The Bell, 7/29/23

The war in Ukraine is woven into the fabric of public life in Russia

Russia’s war in Ukraine is already in its 17th month. In that time, President Vladimir Putin has clearly demonstrated that he is not bothered by losses — whether they be financial, material, or human. His war will go on as long as he needs. And, judging by how the authorities have woven the so-called “special military operation” into Russian life, that will be a long time. The government has cash reserves and policy options (such as tax hikes) that mean the current level of military expenditure can be maintained. Putin has not unveiled a coherent plan for “eternal war,” but the Russian parliament has recently passed many laws that institutionalize the war; making it ever-present in day-to-day life.

Wartime legislation

This week, before it went into holidays, the State Duma greenlighted a whole series of amendments to the law on military service. Most of these were only published hours before they were passed (a tactic deputies typically use when they want to prevent a public outcry). “This law has been written for a major war, for general mobilization,” said Andrei Karatonov, head of the State Duma’s defense committee.

Perhaps the most significant change was an extension of the age at which men can be conscripted for military service. Now, young people aged between 18 and 30 can be called up for military service, not just those aged between 18 and 27 (as it had been since Soviet times). This comes into force next year (legislators said that anyone turning 27 before the New Year will not be affected — however, the law itself does not state this).

In addition, failing to report to a recruitment office or provide up-to-date personal information to the military authorities can now be punished with much higher fines. And there will be tougher penalties for organizations that try to help employees avoid the draft.

Interestingly, these amendments were not unanimously supported by Duma deputies, notices independent journalist Farida Rustamova. Some even voted against — a rare occurrence when it comes to major political initiatives.

This week’s changes follow legislation passed earlier this year that means, as soon as call-up papers are issued (i.e. included in an online call-up register), men will face restrictions on leaving Russia. Being unaware of the call-up does not relieve a conscript of responsibility. Draft dodgers can be hit with limits on acquiring real estate and cars, as well as huge fines.

Other significant laws added to the statute books in recent weeks include those on military companies, which governors can now create in their regions on the president’s behalf (during periods of mobilization and martial law). Rosgvardia, Russia’s National Guard, is obliged to provide arms to these groups, and their soldiers have the right to carry and use them. The Moscow mayor has extra powers and he can make his own arrangements directly with Rosgvardia. This law was a clear response to Wagner’s rebellion.

Deputies have also approved laws allowing the Defense Ministry to make purchases for the armed forces in cash, canceling maximum purchase sizes and requirements about suppliers. In simple terms, the Defense Ministry can now buy almost anything from almost anyone – if the purchase can be justified by the needs of the war.

The war and elections

Electoral legislation has also been altered as a result of the war — and the course of the fighting will be a key part of upcoming campaigns in both regional and local elections. On Sep. 10, there will be governor elections in 21 regions, 16 regional parliament elections and local assembly elections in 12 cities. This is the start of the current electoral cycle culminating in a presidential election expected to be in March next year. According to sources cited by independent media outlet Meduza, the Kremlin’s aim is to deliver a record 80% support for the aging president (in 2018, Putin officially got 78% of the vote).

Between June 2022 and May 2023 Russia’s parliament passed six amendments to the law on electoral rights, according to election monitor Golos. They included banning so-called “foreign agents” from being members of electoral commissions or serving as election observers. Elections can now also be held under martial law (something explicitly prohibited in the Russian constitution).

There is almost no doubt that Putin will be re-elected for another six-year term. The Kremlin is already preparing for the vote and the war will be a major part of Putin’s campaign. According to political expert Tatiana Stanovaya, there will be a big emphasis on the social issues linked to the war like assistance to families and children and support for veterans. At the same time, she predicts patriotic messaging will be less prominent.

War and the economy

The nation’s finances have inevitably been influenced by the war and the upcoming elections. Despite problems at the start of the year, things have improved in recent months. The budget deficit fell from its April peak of 3.4 trillion rubles to 2.6 trillion at the end of June. In addition, economic growth has led to a rise in non-energy taxation revenue and spending fell. Finance Minister Anton Siluanov has promised the annual budget deficit will not exceed 2.5% of GDP, but there is still a high risk that it will increase above its current level.

In 2024, we expect some tweaks to expenditure. But any major cuts seem impossible: not just for political reasons but because state spending – primarily military spending and social handouts — are driving economic growth and rising salaries (you can read more about this here). On a structural level, the war is now an integral part of the country’s economy. Even if the conflict in Ukraine transitions from an active war to a more frozen conflict, Russia’s military spending is extremely unlikely to decline.

Without spending cuts, the government has a range of measures to combat the deficit. First, it can increase taxes. Although this cannot be used right away — the current moratorium on tax rises expires in 2024. It’s unlikely the government will rush to announce tax hikes on the eve of the election, but this could happen immediately after the vote. There is also the possibility of “stealth taxes.” For example, there was a recent proposal to increase duties on alcohol from countries that Russia has deemed “unfriendly.” But the market for wine is not large and demand is elastic, so higher duties would mostly benefit Russian winemakers and importers from Latin America and South Africa.

