Russia’s war economy is a house of cards

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The most important thing that Russian President Vladimir Putin is trying to impress Ukraine’s western friends is that he has time on his side, so the only way to end the war is to agree to his wishes. The apparent strength of Russia’s economy, and doubts in some quarters that Western sanctions have had an effect, is a major part of this information war.

The truth is that the financial foundations of the Russian war economy are increasingly looking like a house of cards – so that senior members of the ruling class raise concerns publicly. They include Sergei Chemezov, chief executive of the state security giant Rostec, who has warned that expensive debt is killing the home. arms export businessand Elvira Nabiullina, head of the central bank.

This couple knows more than most westerners, that are taken numerically showing steady growth, low unemployment and rising wages. But any economy in full accumulation can produce such results: this is basic Keynesianism. The true test is whether obsolete equipment – as opposed to obsolete – has been removed from its original use and combat requirements.

The country has three ways to achieve this: borrowing, inflation and confiscation. It is necessary to choose the most effective and painless combination. Putin’s pride – to the west and to his own nation – has been that he can support this war without financial instability or significant sacrifices. But this is an illusion. If the confusion between Chemezov and Nabiullina is spilling over into the public eye, it means that the deception is weak.

A new record by Russian analyst and former banker Craig Kennedy highlights the huge growth of corporate debt in Russia. It is up 71 percent from 2022 and cuts new household and government loans.

In private, this loan is actually a national creature. Putin has ordered Russia’s banking system, and banks must lend to companies selected by the government on specified terms. The result was a flood of subprime mortgages to favored financial backers.

In fact, Russia is dealing with a large printing of money, which has been taken out so that it does not appear on the public balance sheet. Kennedy estimates a total of about 20 percent of Russia’s national production in 2023, compared to the overall budget allocations for the full war.

We can see from the actions of the Kremlin that it sees two things as critical: public finances that seem weak and inflation.

The government is avoiding a major budget deficit, despite increasing war-related spending. The central bank remains free to raise interest rates, currently at 21 percent. It is not enough to lower the inflation driven by government-mandated debt, but it is enough to keep inflation within limits.

The announcement is that the problems of Chemezov and Nabiullina are not a fault that can be fixed but are inherent in Putin’s choice to manipulate the public finances and keep a (high) lid on inflation. Something has to be given, and that something includes businesses that cannot operate profitably when the cost of borrowing exceeds 20 percent.

Putin’s private credit policy, meanwhile, is keeping the credit crisis at bay as loans go sour. The country may bail out the banks – if they don’t fail first. Due to the Russian experience of sudden useless deposits, the fear of repetition can easily trigger compensatory measures. That would not only destroy the banks but also the credibility of the government.

Putin, in short, does not have time on his side. He is sitting on a ticking financial time bomb of his own making. The important thing for the friends of Ukraine is to deny him the one thing that would destroy it: to get a lot of foreign currency.

The West has blocked Moscow’s access to about $300bn in reserves, put the spanners in its oil trading operations and has limited its ability to import various goods. Combined, these prevent Russia from using all of its foreign earnings to alleviate resource problems at home. Strengthening sanctions and transferring reserves to Ukraine as a minimum payment of reparations will strengthen those barriers.

Putin’s impasse is a sudden collapse of power. That, as he must realize, is the danger that his war economy has produced. Making it less, by increasing access to foreign resources through sanctions relief, will be his goal in any negotiations. The West must convince him that this will not happen. That, and that alone, will force Putin to choose between his invasion of Ukraine and his hold on power at home.

martin.sandbu@ft.com