Pierre-Marie Meunier

September 11, 2024

Editor’s Note: This is an adaptation of an article originally published in Le Rubicon, which is affiliated with War on the Rocks.

Russia is faced with an insoluble equation: how to finance a war in the long term, for which expenditure is soaring while budget revenues are falling, against a backdrop of tightened sanctions. Between rising taxes, falling hydrocarbon revenues, inflation, and crises in employment and foreign investment, with a labor market short by 4.8 million workers (about 7 percent of the country’s labor force), and with the value of foreign assets in Russia dropping by almost 20 percent between December 2022 and March 2024, Russia has embarked on a risky gamble from which it will not emerge unscathed. Now spinning at breakneck speed on the momentum of its “war economy,” this Russian spinning top cannot slow down, or it will fall. But it may soon run out of momentum as well as finances. Russia’s economic future after 2024 rests essentially on the price of oil from the Urals and on the quantities exported, two subjects that are all the more uncertain for Russia in the near future. Russia may soon no longer be able to rely on its depleting financial reserves. With no possibility of borrowing on international financial markets, and constrained by a limited domestic financial market (in the context of China’s gradual disengagement), Russia risks nothing less than bankruptcy in the medium term.

Interpreting the 2023 Budget

The year 2023 is a perfect illustration of how Russia was forced to dip into its savings to balance its budget, and was also the first year of Russia’s “war economy.” According to the Russian Ministry of Finance, in 2022, Russia spent around 31.131 trillion rubles for 27.825 trillion in revenues, resulting in a deficit of roughly 3.306 trillion rubles. However, inflation was estimated at 13.8 percent for the year, with an unsurprisingly high GDP deflator of 15.8 percent. Faced with a large deficit and the prospect of a long war, Russia switched to a “war economy” at the end of 2022.

In 2023, Russia spent 32.364 trillion current rubles (up 4 percent on 2022, which would explain part of Russia’s growth according to the research firm Astérès) for 29.123 trillion in revenues (almost 5 percent up on the previous year), with a stable deficit of around 3.241 trillion rubles. This apparently linear progression of the various indicators between 2022 and 2023 in fact conceals major disparities.

On the spending side, Russia has made no secret of the drastic increase in its defense and security budgets, with military spending in 2023 estimated at over 6 trillion rubles or 3.9 percent of GDP, compared with 2.7 percent in 2021. Similarly, in a pre-election year, social spending has been maintained or even increased.

On the revenue side, things are more complex. Russian revenues are budgetarily divided between hydrocarbon revenues (oil and gas) and the remainder, so-called “non-hydrocarbon” revenues (value added tax, income tax, etc.). While oil and gas revenues have collapsed by 24 percent between 2022 and 2023, from 11.586 trillion rubles to 8.822 trillion, non-hydrocarbon revenues have risen from 16.238 trillion rubles to 20.301 trillion, an increase of 25 percent over one year.

Behind these other revenues are mainly value added tax receipts on domestic production and imports, which account for around 60 percent of this subtotal. These have risen by almost 22 percent year-on-year, a figure which should be seen in the context of Russian growth of 3.5 percent in 2023. The second revenue line, income tax revenues (around 10 percent of total revenues), rose by almost 15 percent, in line with rising wages and very low unemployment. The evolution of these two accounting lines is therefore consistent, at least in terms of trends, with what we know about Russia’s economic situation.

But there’s still around 30 percent of other revenues that aren’t detailed, but which nevertheless rose by 27 percent between 2022 and 2023 without any explanation of where these sums come from or what explains this substantial increase. If it’s not value added tax or income tax, what is it? According to the Regional Economic Service of the French Embassy in Russia, these unknown revenues actually cover several types of non-tax revenues received by the state: dividends from public companies returned to the budget, revenues linked to the management of the assets of the sovereign fund, fines, “ecological” tax on the import and production of automobiles, etc. But what remains unexplained is such an increase in the space of a year.

2023 Trade Balance in Freefall

This increase in Russian revenues in 2023, which remains unclear for the most part, cannot be explained by Russia’s trade balance. In fact, according to the Russian Central Bank’s 2023 data, recently published online, Russia exported fewer goods and services in 2023 than in 2022: in value terms, exports of goods and services fell by 29 and 17 percent respectively between 2022 and 2023, but imports of goods and services rose by 10 and 5 percent respectively.

As a result, Russia’s trade surplus will barely exceed $50 billion in 2023, compared with $238 billion in 2022 and $122 billion in 2021, a drop of almost 80 percent year-on-year. Admittedly, 2022 was a record year for Russian exports, but that was before Western oil sanctions came into force.

While the price of a barrel of crude oil from the Urals only bottomed out significantly in 2020 (the first year of the COVID-19 pandemic), it hardly ever fell below $55 a barrel after that date. Gas prices, on the other hand, fell sharply in 2023 after peaking in 2022. The drop in export revenues in 2023 is therefore probably due to the fall in gas prices, combined with the loss of European customers: 40 percent of European gas came from Russia before 2022, compared with 15 percent at the end of 2023.

