It came as little surprise to me—though perhaps more jarring for market observers who rely on topline figures—that the Russian economy appears to be officially entering recession. MinEkonomiki let slip that, in annualized terms, GDP fell 2.1% in January after posting 1.9% growth in December. Timing matters. December often produces statistical noise as federal agencies, state enterprises, and large private businesses race to spend remaining funds before the financial year closes. Notably, this decline occurs even as industrial output shows growth driven by military enterprises. Demand for investment goods needed to sustain production has stabilized around 2019 levels—well below 2021 peaks and roughly 15% lower than during 2023−2024. That will have negative knock-on effects for GDP later in the year.
To be clear, this is still just one month’s data. March 2023 technically saw the economy contract even as the wartime boom narrative took hold. What sets the current situation apart is the evident pain felt by households, which is dragging down the civilian economy—compounded by the disruptions and unintended consequences of the US-Israeli war with Iran. Consumer spending is no longer rising and even fell 2.2% in annualized terms ahead of the four-day weekend that began on February 23, according to Sberindex. Expanding the federal investment tax deduction for businesses modernizing or expanding production is exactly the kind of minor tweak the cabinet adopts when it cannot make fundamental changes. What ails the Russian economy is ultimately political. Technical fixes can smooth the roughest edges but cannot address the underlying problem: the state continues to funnel resources into enterprises that produce little economic value for the wider economy while burning through working-age men.
The potential extended interruption to unimpeded energy and commodity transit through the Strait of Hormuz—stemming from the ongoing war in the Gulf—is already being spun by many as a loss for Ukraine and a potential opening for Russia. While there is some truth to this (particularly as a new energy and commodity shock hits Europe, affecting Ukrainian importers and macroeconomic conditions), the assumption leaves much to be desired when examining precisely how Russia is supposed to benefit. The most obvious «positive» is renewed pressure on energy markets to buy crude oil and gas from any source outside the Gulf. Now that White House strategists have realized oil, gasoline, diesel, and jet fuel prices are rising ahead of the midterms, they’ve granted Indian importers a 30-day waiver to buy Russian crude.
Given the unlikelihood of a quick resolution—and the risk of escalation into increasingly unpredictable territory—the Russian budget theoretically benefits. Discounts on Russian crude will undoubtedly collapse the longer barrels remain trapped in the Gulf or shut in by producers in Iraq and elsewhere. Prices for refined products in the Asia-Pacific have exploded, with Europe following. The Qatari energy minister is warning that oil could hit $ 150 a barrel if the disruption persists for a few more weeks. Yes, this provides fiscal breathing room on paper for the Kremlin at a moment when the non-military economy’s wheels are finally coming off. But it is not a windfall they will do much with, nor does it truly benefit the broader economy. Much like post-Crimea talk of «diversification,» the federal budget is not everything.
First, the effect of a global commodity shock of this scale is unprecedented. Never before have so many physical barrels been suddenly trapped or lost so quickly, against fundamentally different global commodity flows than in 1979−1980. It is not just oil. The loss of LNG transit is driving up energy prices and, crucially, fertilizer costs. Without the sulfur that typically transits the Strait, a cascade of critical inputs rises in tandem. In the short term, that includes some metals production. Food will become more expensive later this year because fertilizer must be delivered in the coming weeks for planting season. Undiscussed so far: emergent constraints on helium, or pressure on Asian governments to prioritize power for air conditioning in spring and summer, may create bottlenecks for semiconductor production—at precisely the moment the world’s largest economies are racing to build datacenters and roll out AI.
China has already set its official GDP growth target below 5%, a terrible leading indicator given its immense trade surplus and continued management of the yuan against the dollar, which have generated macroeconomic imbalances that weaken global growth. Optimism about Eurozone growth—driven largely by Germany’s fiscal stimulus—is swiftly unraveling under the weight of higher energy prices on inflation and costs. US bond markets show no signs of confidence that prices will come down, pointing instead to higher inflation. The typical recipe for these factors is higher interest rates, lower commodity demand, and slower growth. Russia lives and dies by what it exports to finance what it imports and will inevitably feel the sting later in the year absent a quick resolution to the war.
But the problem extends beyond GDP outlooks as a proxy for commodity export earnings. A massive spike in oil prices will rapidly strengthen the ruble, as exporters are forced to buy rubles to generate market liquidity and stabilize the exchange rate. The net effect reduces the cost of military and dual-use imports but renders huge swathes of Russian industry uncompetitive. You might also see more Russians opt to travel abroad rather than domestically, hurting hospitality and services businesses that emerged after the 2022 sanctions shock. Real-terms budget revenues will also fall compared with the boost from a high oil price and weaker ruble.
Policymakers can sequester some of this windfall to prevent excessive currency appreciation, parking more funds in the National Welfare Fund. But they won’t be able to spend much of it without weakening the ruble or fueling inflation. Add to this that rising commodity prices feed back into domestic inflation—on top of the structural price increases driven by the regime’s handling of the labor market and military recruitment. Ten percent of global aluminum supply is currently stuck behind the Strait of Hormuz. Energy costs will rise globally for steelmaking and other industries as coal prices climb alongside gas. Russian producers will mark up prices to clear products on export markets, and domestic buyers will have to compete with importers elsewhere on price. Government policy can «help» prices, but only by denying these industries the profits needed to sustain investment in production that has already suffered since 2022. Higher prices mean higher inflation. Higher inflation means higher interest rates while industries and households continue to suffer.
Finally, all of this becomes moot in the event of a global recession, given the bizarre interplay between commodity prices and general inflation. After the initial pain, recessions typically bring inflation down in economies with relatively open trade and capital accounts and reasonably flexible labor markets. For all its shortcomings, a catastrophic energy shock in Europe may ultimately pull interest rates lower as non-energy inflation collapses into deflation amid rising unemployment and related factors. In that world, ironically, it becomes cheaper to finance lending to Ukraine. There is so much uncertainty that any firm claims of who wins or loses are foolish. Suffice it to say, however, that there are very few ways Russia can truly win beyond an initial burst of adrenaline and cash.
Structurally, energy shocks prompt customers to diversify their options. With clean technologies where they are today, that response will not simply mean reopening the taps to buy more Russian hydrocarbons in perpetuity. China is crimping exports of refined products while sitting on over 1.2 billion barrels of crude reserves—enough, by most estimates, to cover roughly three months of demand. Japan is tapping its large reserve. The US no longer has the spare capacity it did in 2022, having failed to establish an adequate mechanism to refill. Europe is, well, Europe—and in trouble as usual. Moscow’s greatest failure today stems from its misunderstanding of autarky: you live by the sword paid for with exports, and you die by it too.
