7 million people, less than 10% of the workforce. Military spending constitutes 6-7% of GDP, but there is still the remaining 93-94%, which is everything else - counted Milov.

As he noted, "in conditions of overall stagnation, this 'military supplement' can create the impression that the economy is growing." - The problem with it is that it depends solely on the money in the budget, and that is running out. This is a short-term model - assessed the economist.

GDP growth is not the only optimistic indicator that proponents of Putin's prosperity like to refer to. The World Bank recently categorised Russia as a country with high-income. For the past four years, Russia has been the fourth-largest economy regarding purchasing power parity, according to the World Bank.

- Why did no one notice this? - This question was asked by Andrei Makarov, the chairman of the Duma (State) Budget and Taxes Commission, during the International Economic Forum in St. Petersburg. - Because it does not affect anything - he answered himself and noted that such indicators as GDP growth are important, but we need to talk not about them, but "about the real level of prosperity."

Makarov is one of the Russian authorities' most "honest" representatives, although not the only one. The Russian economy was ironically described as a "closed-loop economy."

- First, we give money to produce goods, and then we give money to the state to buy them. Then we pay to build a warehouse to store the goods because no one needs them. Then there is the fourth stage: we give money to dispose of them - said Makarov in St. Petersburg.

According to him, the remedy could be private investments, but these require investor trust.

- The liquid reserves of the National Welfare Fund (NWF), i.e., real money managed by the finance ministry, have almost halved since the aggression in Ukraine, while the budget deficit is constantly being raised (and it is financed from these funds). They have now adopted amendments to the budget, the deficit is to increase to over £21 billion, which is at least 40% of the money left in the Fund - calculated Milov.

The Russian NWF, accumulated during the fat years of Putin's rule thanks to prudent economists, is, as economists explain, gradually being lost in supporting the economy. This well has a bottom. Meanwhile, according to Milov, further increases in the military budget are necessary.

- Military expenditures must be increased, it's already visible. The money for personnel and army equipment needs to be significantly increased. Recently, even the retired Russian General Sergei Stepashin, the former prime minister and head of the FSB, publicly stated that Russian soldiers are begging. Raises for the military are also needed - counted Milov.

- With the current inflation, military salaries need to be indexed. Moreover, nobody wants to join the army. This is also very evident in the numbers. Two years ago, the authorities offered a one-time payment of £2,100 for signing a contract. This amount has long exceeded £10,600, and in some regions, it has reached £17,000! - emphasised the expert.

Officially, the authorities claim to recruit 30,000 new "volunteers" per month. In Milov's opinion, "the same principles apply here as everywhere else - the price rises when the supply is low." - And this means that the authorities are having huge problems recruiting people for the war - he added.

In his opinion, "in this situation, Putin is not coincidentally talking about peace talks." - Because he sees the moment when the money runs out - concluded Milov.

- Those experts who write that everything is fine in the Russian economy are simply participating in Putin's information war on Putin's side - concluded Milov, according to whom many media in the West fall under the spell of propaganda and the temptation of easy and catchy bad news. - Everything is bad, sanctions do not work, Putin is doing great, etc. Bad news sells better - he said.

- The real picture is that this economy is collapsing. Maybe not as quickly as the countries imposing sanctions would like, but it is happening - he added.

- The wartime economy is temporary and possible as long as there is money. Central Bank head Nabiullina has bet a lot because everyone except her is against the strict monetary policy. Everyone wants it loosened and may want cheap money. Lobbyists, the military, the defence industry, and businesses are all pushing for a lower interest rate - declared Milov.

Sergey Chemezov, head of the leading Russian defence giant Rostec, said in a May interview for RBK that the Russian defence industry operates with critically low profitability (2.28%), which is "absolutely insufficient for development", and Rostec enterprises act "in survival mode." With the current interest rate, defence companies cannot afford to take loans unless they receive state subsidies. Besides, about 25% of transactions are carried out through barter.

- For Elvira Nabiullina (the governor of the Central Bank), admitting that inflation couldn't be reduced is political suicide. On the other hand - following the advice of money-printing advocates would turn Russia into another Argentina with hyperinflation, declining purchasing power, and an impoverishing society - said Milov.

In his view, monetary juggling alone will not save the Russian economy. - Inflation can only be defeated by changing the economic model, returning to normality, and reconciling with the West, but Nabiullina cannot say that - assessed Milov.