Russia’s economy on the verge of stagflation due to military spending – Newsweek
29 July 2024 09:49
Russia’s central bank has predicted a drop in the country’s economic growth and announced a sharp increase in the key interest rate to curb rising inflation and overheating of the economy. This is stated in the material of Newsweek, reports "Komersant Ukrainian"
Russia’s central bank has raised the key rate at which other banks can borrow money from 16% to 18%, not far from the 20% announced at the start of the war. Bank Governor Elvira Nabiullina did not rule out further rate increases. Nabiullina has steered Russia’s economy through the turbulence caused by Western sanctions aimed at curbing Putin’s war machine.
Although the Kremlin boasts a projected GDP growth of 2.9% for this year, it has been driven by record military spending on the war. Huge military losses and a massive outflow of people fleeing mobilisation have created a labour shortage, fuelling wage growth and inflation as further macroeconomic challenges are expected in the coming years.
“The inflationary risks associated with the sanctions have materialised,”
– nabiullina said at a press conference on Friday. This calls for “tighter monetary policy” to curb the current annual inflation rate of 8.6%.
Bartosz Sawicki, a market analyst at fintech company Conotoxia, argues that Russia is trying to put out a fire.
“Initial plans to start cutting rates in the second half of the year had to be abandoned as inflation showed signs of getting out of control. “Instead, additional monetary tightening had to be implemented in an attempt to cool down the overheated war economy,” he said,
– he says.
Nabiullina predicts that Russia’s GDP will grow to 4% this year, but that growth will fall in 2025 to a maximum of 1.5%, or 0.5% in the most pessimistic scenario, eight times less than the 2024 forecast.
“The overheating in the economy remains significant, and the reserves of labour and production capacity are almost exhausted. This is actually a stagflation scenario that can only be stopped by a deep recession,”
– the Russian official said, adding that the Central Bank’s decision would help prevent such a scenario.
Stagflation
Stagflation is an economic phenomenon characterised by the simultaneous combination of high inflation, slow economic growth and high unemployment. The term originated in the 1970s when many developed countries faced a similar situation.
Under normal conditions, economic theory suggests that inflation rises when the economy is growing rapidly and unemployment is low. In contrast, in stagflation, the economy stagnates (hence the first part of the word “stag-“), but prices continue to rise (hence the second part of “-flation”).
Stagflation is a particularly challenging problem for economic policy, as measures aimed at fighting inflation (e.g., raising interest rates) can worsen economic growth and employment. Conversely, attempts to stimulate the economy can lead to further inflation.
The causes of stagflation can be diverse, including supply shocks (e.g., a sharp increase in oil prices), ineffective economic policies, structural problems in the economy, or a combination of these factors. Overcoming stagflation often requires complex and painful economic reforms, which may include changes in monetary and fiscal policy, as well as structural reforms to improve the productivity and competitiveness of the economy.
