If one were to choose a word describing the state of business activity heading into September, “sputtering” would be a good place to start. The July PMI readings from S&P returned their best result since January 2025—50.7—and followed a positive print in June after the pessimism of the first half of the year. But the improvement likely incorporates a response to logistical difficulties from the fuel crisis. Anyone who could have done so rushed their orders out as fast as possible to get inventory in the door. Wildberries is already seeking new warehouse capacity in Kazakhstan to avoid Ukrainian attacks on Russian territory, a development that parallels a 62% decline in warehouse demand in Moscow and St. Petersburg. Unsurprisingly, businesses do not want to move product to cities they know are high-priority targets for attack. Although procurements are a different category of activity, Moscow mayor Sergei Sobyanin points to a similar “displacement” shifting demand around the country: one-third of Moscow’s contracts go to businesses from the regions, accounting for nearly 5% of all procurement contracts nationally.
Limited though they are in impact, these two examples highlight an interesting tension. On one hand, the expansion of the military-industrial sector offers a wealth of targets distributed across European Russia and Eastern Siberia for Kyiv to hit. On the other, the expansion of strikes onto Wildberries warehouses exacerbates the over-concentration of physical trade and turnover in Moscow and, to a much lesser extent, St. Petersburg. Combined with the effects of recruitment bonuses and military payouts, the war has created conditions for a significant geographic realignment of demand away from Moscow. While unlikely to redress extreme inequality, this might have created tailwinds for structural trends to uplift Russia’s second- and third-tier cities economically.
Handing out money works well as a kickstarter for this process when an economy’s supply side—its labor markets, capital markets, and productive businesses—can work, invest, and produce to meet that demand. This clearly has not been the case since 2023. Inequality has worsened throughout the war. Without broadly distributed real wealth gains outside Moscow and St. Petersburg, the effect has been to overheat local economies and widen the gap between haves and have-nots within regions. In conditions where growth stops and starts each month due to policy shocks or other peculiarities rather than positive stimuli, the risk is that post-war, Russia’s regions will be even more dependent on federal transfers, state enterprises, or other formal and informal interventions from Moscow.
The lack of positive, self-sustaining development has many causes, but none is more pressing in the immediate term than interest rates. With rates this high, any business or investor borrowing to invest needs some combination of loan subsidies, guaranteed demand, or sufficient confidence in returns to make the cost of servicing debt manageable. The Bank of Russia’s 14% key rate does not really help most businesses or consumers, who pay higher rates to commercial banks; only the surest bets pay off. Given the distribution of wealth, it is fairly safe to assume that Moscow will absorb more capital by virtue of its scale and the opportunities that remain there. Most cities elsewhere must hope that defense contracts continue to prop up businesses that bid up wages, create some ancillary investment, and generate demand. But as covered at length in this column, that multiplier effect is exhausted, if not now negative.
The Bank of Russia’s slow approach to cuts suggests little confidence that inflation can be controlled if rates ease materially. Yet the central bank’s policy cannot credibly control inflation, because its causes are ultimately downstream of fiscal policy, commodity markets, and the conduct of the war. The state is paying the cost. Five-year forward rates for OFZ issuances show that the Ministry of Finance must pay rates above 17%—a hefty discount relative to the underlying value of Russian debt—to cover deficits. These rates are higher than at any point since the early 2000s, higher even than the yields on Russian debt during the Global Financial Crisis. Capital in Russia is demanding its pound of flesh if the regime intends to continue the war.
Beyond the obvious concern of renewed spending cuts outside military outlays, the continued rise in Russia’s sovereign yields exposes policymakers’ impotence. There is simply no credible way to communicate to markets that all is well or that risks are not escalating. And the broader game of musical chairs—distributing and redistributing demand in the wake of Ukrainian strikes, new policy announcements from Moscow, or other pressures—shows that capital cannot be deployed effectively. Russia is therefore an economy running its real resources—its human capital and existing assets—into the ground while capital is wasted.
Money is being redistributed to the regions through the defense sector and recruitment, only to be taken away again by the macroeconomic conditions the war has unleashed. As long as the economy stops, starts, and stops in reaction to war-related developments, capital cannot be used productively. What was already an underinvested economy for nearly a quarter-century will become even more so until the cycle starts again—though we cannot know when an end to the conflict will come. Regional economies will keep hitting a ceiling, only to have Moscow force them back down by economic design.
