Trump provides support to the Russian economy following three years of conflict

Russia’s economy, which is currently experiencing overheating, is on the verge of a significant downturn due to substantial fiscal stimulus, rising interest rates, persistently high inflation, and the impact of Western sanctions. However, after three years of conflict, Washington may have inadvertently provided Moscow with a potential opportunity for relief.

U.S. President Donald Trump is advocating for a swift resolution to the war in Ukraine, which has raised concerns among European allies as he has excluded them and Ukraine from preliminary discussions with Russia, attributing blame for the 2022 invasion to Ukraine. This approach could yield political advantages for Moscow, along with considerable economic gains.

According to Oleg Vyugin, a former deputy chairman of Russia’s central bank, Moscow is confronted with two unfavorable choices. Russia can either curtail its military expenditures while attempting to expand its territory in Ukraine or continue its current spending levels, which would result in prolonged slow growth, elevated inflation, and declining living standards, all of which pose political challenges.

While government spending typically promotes growth, the excessive allocation of funds towards military resources at the expense of civilian needs has led to overheating, with interest rates at 21% hindering corporate investment and inflation remaining unmanageable.

Vyugin stated, “For economic reasons, Russia is interested in negotiating a diplomatic end to the conflict. This will prevent further misallocation of limited resources for unproductive purposes and is the only way to avert stagflation.” Although a rapid reduction in defense spending is unlikely—given that it constitutes approximately one-third of the national budget—the possibility of a diplomatic agreement could alleviate some economic strains, potentially lead to sanctions relief, and facilitate the return of Western businesses.

Alexander Kolyandr, a researcher at the Center for European Policy Analysis (CEPA), noted that Russia would be hesitant to abruptly halt arms production, fearing a recession and the need to rebuild its military capabilities.

Allowing some soldiers to return could alleviate some of the pressure on the labor market.

The ongoing recruitment efforts and emigration linked to the war have led to significant labor shortages, resulting in a record low unemployment rate of 2.3% in Russia. Kolyandr noted that inflationary pressures might also diminish, as improved prospects for peace could reduce the likelihood of Washington imposing secondary sanctions on companies from nations such as China, thereby simplifying and reducing the cost of imports.

NATURAL SLOWDOWN

Russian markets have already experienced an uptick, with the rouble reaching a near six-month high against the dollar on Friday, driven by expectations of sanctions relief. Following a slight contraction in 2022, Russia’s economy has rebounded robustly, but authorities anticipate that the projected growth of 4.1% for 2024 will decelerate to approximately 1-2% this year, and the central bank has yet to identify sustainable conditions for a rate cut.

During the decision to maintain rates at 21% on February 14, Central Bank Governor Elvira Nabiullina indicated that demand growth has consistently outpaced production capacity, leading to a natural deceleration in growth.

The central bank faces the challenge of balancing economic growth with inflation reduction, a task made more complex by significant fiscal stimulus. Russia’s fiscal deficit surged to 1.7 trillion roubles ($19.21 billion) in January alone, marking a 14-fold increase compared to the previous year as Moscow accelerates spending plans for 2025. “It is crucial for us that the budget deficit remains aligned with the government’s current plans,” Nabiullina stated.

The finance ministry anticipates a total deficit of 1.2 trillion roubles for 2025 and revised its budget plans three times last year.

CARROT & STICK

The ongoing conflict has created economic benefits for some Russians while causing hardship for others. Workers in military-related sectors have seen significant wage increases due to fiscal stimulus, whereas those in civilian industries are grappling with skyrocketing prices for essential goods. Certain businesses have capitalized on the substantial changes in trade dynamics and diminished competition.

For instance, Melon Fashion Group has experienced consistent revenue growth by tapping into rising consumer demand. The company reported to Reuters that its brand portfolio has notably expanded over the past two years, and since 2023, the average size of its new stores has doubled.

However, many others face significant challenges due to high interest rates. “With current lending rates, it is challenging for developments to initiate new projects,” stated Elena Bondarchuk, founder of warehouse developer Orientir. “The previously broad pool of investors has shrunk, and those that remain are increasingly reliant on the terms set by banks.”

Economic risks confronting Russia include declining oil prices, budget limitations, and an increase in problematic corporate debt, according to internal documents reviewed by Reuters. Meanwhile, Trump has offered potential concessions regarding Ukraine but has also warned of further sanctions if an agreement is not reached.

Chris Weafer, CEO of Macro-Advisory Ltd, stated to Reuters, “The United States holds considerable economic leverage, which is why the Russians are willing to engage in discussions. The U.S. is essentially communicating: ‘We can reduce sanctions if you comply, but if you fail to do so, we can escalate the situation significantly.'”