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The most important impression that Russian President Vladimir Putin is trying to make on Ukraine’s Western friends is that he has time on his side, so the only way to end the war is to grant his wishes. The apparent resilience of the Russian economy, and the resulting doubts among some about the effectiveness of Western sanctions, are a central part of this information war.
The reality is that the financial foundations of Russia’s wartime economy increasingly resemble a house of cards—so much so that senior members of the ruling elite are publicly expressing concern. These include Sergei Chemezov, chief executive of state defense giant Rostec, and central bank governor Elvira Nabiullina, who warned that expensive Credit is killing his arms export business.
The couple knows better than many Westerners, who are dazzled by numbers showing steady growth, low unemployment and rising wages. But any economy on a fully mobilized basis can produce such an outcome: it’s basic Keynesianism. The real test is how to divert used resources (rather than idle resources) from their previous use to the needs of war.
The state can achieve this through three methods: borrowing, inflation, and expropriation. It has to choose the most effective and painless combination. Putin’s conceit with the West and his own public is that he can finance the war without causing financial instability or major material sacrifices. But this is an illusion. If Chemezov and Nabiullina’s frustrations spill into the public eye, it means the fantasy is flickering in and out.
A new report from Russia analyst and former banker Craig Kennedy highlights the huge growth in Russian corporate debt. It has soared 71% since 2022, dwarfing new household and government borrowing.
This kind of loan is nominally private, but in fact it is a creation of the state. Putin has commandeered the Russian banking system, and banks are required to provide loans to government-designated companies on selected favorable terms. The result is a massive flow of credit at below-market rates to favored economic actors.
Essentially, Russia is printing money on a massive scale and outsourcing it so it doesn’t show up on public balance sheets. Kennedy estimated that this total would be about 20% of Russia’s national output in 2023, equivalent to the cumulative budget allocation for a full-scale war.
We can see from the Kremlin’s actions that it is disgusted by two things: the apparent weakness of public finances and runaway inflation.
Despite rising war-related spending, the government avoided running a large budget deficit. The central bank is still free to raise interest rates, which currently stand at 21%. Not enough to suppress inflation driven by state-mandated subsidized credit, but enough to keep price growth within bounds.
The upshot is that the problem with Chemezov and Nabiullina is not a fixable mistake but inherent in Putin’s choice to flatter public finances and (highly) control inflation. Something else has to give, including businesses that cannot turn a profit when borrowing costs exceed 20%.
At the same time, Putin’s credit privatization plan is brewing a credit crisis as loans become nonperforming. The state may bail out banks — if they don’t fail first. Given that Russians have experienced situations in which their savings suddenly became worthless, fear of a repeat of the past could easily trigger a self-fulfilling run. This would undermine the legitimacy not only of banks but also of governments.
In short, Putin has no time on his side. He is sitting on a ticking financial time bomb of his own making. The key for Ukraine’s friends is to prevent him from doing the one thing that would defuse the crisis: getting more outside funding.
The West has blocked Moscow’s access to some $300 billion in reserves, intervened in its oil trade and cracked down on its ability to import a range of goods. Taken together, these factors prevent Russia from directing all of its overseas earnings toward easing domestic resource constraints. Tightening sanctions and eventually transferring reserves to Ukraine as a down payment on reparations would exacerbate these constraints.
What troubles Putin is the sudden collapse of power. He must realize that this is the risk that his war economics entails. Increasing access to external resources through lifting sanctions, allowing them to recede, will be the goal of any diplomacy on his part. The West must convince him that this will not happen. Only in this way can Putin choose between attacking Ukraine and taking control of domestic power.
martin.sandbu@ft.com
