The Russian economy is slowing down, primarily due to the extremely high key rate of 21%. In the third quarter, growth was 3.1% compared to the same period last year, after 4.1% in the second quarter and 5.7% in the first. However, the question remains whether the slowdown is occurring quickly enough for inflation to start steadily decreasing. Expert assessments of quarterly GDP dynamics do not yet provide a clear answer.
Preliminary data from the Central Bank's statistics show that in October, economic activity was lower than the average in the third quarter. This indicates that the slowdown is intensifying, particularly in the raw materials sector, while the consumer sector remains in a period of weak positive growth.
Experts close to the dirigiste camp within the Russian leadership are sounding the alarm, claiming that the economy will shift from growth not to stagnation, but to contraction if the key rate is not reduced to at least 15-16% by mid-next year. This forecast seems convincing in terms of output dynamics, but in such a scenario, the Central Bank will almost certainly be unable to reduce inflation to desired levels.
For now, the Central Bank is debating with experts from the dirigiste camp about how destructive a prolonged period of high interest rates will be for Russian business, the role that servicing past loans will play in this, and the inevitable reduction in productive investments. However, large Russian businesses are now joining the debate, calling for limiting the Central Bank's autonomy. The struggle over the interest rate is escalating, just as we predicted.
The goals of maintaining strong economic growth and macroeconomic stability have become incompatible. At the same time, the outcome of the confrontation between the 'growth party' and the 'Nabiullina party' (the 'hard credit policy party') is largely predetermined. The 2025 budget suggests an increase in the tax burden on the private sector and a redistribution of funds through the budget in favour of the military sector. This will further exacerbate existing economic imbalances. It is likely that the Central Bank leadership will have to silently accept that the actual inflation target will be shifted upward, although this will not be officially announced. This is the logic underpinning the militarisation of the economy: in the struggle between the 'growth party' and the 'Nabiullina party,' the 'war party' will win.
According to preliminary data from Rosstat, Russia's GDP growth in the third quarter of 2024 was 3.1% compared to the same period last year, after growth of 4.1% in the second quarter and 5.4% in the first. Thus, the growth rate for the first three quarters amounts to 4.1% compared to the first nine months of the previous year. In the fourth quarter, economists expect further slowing: the consensus forecast from the HSE Development Centre projects 2.8% growth compared to the same quarter last year. Under this scenario, growth for the year will be between 3.7% and 3.9% year-on-year.
The Russian economy is slowing down, but the key question for experts is how quickly. The assessment of quarterly GDP dynamics (i.e., growth rates compared to the previous quarter) depends on the seasonal adjustment model. According to calculations by the Central Bank's Research and Forecasting Department, in the first quarter of 2024, the economy grew by 1% compared to the fourth quarter of 2023, and by 0.6% in the second quarter compared to the first. According to the MMI Telegram channel, GDP growth in the third quarter was 0.6% compared to the second quarter. The channel's authors conclude that the GDP growth slowdown is insufficient, meaning that the Central Bank will need more time to combat inflation, and the key rate will remain at an exceptionally high level for longer. Analysts at Raiffeisenbank estimate that GDP increased by 1.14% in the first quarter compared to the previous one, and by 0.46% and 0.45% in the second and third quarters, respectively. This represents a more dynamic slowdown.
The Central Bank's monitoring of sectoral financial flows shows that economic activity was lower in October than the average for the third quarter, meaning the slowdown is accelerating. The volume of incoming payments channelled through the Central Bank fell by 2.9 per cent. The biggest decline (-7.9%) was in industries oriented to external demand. This noticeable decline is mainly explained by the decline in oil and gas production (-7%). Just in October, Russia had to reduce oil production by 10,000 bpd in order to fulfil its OPEC+ commitments. Excluding production, production of petroleum products and public administration, revenues in October decreased by 1.7% compared to the average level of the third quarter. In contrast, in the consumer demand industries, the flow of payments continued to grow, albeit at a slower pace than before (+1.1% vs. the third-quarter average). In other words, the cooling in the consumer sector looks insufficient.
In the ‘near future’ Russia faces the threat of ‘economic decline and a collapse in investments’, warn experts from the Center for Macroeconomic Analysis and Short-Term Forecasting (CMASF) in their note ‘On the Risks of Stagflation’. The economy will begin to shrink if the key rate is not reduced to 15-16% by mid-next year, they assert. Based on surveys of enterprises, the CMASF experts show that a lack of financing is the main factor limiting economic activity. This factor was mentioned by 47% of companies, with high credit rates being cited by 45%. Both of these factors have increased and now surpass the ‘popular’ growth limiter, such as ‘lack of skilled workers’ (42%). Only 25% of companies reported that they cannot increase production due to lack or wear of equipment. The share of companies that cannot service their loans or are doing so with great difficulty is also growing, the experts claim. In 2023, 4.4% of companies were unable to service their debt, and another 4.1% faced difficulties. In 2024, 12% cannot service their debt, and 8.9% have problems with debt servicing.
