Unrelenting energy-market pressures, driven by sky-high diesel prices, are creating a perfect storm for the global economy as bond yields rise worldwide. The Federal Reserve, European Central Bank, and Bank of Japan are raising rates amid a worsening energy shock—a combination that has historically elevated the risk of recession. Russian policymakers will not escape the fallout.
According to Kirill Tremasov, one of Elvira Nabiullina’s advisers, the economy remains within the Bank of Russia’s base-case parameters despite ongoing external shocks. The central bank is targeting a decline in interest rates from 14% to 10.5−12.5% in 2027. Putin has stated that the government expects 1% GDP growth this year. Unsurprisingly, higher energy prices are not translating into meaningful growth.
A strengthening ruble tends to reduce inflation by making imports cheaper, but it also increases the real-terms cost of domestic production relative to imports, creating problems for the GDP outlook. Cheaper imports benefit military producers far more than consumer-oriented industries, which previously benefited from capital controls, a weaker ruble, and the sheer volume of money pumped into the economy.
Nor can the Ministry of Finance easily set aside oil revenues to manage the exchange rate. Oil-tax receipts were still down 16% year on year in August. Ukrainian strikes on refineries are forcing officials to subsidize fuel prices to prevent even larger cost increases, while the deficit is apparently being held at 2% of GDP. Assuming that figure holds, it can only be explained by deeper cuts to social services outside pensions and social transfers. Such cuts are evidenced by the nationwide loss of almost 20,000 healthcare and social-care providers in the first half of the year as a result of budget reductions.
Without some form of short-term fiscal stimulus, a stronger ruble will create as many problems as it solves. The collapse in investment is the biggest reason the economy is on the precipice of a sharp decline. Investment creates wages and demand for goods and services, which in turn generate profits for businesses meeting demand linked to other companies’ investment. Because a strong ruble makes domestic production more expensive and consumers still face high interest rates, it does little to create a growth tailwind.
Consumer spending from June through August was 4% lower than in the second quarter. Wage growth has slowed to a crawl, accompanied by increasing quality substitution among consumers seeking to save money—consider how popular turkey has become—and the lowest recorded levels of alcohol consumption since 1996. Any signs of stability in larger-ticket purchases, such as cars, reflect the continuing conveyor belt of recruitment bonuses.
Higher oil prices arguably conceal the extent of the problem by offsetting some of the losses caused by falling investment, but they cannot hide how badly conditions are deteriorating. Commercial real-estate investment is down 25% year on year, while investment in light industries selling to consumers is down 14%. In nominal terms, investment in fixed assets has remained stable or increased in only 23 of 89 regions across the country. Nationally, investment declined by 9.9% in the first half of the year, to 16.2 trillion rubles. A decline of that scale is the largest recorded since 2016—a year when oil remained below $ 40 a barrel for much of the year, the OPEC+ agreement was not reached until December, and the country was mired in recession.
If 1% GDP growth is possible despite investment falling on this scale, government spending is the entire story. So what use is the current base case in an environment where external conditions are becoming increasingly difficult for officials to mitigate?
The only reason fuel prices have not done even more damage is that the government is recycling energy revenues—of which there are fewer now than a year ago—into price subsidies intended to hold back inflation. But food, the most important component of household spending, is likely to become more expensive globally. Fertilizer prices are elevated, logistics costs are rising, and shipping freight rates are increasing. At the same time, markets face what could be the worst El Niño in recorded history, which typically brings drought to large parts of the Asia-Pacific, southern Africa, Central America, and northern South America.
These factors may take months to appear in the data, but they will create another headwind for plans to continue cutting rates and stimulate investment in 2027.
Fortunately for the Bank of Russia, foreign rate hikes do not have a direct material impact on the exchange rate because of extensive capital controls. Without those controls, a new rate-hiking cycle abroad, combined with stable or falling rates in Russia, would likely weaken the ruble and worsen import-driven inflation.
That said, Russia’s base case is bleak. TsMAKP notes that any recovery in consumer manufacturing does not yet appear sustainable, while July data showed that net manufacturing output rose by just 0.1% compared with June—effectively stagnating amid falling investment. Yet the cabinet seems content to use manufacturing as the primary proxy for measuring its success.
The fact that Deputy Prime Minister Aleksandr Novak has requested that relevant authorities prepare analyses of the structure of investment activity and imports is a subtle indication that growth expectations are falling off a cliff. It is a typical bureaucratic request, the sort of initiative that dominated in 2015−2016, when Medvedev’s cabinet raced to find import-substitution solutions amid a deep recession. In practical terms, a new effort to identify the most important imports to substitute repeats the mistakes of the 2010s.
The state typically backs projects led by companies with no track record of success. Such projects are inefficient and inevitably produce goods at a higher price than imported alternatives. Add the resulting demand for labor to the effort to localize production, and policymakers end up exposing their value chains much more heavily to domestic economic conditions—conditions that will remain structurally inflationary until military spending is cut, the Ministry of Finance delivers a budget surplus, and a painful recession allows for a “correction” of various imbalances.
JPMorgan’s admission that it can no longer provide a base-case scenario for oil markets should give officials pause when they claim that everything remains within their projections. High energy prices now create more problems than solutions for the Kremlin, especially if it moves to pursue another round of state-directed import substitution at the public’s expense.