Borrowing could also plug the deficit. There is liquidity in the market. However, Russian banks, which no longer face foreign competition, are increasingly dictating their own terms. They prefer to shift inflationary risks to the government and buy inflation-linked bonds. In the context of accelerating inflation, this will make servicing debt more expensive.

The Kremlin could also increase withdrawals from the National Welfare Fund. Over the past six months, doing this has helped plug a 507 billion ruble hole in the budget, the Finance Ministry reported.  A further 300 billion rubles went into shares and bonds of state-owned companies. In total, the fund has 6.8 trillion rubles of liquid assets left, specifically gold and yuan. By the end of next year, 2.3 trillion rubles should remain (according to the Finance Ministry). However, the budget deficit could grow much faster than planned and there is likely reluctance to spend every last cent from the fund.

Western sanctions mean the Russian economy is securely insulated from global shocks. If there is no sudden fall in oil prices, or anything similarly catastrophic, there is enough money to maintain current spending for about two years.

Signs of crisis

The Russian economy is set to completely reverse last year’s slump – something Putin has recently highlighted. Manufacturing and construction lead the way, alongside retail. In a broad sense, all three sectors are beneficiaries of the war. The defense sector, working in three shifts, is boosting production: in June, for example, the biggest increases were in finished metal products (+45.8% year-on-year); computers, electronics and optics (+71.6% year-on-year), radar equipment (+75.4% year-on-year) and electrical equipment (+32.1% year-on-year). Production capacities are running at their maximum.

Construction is primarily driven by discounted mortgages: currently, 51% of loans come with state support, up two percentage points since April. Overall, the mortgage portfolio of Russia’s top 20 banks was up 3% in May. In addition, construction continues on occupied Ukrainian territory. “In the first half of the year, 20 apartment blocks were built and more than 2,000 were restored. More than 150 public buildings, plus more than 1,000 residential and community objects. Federal contractors restored 260 kilometers of roads,” Deputy Prime Minister Marat Khusnullin said recently. These projects, along with the construction of massive defensive fortifications on the frontline, even led to a shortage of cement.

Retail growth has been driven by increased salaries and social handouts (some of which are connected to the war). Real incomes are up in regions that are home to military factories and where reports suggest there are large numbers of contract soldiers (for example, Buryatia, the Jewish Autonomous Okrug and Chechnya). Double-digit wage growth masks one of the biggest barriers to economic growth — a shortage of labor. A lack of workers and limits on production capacity lead to what economists call an “overheated economy”: supply cannot match rising demand, and prices increase accordingly. To cool down the economy, the Central Bank may be forced to further increase interest rates.

Why the world should care

The distribution of demand via military expenditure encourages the Kremlin to drag out the war as long as possible. Or to start a cold war in place of the current hot one. All indicators suggest that this is what is happening: economically and legally, the Russian authorities are weaving the war in Ukraine — and more generally the struggle against the West — into the fabric of public life. However, the more the economy binges on military expenditures, the greater the hangover. In political terms, “eternal war” is increasingly becoming a cornerstone of the Kremlin’s narrative. Putin has no other vision to offer.

Deputy Central Bank head Ksenia Yudaeva steps down

Russia’s Central Bank has lost its fourth deputy since the invasion of Ukraine as Ksenia Yudaeva said Friday she was resigning. Along with Central Bank head Elvira Nabiullina, Yudaeva has played a key role in transforming the Central Bank into one of Russia’s most effective institutions and managing the economic fallout from the Ukraine war.

From Aug. 1, Yudaeva will be an adviser to Nabiullina. She will remain a member of the Central Bank’s Executive Board and the Financial Stability Committee.

Yudaeva became deputy head of the Central Bank in 2013 shortly after Nabiullina was appointed chairwoman by Putin. Initially, Yudaeva was responsible for monetary policy and inflation targeting. In recent years, she has overseen financial stability and analytics.

A prominent economist who received her Phd from MIT in the United States, Yudaeva was widely seen as a technocrat with liberal views. However, like her boss Nabiullina, she remained in post following Russia’s invasion of Ukraine. Prior to joining the Central Bank, Yudaeva was in charge of state-owned Sberbank’s macroeconomic research center. She was sanctioned by the U.S. last year for her affiliation with bailed-out lender Otkritie Bank.

Key figures

Between July 18 and July 24, inflation accelerated from 0.18% to 0.23%. Year-on-year inflation reached 4.19%. This increase is primarily a knock-on effect of the exchange rate on prices. Last week, the Central Bank increased interest rates by a percentage point to 8.5%.

The IMF updated its forecast for the world economy. Expectations of GDP growth in Russia in 2023 were upgraded from 0.7% to 1.5%. The prediction for 2024 is unchanged at 1.3%.