Russia’s economy, overheated by unprecedented Kremlin spending on its Ukraine invasion, may soon face a sharp slowdown as constraints tighten on key growth sectors.
With labor resources nearly depleted, competition for recruits between the military and businesses is stifling further expansion in defense-related industries.
The construction and banking sectors, once insulated by state-subsidized mortgage programs, are now feeling the squeeze from soaring interest rates after many of these programs ended last month.
The economy saw a 4% annual GDP increase in the second quarter, according to a preliminary estimate from the Federal Statistics Service.
But economists surveyed by Bloomberg predict growth will halve in the latter part of the year.
This could be the final growth spurt before the economy takes a significant hit, according to Alex Isakov, a Russian economist at Bloomberg Economics.
He forecasts growth slowing to about 2% in the second half and dipping to just 0.5%-1.5% next year.
Government spending surged after the February 2022 invasion, flooding the military and defense sectors with funds while cushioning domestic businesses from the impact of Western sanctions.
This spending spree pushed the economy to a level of overheating unseen since before the 2008 financial crisis, according to Bank of Russia Governor Elvira Nabiullina, driven by a surge in domestic demand.
Reserves of labor and production capacity are almost exhausted, Nabiullina remarked.
To combat the risks of stagflation, the central bank raised the key interest rate by 200 basis points last month, bringing it to 8.5%, the highest since the war’s early days, as inflation continued to rise.
Unemployment, a telltale sign of economic overheating, has dropped to a historic low of 2.4%, lower than any of the G7 nations.
Businesses are grappling with a shortage of over 2 million workers, according to the Federal Statistics Service.
Even the Bank of Russia had to halt its armored cash collection services due to a shortage of employees, many of whom left for defense factory jobs.
The military’s ongoing demand for recruits further strains the labor market, especially as the government raises recruitment bonuses to bolster its ranks.
Signs of cooling appeared in June, with construction growth hitting its lowest level since 2020.
Military-driven manufacturing expansion halved compared to May, and wholesale trade, including energy sales, slowed to under 2% growth from previous double digits, according to Economy Ministry data.
Policymakers are eyeing the June and July slowdown as a potential indicator of cooling domestic demand, according to minutes from the Bank of Russia’s latest rate-setting meeting.
However, the limits on production capacities suggest inflationary pressures could remain elevated despite the bank’s efforts to tame them.
It might be too soon to declare a downturn, warned Tatiana Orlova, an economist at Oxford Economics, noting that the June data could be an anomaly.
Nonetheless, growth is expected to ease in the second half of the year, especially after the monetary tightening and the conclusion of the popular mortgage subsidy program, which is likely to hit construction hard.
Capital investment remains robust, defying expectations and potentially testing the limits of economic growth in the long term.
Sanctions have driven investment into domestic production of aircraft parts, equipment, electronics, and components, according to Ildar Mukhamediyev, director of procurement platform TenderPro LLC.
Investment activity in Russia hasn’t slowed, Mukhamediyev said, citing a survey showing a 70% surge in capital projects in the first seven months of the year compared to the same period in 2022.
But capital investment is just one piece of the puzzle. Labor shortages and technological constraints could pose bigger challenges as Russia’s war drags into a third year.
Russia’s growth potential is hampered by several issues, including low population growth, high labor costs, and a poor investment climate, noted Orlova at Oxford Economics.
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