The Russian trade balance for 2023 simply confirms what the Ministry of Finance’s figures were already saying: the increase in Russian budget revenues is primarily due to higher taxation in Russia (excluding value added tax and income tax). As of September 2022, the Russian government has decided to tax oil and gas companies, with the avowed aim of recovering 628 billion rubles by 2023. Voted into law in August 2023, an additional 10 percent tax on profits was introduced for companies with sales in excess of $10 million in Russia, including foreign companies. Although this text initially spared companies in the oil and gas sector, a month later the government decided to increase taxes on this sector too. This time, it hopes to raise around $37 billion in taxes from 2023 to 2025. However, it is not clear that this tax target will be met, given, for example, that Gazprom’s revenue collapsed by 40 percent in 2023 compared to 2022, and by 42 percent compared to 2021, another record year before 2022. As a result, the company is paying significantly less tax than before: While it was the biggest contributor to the state budget in 2022, paying just over 5.380 trillion rubles, it is expected to pay “only” 2.5 trillion rubles in 2023, despite the increased tax burden.

The increase in Russian revenues in 2023 is therefore largely based on the increase in taxation and catch-ups compared to 2022. Is the effort reproducible on an identical scale in 2024? Nothing is less certain, which does not prevent the Russian government from already thinking about the next tax increase — and it could be a huge one.

National Welfare Fund Cuts

Despite the generalization of tax increases, the Russian government has not managed to prevent the budget from being in deficit in 2023, as in 2022. How does it remedy this situation? In addition to the loans that Russia can still contract on its domestic market (around 2.5 trillion rubles in 2023), the unknown share of Russian revenues is also likely to come from substantial withdrawals from Russia’s reserve fund, its major sovereign wealth fund, the National Welfare Fund — the Russian “wool bank” into which oil revenues are normally deposited to finance pensions and infrastructure.

Indeed, in January 2024, a cryptic statement from the Russian Ministry of Finance on the use of the National Welfare Fund read:

Part of the funds of the National Welfare Fund deposited in accounts with the Bank of Russia in the amount of 114,947 million Chinese yuan, 232,584 kg of gold in impersonal form and 573 million euros were sold for 2,900,000 million rubles. The proceeds were credited to a single account in the federal budget to finance its deficit.

Over the whole of 2023, Russia withdrew 2.9 trillion rubles from its “savings account.”

This is all the more necessary as Russia no longer has access to international financial markets: Russia has been considered to be in default since 2022. Sanctioned by both the European Union and the United States, it cannot issue debt in dollars or euros. The principle isn’t necessarily embarrassing for Russia, since it has managed to run a budget surplus most of the time. But Russia is now “forbidden to overdraw” by Western countries (bearing in mind that even China is becoming increasingly reluctant to finance Russia): It doesn’t matter whether it has little or no debt, since it can no longer really go into debt as Western states can. The federal budget deficit must therefore be financed in other ways.

In any case, this use of the National Welfare Fund is not exceptional: This had already taken place in 2022, in the amount of 2.412 trillion rubles, when the Russian Ministry of Finance sold off its reserves of Japanese yen, dollars, and pounds sterling, currencies deemed “toxic” by the Russian authorities. The 2023 drawdown was not unexpected either: The Russian Ministry of Finance announced it as early as August 2023. In the same press release, it also announced the amount planned for 2024: 1.3 trillion rubles, half the size of the previous year’s drawdown. Is 2024 looking better for Russian finances? Nothing is less certain.

Russia’s Economic Context

Russia’s GDP in 2024 is expected to grow at the same rate as in 2023, when it expanded by 3.6 percent, according to Russian Finance Minister Anton Siluanov. In any case, Russian growth is artificial, “bought on credit.” It’s a sort of Russian Keynesianism, aimed primarily at the military-industrial complex, as explained by Alexandra Prokopenko, a former Russian Central Bank official and now a contributor to the Carnegie Russia Eurasia Center. At the end of December 2023, the Russian Central Bank warned that the Russian economy was in danger of overheating.

This overheating can be seen first and foremost in the Russian unemployment rate, since below a certain threshold of frictional unemployment (job changes, professional transitions, training, etc.) an unemployment rate equivalent to that currently experienced in Russia reflects above all a labor shortage: At the end of 2023, the Russian media were reporting a labor shortage estimated at 4.8 million jobs. In August 2023, the Russian minister for digital development was already talking about a shortage of 500,000 to 700,000 information technology workers, in addition to 400,000 unfilled positions in the defense industry, whose products are currently in very high demand. According to Oleg Deripaska, a Russian oligarch in the metallurgy and mining sector, the fundamental problem is above all one of investment in production structures, with industries that are too poorly automated compared to their Western equivalents, and therefore still highly labor-intensive. Added to this internal Russian constraint is the fall in foreign investment in Russia, given the sale of assets by companies leaving Russia: $27 billion in foreign investment in 2021, compared with $40 billion in withdrawals in 2022 and $8 billion in 2023.

Inflation is Russian Central Bank’s number one concern for the coming years. In November 2023, when presenting its forecasts for 2024, the Russian Central Bank referred to a “risk scenario” in the following terms: If inflation gets “out of control,” the Russian Central Bank could be forced to raise its key rate to 16 or 17 percent in 2024. This was a month before the key rate was raised to 16 percent, with inflation over 2023 estimated at 7.5 percent, far from the 4 to 4.5 percent range the Russian Central Bank was aiming for. Still according to the bank, which chooses its words carefully, the persistence of high inflation is due to “domestic demand far exceeding the estimated growth in production capacity for goods and services.” However, given the labor shortage, the drop in certain investments ($315 billion in foreign direct investment “stocks” in September 2023 versus $442 billion in December 2022, for example) and the Kremlin’s ambitions to further increase military spending in 2024, it is highly unlikely that inflation will fall in 2024. In fact, in 2024, the Russian Central Bank reported inflation as high as ever in all its inflation reports over the year.

(c)WARONTHEROCKS 2024