‘Slow death’: Russia in deep trouble as its rainy day fund runs dry

Vladimir Putin is nervous. Almost three years into his war in Ukraine, the Russian president is increasingly concerned about the state of the economy.

The cost of borrowing has surged to painful levels, as interest rates of 21 per cent pile pressure on companies. The strain is such that Putin has reportedly been scolding officials over a drought in private investment.

Russian President Vladimir Putin. Russia’s economic resilience has surprised many, but signs of fragility are starting to emerge.Credit: AP

Unsurprisingly, Russia’s oligarchs are squirming. Igor Sechin, the boss of Rosneft, and Oleg Deripaska, the billionaire aluminium magnate, are among those who have publicly criticised high interest rates.

Deripaska warned in 2023 that Russia could soon run out of money, and other senior officials are also beginning to ask themselves the same question.

The country’s wealth fund is being depleted, with the liquid portion of assets now down to just $US38 billion ($60.7 billion), from roughly $US100 billion at the start of 2022.

And while Russia’s economic resilience has surprised many, signs of fragility are starting to emerge.

Prices are rising at an annual rate of 9.5 per cent in Russia. While this is far from the peak of 17.8 per cent seen in the immediate aftermath of the invasion three years ago, the factors driving up prices today are much more problematic.

The combination of massive war spending – equivalent to more than 6 per cent of its economy – and acute labour shortages suggests that squeezing inflation out of the system is going to prove difficult.

Russia’s central bank is also under pressure to slow down its aggressive campaign of rate hikes, with three words from Putin in December seemingly able to do the trick.

Governor Elvira Nabiullina kept borrowing costs on hold at its last meeting in December, the day after Putin called for a “balanced rate decision”. Analysts had expected the central bank to raise rates to 23 per cent.

Pressure is building on Russia’s economy as inflation soars.Credit: Bloomberg

Benjamin Hilgenstock, a senior economist at the Kyiv School of Economics (KSE), believes Russia is suffering a “slow death”.

While he does not believe Russia is at imminent risk of running out of cash, policymakers are increasingly resorting to what he describes as “unorthodox” measures to keep the economy afloat.

The value of Russia’s rainy day fund – otherwise known as the National Welfare Fund – stood at $US117 billion, or 6.6 per cent of gross domestic product (GDP) at the end of last year. However, the liquid portion declined to $US38 billion after a large chunk was used to fund day-to-day spending.

Its liquid assets – held mainly in Chinese yuan and gold – have dropped by 60 per cent since the start of the war, according to the KSE. Based on recent trends, this could run dry within two to three years.

The rest of the fund consists of shares in state-backed Sberbank and $US40 billion in illiquid assets that cannot be sold easily.

Hilgenstock highlights that as long as Russia controls its own currency, Putin will have enough money to continue his warmongering, even though it will be far from cost-free.

“Ultimately the war is paid for in roubles, so Putin can’t actually run out of money,” he says. “It just means the further along we get, the more painful it’s going to become to fund the war. But that doesn’t mean it’s impossible.”

Hilgenstock adds that Putin would need to start issuing more domestic debt: “There doesn’t seem a huge appetite to buy it, even at relatively high interest rates, but we’re talking about a country with a largely state-owned banking system, so you can basically force your banks to buy it.”

Russia’s central bank made it easier for lenders to tap extra liquidity at the end of last year that in theory could be used to buy more domestic bonds.

At the same time, an increasing number of loans in the economy are being offered at subsidised interest rates, which threatens to make Russia’s inflation problem worse.

Hilgenstock says: “You can ultimately print money for the war if you want to, right? But it’s a very bad idea. We’ve got rising inflation, and the central bank has to address that by increasing interest rates. But if a lot of the loans in the economy are at subsidised rates, then you have broken the monetary policy transmission mechanism, and your higher interest rates are not effectively fighting inflation.”

‘High risk’ of banking crisis

Even Russia’s central bank has sounded the alarm, albeit in a more diplomatic way. Its latest interest rate decision warned that the “balance of inflation risks is still significantly tilted to the upside”.

Billionaire aluminium magnate Oleg Deripaska is one oligarch who has publicly criticised high interest rates.Credit: Bloomberg

Others are more blunt. “The Russian economy is facing the threat of a large-scale surge in corporate bankruptcies,” wrote researchers at the TsMAKP think tank that advises the government.

They added that by the end of 2024, one in five companies had interest payments at a “risky” level of two thirds of adjusted earnings.

Capital Economics believes Russia is “now at high risk of a banking crisis”.

Liam Peach, at the economic consultancy, said: “There are certainly reasons to be concerned. Bank lending is running hot at 20 per cent annually despite very high interest rates, particularly the corporate loan segment. Loan quality has declined, with a high share of unsecured lending to individuals with low debt service capacity.

“Central bank data show that 25 per cent of outstanding corporate loans have a maturity of one year or less and more than half of new corporate loans extended by banks are floating rate, which leaves them exposed to high and rising interest rates.”

However, others believe the charade can continue for years.

Tatiana Orlova, an economist at Oxford Economics, says the wealth fund will continue to bankroll Putin’s war effort for the foreseeable future: “Three years ago when the war was beginning people said ‘Oh they’re very quickly going to spend the whole of the fund and then basically that will be the end of it’. But there is more fiscal resilience than people had previously expected.”

She says banks are being buoyed by an influx of deposits: “I travelled to Russia four times last year, and everyone I talk to in Moscow is asking, ‘Where do I put my savings to maximise my interest rate?’ ”

‘You can ultimately print money for the war if you want to, right? But it’s a very bad idea.’

Benjamin Hilgenstock, a senior economist at the Kyiv School of Economics

However, Orlova still believes Russia is headed for recession this year. “Monetary policy is very tight and fiscal policy is also going to be tight, and this is basically suffocating growth.”

Hilgenstock believes a change of administration in the US won’t be enough to end the war on its own. He says tougher sanctions are needed in order to make Russia think twice.

Russia is now the biggest supplier of oil to China, with India also snapping up barrels at a discount in order to partially make up for a shortfall in shipments to the West.

Hilgenstock says: “If you take actually some Russian oil off the market [instead of allowing it to be sold at a discount], then I think Russia very quickly will be in a situation where macro stability is fundamentally undermined. But for now, we do not live in this world.

“The world we live in right now is one of a slow death of the Russian economy. But that doesn’t at any point, exert the kind of pressure that you need to actually get Putin to move away from his deep commitment to this war.”

As a result, British and European officials believe the West’s support for Ukraine must be unwavering.

One senior European security source says: “One of the things I find most frustrating about Ukraine and not being quite all in, in the way we should be, is that I can see down the track that in two, three years’ time, Putin is going to be in big trouble if we hold our nerve.”

Telegraph, London

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