Elvira Nabiullina’s decision, announced on September 11, to hold the key rate at 14% symbolized a small victory in her fight over monetary policy with the Presidential Administration and big business. Ukraine’s attacks on refineries and the ongoing fuel shortages have proven definitively pro-inflationary, alongside the US-Iran war. Oil and refined-products markets were rattled last week by evidence that the Houthis had successfully seized Mayun Island in the Bab el-Mandeb Strait and by a strike on Saudi Arabia’s East-West Pipeline.
Holding the rate says little about officials’ ability to rein in prices. It is akin to a defensive crouch: a move intended to avoid further damage to investment without unleashing a new round of inflation that would quickly become embedded and prove difficult to tame. But it does suggest that a foundational talking point from the Kremlin and those dancing to its tune — that the economy is slowing in preparation for a “new investment cycle” – is absurd. In the words of former economy minister Andrei Nechaev, the economy is set to “flounder in a swamp.” The reasoning comes down to relatively simple math: unless Russian businesses and workers become significantly more productive, investment is no panacea for growth. In wartime, with so many competing inflationary pressures, supply constraints, labor shortages, high interest rates, and the broader deformation of the Russian economy, investment-led growth competes with consumption.
The peculiar conditions of wartime do not mirror the Soviet system in any direct sense. Today’s economy has relatively liberalized prices, does not directly plan or allocate resources, reflects costs with relative accuracy, and the private sector largely faces hard budget constraints. The defense sector and the military do not. Military spending — classified and publicly reported — was equivalent to over half of all year-to-date revenue in the second quarter. Demand for recruits keeps bonuses flowing. While the Finance Ministry attempts to limit the pace at which the deficit increases, keeping the first-half deficit under 3% of GDP was largely possible thanks to the war in the Middle East. Since June, however, Russian oil output and refinery output have declined or failed to recover, eating into those gains even as prices rise. More importantly, Kremlin spokesman Dmitry Peskov dismissed talk of raising taxes for the simple reason that the only available option is to tax consumption further. Meanwhile, military spending is at record highs and almost certainly understates the role of state-enterprise procurements, loan subsidies, and purchases of domestic debt using the National Welfare Fund to back wartime industries.
The implication is that in an economy short of labor, with elevated input costs from sanctions, limited competition in many strategic sectors, inflated procurement costs, and a high cost of capital, the private sector and households — both of which face hard budget constraints — are bearing the adjustment costs of a military sector that does not. As in the Soviet system, every company has good reason to hoard labor once it has hired, because replacements are so hard to find until unemployment rises. This is the slow squeeze, the floundering Nechaev described. In such conditions, additional investment leads to sustainable growth only if output per ruble invested increases. Otherwise, every ruble invested intensifies competition for labor, imports, and whatever else is needed to build or expand a business.
Despite the surge in IT investment since the war began, the “boom” of 2023−2024 did not correspond to any change in labor-productivity trends. The scale of public-sector spending created huge demands for which the economy was unprepared. In response, businesses paid more and more for labor but, in many cases, simply worked people harder or increased bonuses — already a disproportionately large share of Russians’ incomes relative to wages. Add to that the psychological pressures of wartime life, and a recent survey from the Managers’ Association now suggests that burnout is having a pronounced effect on labor productivity. Nabiullina noted in her press conference that labor-productivity growth has fallen off. There is no more juice to squeeze.
It does not help that economists both abroad and inside Russia see Rosstat inflating industrial-output data, implying that the vast sums of investment flowing into defense manufacturing at other sectors’ expense are extremely inefficient. The labor associated with that investment would be equally so. Nor does it augur well when business organizations such as Opora Rossii ask United Russia to partner on labor-productivity programs through municipal governments to promote AI and IT adoption — not because the intent is wrong per se, but because these businesses are not doing it themselves. If major productivity initiatives must be run through the state — a reality if the cost of capital is prohibitively high, as RUIE head Aleksandr Shokhin has suggested, it is because the war is making capital too expensive for businesses to act on their own. The state’s track record does not suggest it will succeed in engineering a new “boom” with more productive workers.
Nabiullina’s rate hold shows that the bloc arguing for price stability as the main path to lower rates is still winning the argument behind closed doors. Putin’s recent comments reflect a deep-seated fear of double-digit inflation, completely at odds with any talk of a new investment cycle. The fear, it would seem, is that the rate cut that unleashes investment — whatever its size, depending on the path of inflation in the coming months — will be the deepest. It may not be large in nominal terms, but if it convinces businesses to start investing again at a scale unthinkable at present rates, those investments will come at everyone else’s expense. Industrial output has stagnated since mid-2025. If inflation remains stubbornly at or above 6% in annual terms amid broadly stagnant output, what do they think happens when a new wave of money competing for scarce labor and resources hits?
