Inflation in Russia Soars Amidst War in Ukraine

Inflation in Russia Soars Amidst War in Ukraine

Rising prices pose a challenge for Russia as inflation accelerates while the rest of the world experiences easing inflation rates.

Russia has a long and tumultuous history with inflation, dating back to the aftermath of the 1917 revolution. From the early years of Josef Stalin’s rule to the global financial crisis of 2007-2009 and Vladimir Putin’s invasion of Ukraine in 2014, the country has faced numerous challenges. As the war in Ukraine approaches its second anniversary in late 2023, inflation in Russia is once again on the rise, even as other countries experience a decrease in inflation rates.

The Central Bank of Russia recently reported that inflation in November reached 7.5% year on year, up from 6.7% the previous month. Concerns are mounting among officials that they may be losing control of the situation. In response, the central bank unexpectedly raised interest rates by two percentage points at its last meeting, and a similar increase is anticipated at the upcoming meeting on December 15th. Despite these measures, most forecasters predict that inflation will continue to rise.

While the inflation of 2022 was primarily caused by a weaker ruble due to Russia’s invasion of Ukraine, currency movements play a smaller role this time. In recent months, the ruble has actually appreciated, partly due to the of capital controls. Inflation in prices of non-food consumer goods, many of which are imported, remains in line with pre-war averages.

However, a closer look at the wartime economy under Putin reveals a dangerous overheating. Inflation in the services sector, which encompasses a wide range of industries such as legal advice and restaurant meals, is exceptionally high. For example, the cost of a night’s stay at Moscow’s Ritz-Carlton, now renamed the Carlton after its Western backers pulled out, has increased from around $225 before the invasion to $500. This suggests that the cause of inflation is domestic in nature.

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Economists attribute the skyrocketing government spending to Putin’s efforts to defeat Ukraine. Defense spending is set to nearly double in 2024, reaching 6% of GDP, the highest level since the collapse of the Soviet Union. In addition, the government is increasing welfare payments in light of an upcoming election. Some families of soldiers killed in action are receiving payouts equivalent to three decades of average pay. Russia’s finance ministry estimates that fiscal stimulus currently accounts for about 5% of GDP, surpassing the measures implemented during the COVID-19 pandemic.

This surge in government spending has led to an increase in the country’s growth rate. Real-time economic data from Goldman Sachs indicates solid growth, and JPMorgan Chase has revised its GDP forecast for 2023 from a 1% decline to a 3.3% increase. Despite initial predictions of an economic collapse by Western economists and politicians at the start of the war in Ukraine, Russia has proven them wrong.

However, the rapid growth is straining the Russian economy, which has seen a significant decrease in its supply side since the beginning of 2022. Highly educated workers have fled the country, and foreign investors have withdrawn approximately $250 billion in direct investment, nearly half of the pre-war stock.

The combination of high demand and reduced supply has resulted in higher prices for raw materials, capital, and labor. With unemployment at its lowest level on record, below 3%, workers are emboldened to demand higher wages. Nominal pay is growing at a rate of approximately 15% year on year, and companies are passing on these increased costs to customers.

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While higher interest rates may eventually curb demand and prevent further inflation, it is an uphill battle against Putin’s determination to win in Ukraine. With substantial financial resources at his disposal, he has the potential to increase spending further, leading to even faster inflation. In Russia, economic stability often takes a backseat to other priorities.

Conclusion:

As inflation in Russia continues to rise amidst the ongoing war in Ukraine, the country faces significant challenges. Government spending, driven by Putin’s efforts to defeat Ukraine and boost welfare payments, has fueled inflation and led to a surge in growth. However, the Russian economy’s reduced supply side and increased demand are straining resources, resulting in higher prices for goods and services. The central bank’s interest rate hikes may provide some relief, but the impact may be limited in the face of Putin’s determination. The future of Russia’s economy remains uncertain as it grapples with the consequences of the war in Ukraine.