Over the past week, the ruble fell to its lowest exchange rate against the U.S. dollar since March 2022, when Russia began its full scale invasion of Ukraine. Inflation has been a persistent problem for Russia since the beginning of the war, due to increased government spending resulting in a rise in demand for goods throughout the market. It is projected to increase to 13.5% next year, exceeding the central bank’s target by more than threefold. However, the impact of the ruble’s depreciation on the military effort is likely to be insignificant. The Russian war machine is resilient and has, in many ways, embedded itself into the structure of the economy.
If anything, it will pose a significant economic challenge when the war ends. The same high spending that caused inflation also supercharged the Russian economy. Indeed, this depreciation may actually help the state to balance its budget and raise the revenue it needs.
Parallel Imports
Since 2014, as the West imposed sanctions on Russia for its annexation of Crimea, Moscow has struggled to develop domestic production, particularly in technology. Facilities and manufacturing often require high-tech products like microchips that must be imported from the West, a dependency worsened by the 2022 sanctions. However, Russia managed to find a workaround in parallel importation, circumventing trade restrictions through third parties. This has allowed Russia to continue its access to these goods, many of which are necessary for military technology. This has weakened the leverage of Western sanctions.
China has emerged as a key player in Russia’s parallel import network, now responsible for 25 per cent of Russian imports. In 2023, Russia imported billions of dollars worth of Western-made chips via China and Turkey. The Caucasus and Central Asia (CCA) have also acted as a rerouting point for Russian imports. Both the United States and the European Union saw exports of sanctioned goods to CCA rise by billions of dollars; particularly in categories such as track-laying tractors, computers, and data processing machines, where exports have risen by over 100 per cent. These channels have ensured that sanctions do not threaten Russia’s ability to supply its military and continue enjoying a great material advantage over the Ukrainian forces.
However, if the country continues to rely too heavily on imports to sustain its war effort, one might expect a budgetary shortfall and high vulnerability to currency shocks or depreciation. Of course, losing access to the European market has significantly lowered oil and gas revenues, despite increased sales to the East.
Ironically, the war itself has in part helped Russia to overcome these obstacles. The year on year growth of non-oil and gas revenues in 2023 was 19.2 per cent to 19.4 trillion rubles (~$190 billion), nearly totally offsetting the drop in oil revenue, 20.2 percent. This contributed to an overall increase of more than two per cent in government revenue. This accomplishment is a product of what has been called “Military Keynesianism,” achieving economic stimulation through high defense spending. While it is risky and prone to inflation, it has helped the Kremlin to maintain ‘business as usual’ in much of Russia and to fund its war without a massive budget deficit.
Russia’s labor and production forces are operating near their maximum capacities, with consumer demand also running high. GDP growth has been above three and a half per cent the past two years, outpacing the United States. Revenues are expected to increase by 12 per cent in 2025. Sure, the government has raised taxes and cut many of its non-defense related programs, but so long as it can manage public discontent, Putin can afford to keep fighting.
Inflation and Ruble Depreciation
Elevated government spending, coupled with Russia’s economy operating at near-full productive capacity, has created the ideal conditions for sustained inflation. As a result, the state has been unable to effectively address inflation, which has consistently remained well above target levels. However, whether this poses a significant issue remains a subject of debate. The problem has not yet come home to roost. We might expect a struggle from Russian consumers, but this is not the case. The labor shortage has driven wages up, with real incomes rising five and eight tenths per cent in 2023, and have grown even faster this year. Some microeconomic indicators, such as a growing mortgage demand and the booming gambling market, suggest that many Russians have more disposable income, defying the anticipated struggle.
The most immediate consequence is the sky high interest rates, now at a two decade high of 21 per cent, implemented as a countermeasure. This has made government borrowing exorbitantly expensive. At the same time, while the government is operating at a deficit, that will be just 0.5 per cent of GDP in 2025, compared to 1.1 per cent this year. Even with the high costs, Russia can afford the debt, partially by continuing to tap its National Wealth Fund, which still contains hundreds of billions of dollars. Depreciation also raises revenue from oil and gas sales, as well as other exports, making it easier for the state to shoulder a high budget. This has been complimented by rising oil and gas demand worldwide.
Nevertheless, the ruble’s continuing depreciation is not without hindrances for Russia. With trade dependence on China being higher than ever, the strength of the yuan against the weak ruble is very taxing. Cuts to social programs and public services demonstrate that the war has and continues to demand huge amounts of resources. Moreover, Russia’s economy is more “overheated” than at any point since before 2008, characterized by exceptionally low unemployment and demand outstripping supply due to persistently high government spending. However, these issues are unlikely to become critical in the near future. Russia’s budget has stayed relatively balanced and its economy has kept growing despite sanctions and the costs of war. The dollar has topped 100 rubles per dollar, a historic high, but as we have seen, this is a double edged sword.
Russia has thus far endured the war’s numerous attritional pressures. Without substantial changes in Western policy or increased support for Ukraine, the economic and military status quo is likely to persist. Russia’s economy is robust and the internal condition has been resilient, despite the hopes of Western leaders that two years of sanctions and stalemate would provoke a crisis. Without major intervention, there seems to be no end in sight; it is likely Russia could continue to fight for multiple years to come.
Edited by Samrawit Terrefe
The opinions expressed in this article are solely those of the author and they do not reflect the position of the McGill Journal of Political Science or the Political Science Students’ Association.
Featured image by Petar Milošević
