From Newsweek:
[Craig] Kennedy said Russia has followed a two-track strategy to fund its war via its defense budget expenditures as well as an off-budget plan of similar size enabled by a law enacted on February 25, 2022, which compels Russian banks to give preferential loans to military-related businesses.
In that period, Russia has faced a 71 percent expansion in corporate debt worth $415 billion or 19.4 percent of GDP—higher than oil and gas revenues and defense budget expenditures, Kennedy said in his Navigating Russia newsletter.
That means Russia’s total war costs “far exceed” what official budget expenditures would suggest.
This off-budget defense funding was harder to sustain during the second half of 2024, spiking inflation and pushing up interest rates for “real” economy borrowers to above 21 percent, “creating the preconditions for a systemic credit crisis,” Kennedy said.
He said preferential bank loans worth up to $250 billion had been given to defense contractors, many of which had poor credit.
I’m looking to see how December inflation plays out (release tomorrow). TradingEconomics forecast is 9.5% annualized (compared to November 8.9%, even if we can’t have too much confidence that the number is accurate (see discussion of Romir estimate vs. reported, here).
Every once in a while, I like to leave finance out in order to think only about real-side activity. Finance has real-side consequences and risks, don’t get me wrong. But real-side activity has to make sense, apart from finance. So, Russia…
Running a wartime economy means diverting resources from civilian consumption and investment. Unemployment is low, but household consumption is also low because productive resources are going into killing people, not feeding them.
Not all of the resources diverted to Russia’s war come from Russia. North Korea is churning out a large part of the dumb artillery shells Russia is using. Iran is cranking out drones for Russia in large numbers. That doesn’t mean Russia isn’t gearing up to produce more munitions, but rather that new bomb factories take time to build. New bomb factories won’t do much for civilian welfare, now or in the future.
Russia’s exports of oil help to pay for munitions imports, but Russia also exports lots of armaments, and those exports are way down. Oil exports, meanwhile, aren’t paying what they once did.
Typically, the end of war on somebody else’s territory leads to a brief falling away from the production possibility frontier (recession) followed by a big rebound as freed-up resources return to civilian production. In Russia, the labor force has lost a good many prime-age workers and investment outside the arms and energy sectors is weak. The post-war economy may not have the real resources needed to rebound strongly.
That, I think, is the real-side context for a banking sector that is burdened with debt not of its choosing, for high inflation and for rising overseas obligations. Problems of inflation, domestic consumption and a weak trade balance would all be easier to remedy with strong growth, but strong growth seems unlikely.
Banks will have a particular problem with force-fed debt as long as inflation erodes the value of that debt. Russia can expect little World Bank or IMF assistance in the immediate aftermath of pissing off the democratic world. Private credit from the democratic world will also be scarce. India will continue to accept Russia oil as long as there’s a substantial discount, as will China. India is not, however, big in the business of granting foreign assistance. Over the past quarter century, India has granted about $48 billion in non-emergency aid – only about $2 billion per year – mostly to Nepal, Afganistan, Burma and Bhutan. China is big into aid, but mostly as a cover for Chinese commercial advantage. I’m eager to see how much of Russia’s post-war investment need will be financed from China. China is also not big on outward tech transfers, and most of Russia’s other wartime trading partners aren’t engines of productivity gain.
This looks to me like a formula for heavy government intervention, just to avoid crisis. Banks will have to be propped up. Credit won’t flow strongly on a purely commercial basis, so there’ll be an increase in directed credit. Foreign banks will be reluctant to do business with Russian banks, and will require strong assurances of being paid. Restrictions on international credit will compound the problems of trade imbalance. Productivity growth may look good during the transition to a peacetime economy (assuming Russia doesn’t start a other war) but inflation, a high debt burden, weak trade and under-investmeent are likely to mean weak productivity growth. Russia has among the lowest fertility rates in the world and an aging population. Immigration won’t fix Russia’s demographics under current management.
Happy to hear a contrary story, one which paints a happier picture of Russia’s future. Well, as long as it doesn’t rely on “controlled burns” or misinformation about rainfall.