At a press conference regarding the key interest rate hike to 21%, Central Bank Governor Elvira Nabiullina, on the contrary, stated that approximately one-third of Russia's GDP is produced by companies that do not have interest expenses, i.e., companies that do not have loans to service. In a major study presented shortly afterward, Central Bank experts showed that from 2019 to 2023, the average ratio of interest expenses to sales costs for companies ranged from 2.5% to 3.3%. Only 5% of companies had a ratio higher than 30%, which created a risk of insolvency if monetary conditions tightened. In other words, according to the Central Bank, the high interest rate does not create systemic risks, although it will lead to the bankruptcy of inefficiently over-leveraged companies.
CMASF, founded by former Deputy Prime Minister and now Minister of Defence Andrei Belousov, is the expert support for the dirigiste wing in Russian economic leadership, advocating for a loosening of monetary policy and higher growth rates, even at the cost of higher inflation. In turn, the Central Bank, at least in the person of Elvira Nabiullina and her team, is focused on suppressing inflation, which requires a prolonged period of a super-high interest rate, bankruptcies of over-leveraged companies, and, likely, not just a slowdown but a contraction of the economy. According to the Central Bank, the rate could theoretically be reduced to 15-16% by mid-next year (the 'Basic Guidelines of Monetary Policy for 2025 and the period 2026 and 2027’ foresees an average key rate of 17-20% for the next year), but this seems unlikely and should depend entirely on inflation dynamics.
In addition, CMASF argues with the Central Bank about whether the investments made recently are sufficient to expand production. Speaking at the Federation Council, Central Bank Deputy Chairman Andrei Zabotkin explained that the slowdown in investment activity due to higher loan costs would not limit the growth of companies that have already reached a high level of investment activity. CMASF experts counter this, pointing to the extensive (low-quality) indicators of investment activity in 2022-2023 (we also drew attention to this → Re:Russia: Investment Decomposition). Despite a general investment growth of 17.2% over two years in 2022-2023, investments in machinery and equipment (which directly determines the scale of capacity expansion) did not increase but decreased by 8%. The situation may be even worse, as noted in another CMASF report: determining the real prices of imported machinery and equipment under ‘current conditions’ has become a non-trivial task.
Russian business has also joined the attack on the Central Bank's leadership. According to Vedomosti, the Russian Union of Industrialists and Entrepreneurs proposed changes to legislation that would obligate the Central Bank to coordinate its actions with the government. There is little doubt that Russian oligarchs were inspired by Donald Trump's victory in the U.S. presidential elections, as he has advocated similar ideas (→ Re:Russia: Merchant or Messiah). One Russian billionaire told Bloomberg that the authorities should stop fighting high inflation. Society, he believes, would be willing to accept price increases if it were officially recognised that Russia is in a state of war, not conducting a ‘special military operation’.
These straightforward remarks actually reflect the central discussion intensifying in the corridors of Russian power. The high economic growth rates demonstrated by the Russian economy over the last six quarters (an average rate of 4.7% annually) are perceived by the Russian leadership, and by Vladimir Putin himself, in a political context – as proof of success in the confrontation with Western sanctions. Accepting the idea that these high rates were a result of an overheated economy, which will have to pay the price in the form of stalled growth or even GDP contraction, is not easy.
The goals of maintaining strong economic growth and macroeconomic stability have become incompatible. However, the outcome of the confrontation between the ‘growth party’ and the ‘Nabiullina party’ seems largely predetermined. Elvira Nabiullina (if she retains her position) will have to make concessions, effectively abandoning the Central Bank's inflation target of 4%. The 2025 budget has already been drafted and proposes an increase in the tax burden on the private sector and a redistribution of funds through the budget in favour of the military sector. This will further exacerbate existing imbalances in the economy, and the Central Bank's ultra-tight policy will not produce the desired effect. Most likely, the Central Bank leadership will have to tacitly accept the fact that the actual inflation target will be shifted upwards, although it will not be officially announced. And this will not happen as a result of pressure from the Central Bank of Russia or the Russian Union of Industrialists and Entrepreneurs but from the logic of the militarisation of the economy.