NY Dispatches: Russia’s new “war economy”

Russia’s economy has enjoyed subdued growth in recent months. However, a damning audit report and the aftermath of a diplomatic spat reveal major structural problems stemming from the president’s reliance on a confrontational foreign policy. 

Last week, the Audit Chamber issued a report on Russia’s Industry Development Fund. The fund was set up as part of Russia’s import substitution efforts following sanctions and counter-sanctions that limited imports in certain sectors of the economy. The Industry Development Fund issues cheap loans – more than 86 billion rubles in 2014-18 – to Russian companies that engage in production to replace these exports, but the companies need to meet performance targets. The report was an embarrassing read. It pointed out that the Fund often reduced these targets for companies all while its budgetary support increased twelve-fold. In 2016, less than 70 percent of the fund’s revenue target was fulfilled, while borrowers routinely delayed projects or inflated prices in order to be able to apply for higher subsidies.

This is not the only sector, in which problematic lending has impacted the economy. As the real disposable income of the population has been falling for five years, the role of consumer lending has increased. Indeed, according to the central bank, unsecured landing has grown by 25 percent year-on-year as of May 2019, in a much greater pace than business lending. This essentially means that to maintain consumption and accelerate economic growth, Russian citizens have to borrow money while companies, instead of investing, prefer to milk the state in the form of problematic loans.

Import substitution has, at best, mixed results and where it has succeeded, it has created dependencies on the state. The share of imported food in Russia’s retail sector only decreased from 36% to 22% in the four years after 2014, while certain sectors, e.g. electronics still massively depend on imports. Construction has not recovered, save for major state orders, e.g. in Moscow or before the 2018 FIFA World Cup. The banking sector is significantly more independent of Western banks today than it was five years ago, but the price was a significant increase of state ownership. In 2018, the Russian government decided to restructure the bailed-out Promsvyazbank to lend to the defence sector and to bail out business affected by sanctions. Business owners with various degrees of political connections lined up. Small enterprises have also increasingly grown dependent on orders from state-owned companies.

And the line for public money is about to get bigger: following the ban on Russian flights to Georgia, announced after a diplomatic spat last week, the Ministry of Transport has started calculating the total loss of airlines in order to compensate them. Estimates range from 46 to 60 million dollars. This is not going to wreck the Russian budget, but it will establish a further precedent of public funds channeled to private business instead of creating circumstances, in which business can operate without major impediments.

The new “war economy” is a consequence of the Russian president’s reliance on geopolitical posturing abroad to maintain domestic popularity and the increasing inability of the government to shift the cost of its bad foreign policy decisions onto the private sector. Last year, following an announcement of Alfa Bank, one of Russia’s biggest lender that it would stop working with Russian defence companies in order to avoid being placed under American sanctions, the State Duma discussed a bill, which would have allowed the government to punish the observance of foreign sanctions. Passing this would have made it official that the government has the right to shift part of the responsibility to the private sector. However, business rebelled and the bill was withdrawn.

In the past year, Vladimir Putin has engaged in foreign adventurism much more sparingly than before and tried (so far with limited success) to re-engage with the domestic policy agenda. As the flight ban to Georgia shows, however, the president is still ready to sacrifice money and forego future economic growth in certain symbolic cases. Last week a verbal spat emerged between the head of the central bank, Elvira Nabiullina and Maxim Oreshkin, the minister of economy over the situation on the lending market with Oreshkin positing that restricting consumer loans would free up lending capacities to business and Nabiullina stressing that investments lag not because of the lack of credit but because of a hostile atmosphere. Ironically, it seems that as long as Putin’s political survival hinges upon a continued confrontation with liberal democracies, it doesn’t matter whether Nabiullina or Oreshkin wins the debate. The most either of them can do is putting out fires.

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