Resilience and Challenges of the Russian Economy

MOSCOW (Reuters) – The Russian economy has demonstrated resilience during the three years of war in Ukraine and Western sanctions. However, as the war approaches its fourth year, the economy faces major challenges with key economic policymakers at odds on how to address them.

Economists describe the outlook for 2025 as an “ideal storm” with multiple negative factors simultaneously at play.
“After several years of very strong dynamics, the economy may disappoint in 2025,” said Dmitry Polevoy from Astra asset managers.

The economic woes add to Russian President Vladimir Putin’s case for talks with U.S. President Donald Trump on ending the war in Ukraine. Trump said on Jan. 21 that Putin was “destroying Russia” and pointed out high inflation.

“Russia is interested in reaching a diplomatic resolution to the conflict in Ukraine based on economic considerations,” said former deputy governor of the central bank Oleg Vyugin.

Key Challenges for the Russian Economy in 2025

INFLATION

• Russian annual inflation reached 9.5% in 2024, driven by high military and national security spending, which is set to account for 41% of total state budget spending in 2025, state subsidies on loans, and spiraling wage growth amid labor shortages.
• Over the last 15 years, inflation has only been higher in 2022 and during the economic crisis of 2014-15.
• Prices for staple foods, such as butter, eggs, and vegetables, are showing double-digit growth. Inflation is impacting the incomes of vulnerable groups, with real pensions falling by 0.7% from January to November 2024.
• The central bank is combating inflation by raising interest rates, but Putin insists that interest rate hikes alone won’t solve the issue.

HIGH INTEREST RATES

• The Russian central bank raised interest rates to 21% in October, the highest level since the early years of Putin’s rule.
• Critics argue that high rates hurt civilian sectors of the economy while heavily subsidized defence sectors remain largely unaffected. Investment has stalled due to high costs of capital.
• High rates increase risks of corporate bankruptcies, especially in vulnerable sectors like real estate.

ECONOMIC SLOWDOWN

• Economic growth rates are expected to slow to 2.5% in 2025 from around 4% in 2024.
• The IMF projects growth at 1.4%, while many industrial sectors outside defence have stagnated since 2023, leading to concerns about stagflation.
• Acute labor shortages have emerged, exacerbated by thousands of men joining the army or fleeing the country, becoming a major bottleneck for economic growth.
• Continued military spending could lead to imbalances in the economy, resulting in recessions and bankruptcies.

BUDGET DEFICIT

• Russia’s budget deficit reached 1.7% of GDP in 2024, with the National Wealth Fund depleted by two-thirds during the war.
• The government raised taxes to reduce the deficit to 0.5% of GDP in 2025, but falling revenues due to U.S. energy sanctions threaten this plan.

ROUBLE VOLATILITY

• The rouble fell to its lowest level since March 2022 due to Western sanctions disrupting international transactions.
• While a weaker rouble helps narrow the budget deficit, it could further fuel inflation in the medium term by increasing import costs.
• China’s yuan has become the most traded foreign currency in Russia’s forex market due to sanctions.