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The main thing that Russian President Vladimir Putin is trying to impress upon Ukraine's western friends is that he has time on his side, so the only way to end the war is to serve his interests. The apparent strength of the Russian economy, and the skepticism caused in some quarters that western sanctions have had an effect, is a key part of this information war.
The reality is that the financial foundations of Russia's war economy are increasingly looking like that house of cards – so much so that senior members of senior management have publicly expressed concern. They include Sergey Chemezov, the chief executive of the country's defense giant Rostec, who warned that the expensive debt was killing him. equipment export businessand Elvira Nabiullina, head of the central bank.
This couple knows better than most people in the west, who taken in numbers showing steady growth, low unemployment and rising wages. But any economy at the full level of integration can produce such results: this is the essence of Keynesianism. The real test is that weapons that are already employed – instead of being decommissioned – are moved away from their original use and wartime needs.
The government has three ways to achieve this: borrowing, inflation and confiscation. It should choose the most effective and painless combination. Putin's pride – to the west and his people – is that he can finance this war without financial instability or significant sacrifices. But this is an illusion. If Chemezov and Nabiullina's frustrations are dissipated in public opinion, it means that the deception is going away.
A new report Russian analyst and former banker Craig Kennedy highlights the huge growth in Russian corporate debt. It is up 71 percent from 2022 and includes new home and government borrowing.
Privately, this loan is a creation of the government. Putin has ordered Russia's banking system, with banks required to lend to companies designated by the government on select terms. The result was a flood of subprime debt to favored economic actors.
In reality, Russia is involved in large-scale printing of money, which is exported so that it does not appear on the public balance sheet. Kennedy estimates that about 20 percent of Russia's national product in 2023, compared to the total war budget accumulated.
We can tell from the actions of the Kremlin that it sees two things as a curse: the apparent weakness of public finances and runaway inflation.
The government avoids a large budget deficit, even as war-related spending increases. The central bank remains free to raise interest rates, currently at 21 percent. Not enough to beat inflation driven by state-decreed subsidized credit, but enough to keep inflation within limits.
The upshot is that the problems of Chemezov and Nabiullina are not errors that can be corrected but are related to Putin's choice to hit public funds and keep the lid (high) on inflation. One thing has to give, and another thing involves businesses that cannot operate profitably when the cost of borrowing exceeds 20 percent.
Putin's private credit system, meanwhile, is keeping the debt crisis at bay as loans go bad. The government can bail out the banks – if they are known first. Given the Russians' experience of a sudden worthless deposit, the fear of repetition could easily trigger a self-fulfilling flight. That would destroy not only the banks' but the government's legitimacy.
Putin, in short, does not have time on his side. He is sitting on a financial time bomb of his own making. The key for Ukraine's friends is to deny the one thing that will destroy it: greater access to foreign funds.
The west has blocked Moscow's access to some 300 billion dollars in reserves, put restrictions on its oil trading activities and hit its ability to import inventories. Combined, these prevent Russia from spending all of its foreign earnings to ease arms constraints at home. Tightening sanctions and eventually transferring reserves to Ukraine as a down payment in return will strengthen those restrictions.
Putin's loyalty is rapidly falling from power. That, as he must understand, is the economic risk of his war. To reverse it, by increasing access to foreign sources with the relief of sanctions, will be his goal in any diplomacy. The west must assure 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.