Russia's wartime economy teeters on brink of collapse

At first glance, the Russian economy appears surprisingly resilient to Western sanctions. In 2023, the gross domestic product grew by 3.6%, with a projected growth of 3.9% for 2024. Unemployment decreased from 4.4% before the war to just 2.4% by September 2024. Moscow has notably expanded its armed forces and defence production, adding over 500,000 workers to the defence industry and approximately 180,000 to the armed forces.

Despite impressive statistics, the reality is less optimistic. 1,000 days of war have been costly for the Moscow regime. The question of the Kremlin's future capabilities is particularly pertinent amidst escalating conflict. This was ignited by reports of Ukraine being permitted to attack deep into Russia using ATAMCS missiles. Vladimir Putin responded to these reports with threats of nuclear warfare.

Simultaneously, Russia is unable to manufacture sufficient weapons to replace those lost on the battlefield. About half of all artillery shells used by Russia in Ukraine originate from North Korean supplies. According to analysts from "The Economist," by the second half of 2025, the country is expected to face severe shortages in several categories of weapons.

The issue of producing barrels for large-calibre guns is particularly critical. Based on video documentation, it has been determined that the Russian army loses an average of over 100 tanks and about 220 artillery guns monthly. The production of barrels requires special rotary forges, each weighing 20 to 30 tonnes and capable of producing only about 10 barrels per month. Russia possesses only two such forges.

In October, Russia's central bank raised interest rates to 21%, the highest level in two decades, and market analysts predict they could increase to 23% by the year's end. This is unusual during wartime when central banks typically avoid stifling economic activity. Defence spending has officially risen to 7% of GDP and is expected to consume over 41% of the state budget next year.

According to The Economist, the true scale of military expenditure is considerably higher. Nearly 560,000 soldiers in the internal security forces, many of whom have been deployed in occupied Ukraine, are financed outside the defence budget. The same applies to private military companies established across Russia.

China has become Russia's most important trading partner, supplying a third of all imported goods and over 90% of microelectronics, used in drones, missiles and tanks. However, this support is not provided for free. Russian officials must closely monitor the value of their currency against the yuan. This year, the rouble has lost 10% of its value, nearing its lowest level since the start of the war.

Until recently, the Russian government managed to mitigate the impact of high credit costs on the economy. Various programmes allowed households to suspend debt repayments and companies to take out loans at lower, subsidised interest rates. The state compensated banks for lost revenue. However, there are signs that such programmes are becoming too costly.

The mortgage subsidy programme, which allowed borrowing at a cost of just 8% when official rates were significantly higher, ended on 1 July. In the following month, the volume of mortgage loans halved. Corporate bankruptcies have increased by 20% this year. The Russian Union of Industrialists and Entrepreneurs estimates that investment plans for next year are being put on hold due to high borrowing costs.

According to "The Economist", the Kremlin authorities face difficult choices because Russia will not be able to continue the war at its current level after 2025. By then, it is expected to start experiencing shortages of key weapons systems. However, reaching a peace agreement presents a different set of challenges. Analysts at the British newspaper observe that reducing the size of its armed forces and defence industry could trigger a recession that might threaten the regime.

In their view, if Russian policymakers maintain high defence spending and an inflated army during peacetime, it will lead to the suffocation of the Russian economy, displacing the civilian industry and stifling growth. Given the Soviet Union's collapse due to similar economic reasons, Russian leaders will likely wish to avoid this scenario.

However, there is a third option that might seem appealing to Russian leaders. Instead of opting for demobilisation or bankruptcy, they could use their army to acquire the economic resources needed to sustain it. "The Economist" claims that conquest and the threat of its use could be employed to fund the military.

Significant gas deposits have been discovered in the internationally recognised exclusive economic zones of Ukraine and Georgia in the Black Sea. When Western countries are preoccupied with other priorities, Russia might resume aggression against Ukraine to seize control of its agricultural resources, gas, and rare earth elements. Moscow could also use threats of force to coerce European nations into lifting sanctions, unblocking Russian assets or reopening gas and oil pipelines.

Higher interest rates will restrict spending by both businesses and consumers. The World Bank anticipates Russia's economic growth will slow sharply to 1.3% next year. Even the state development bank VEB has lowered its growth forecast to 2%. The combination of reduced investments and a workforce lost on the front is taking its toll.

The need to maintain the rouble's value to pay for crucial imports poses a significant problem for Vladimir Putin. This might soon impair his ability to continue the war. The Russian leader may hope that Donald Trump will keep his promise to end the conflict. Waging war with interest rates at 3% is one thing, but doing so at rates of 21% is entirely different, "The Economist" assesses.