Putin Struggles with Falling Ruble, Rising Prices as Sanctions Bite

REUTERS/Maxim Shemetov
Noctilucent clouds are seen over the Kremlin in Moscow, Russia July 4, 2023.

LONDON – When Russian President Vladimir Putin addressed top economic officials last week after a bruising month in which the Russian ruble plummeted to a 16-month low against the U.S. dollar, the Russian president sought to set a confident tone. The Russian economy, he said, was growing again and wages were rising.

But despite the show of bravado, Putin could not avoid mentioning a growing weakness that is stalking the economy as Western sanctions bite ever deeper, and one that has been exacerbated by the ruble’s plunge.

“Objective data shows that inflationary risks are increasing, and the task of reining in price growth is now the number one priority,” Putin said, with a note of tension in his voice. “I ask my colleagues in the government and the Central Bank to keep the situation under constant control.”

Rapidly rising prices caused by a 20 percent drop in the value of the ruble between early June and mid-August and the government’s pouring of funds into Russia’s defense industry are bringing Russia’s war – and the impact of sanctions – home to many Russians for the first time, economists say.

“The Russian people have been isolating themselves from these political developments, but the inflation rate is something they can’t isolate themselves from because they have to pay,” said Janis Kluge, an economist at the German Institute for International and Security Affairs. “It is a way in which politics really interferes in their lives, and this is the part which is worrying for the Russian leadership. Because no propaganda will make this go away.”

Russia’s Central Bank forecasts inflation will reach up to 6.5 percent by the end of 2023. But economists say the rapid ruble devaluation could fuel a further surge in prices over the next 3 to 6 months and the inflation rate could reach double digits by the end of the year, even after the Central Bank made an emergency hike this month to its key interest rate, now at 12 percent, to try to counter that.

With imports still making up to 40 percent of the average Russian consumer basket, two recent surveys show Russians have already started to reduce spending. One published Aug. 16 by Russia’s largest market research agency, Romir, found that 19 percent of respondents had begun cutting back on purchases of basic goods such as toothpaste, washing powder and food in July, compared to 16 percent the month before.

The ruble’s loss of more than a third of its value since November last year to a large degree is a result of sanctions imposed on Russia’s energy exports at the end of 2022, when the European Union banned most Russian oil imports and the G-7 group of nations imposed a price cap on Russian crude sales elsewhere, decreeing its oil could be sold for no more than $60 per barrel.

Even though Russian oil traders have sunk into the shadows, deploying phantom fleets seeking to sidestep the curbs, the measures, combined with a sharp reduction in Russian gas exports to Europe, have deprived the Russian budget of a key source of revenue, with income from energy exports falling 47 percent the first half of 2023, compared to the same time the previous year.

At the same time, Russia’s turn to gray import channels to avoid export controls – through countries such as Turkey, China and Central Asian states – have brought imports back to prewar levels, further putting pressure on the ruble.

Russian officials are grappling with the transformative economic consequences of Putin’s war against Ukraine, analysts say. The government has doubled its defense spending target for 2023 to more than $100 billion, pumping in more than $60 billion in budget funds into the defense industry in the first half of 2023, according to government figures disclosed this month by Reuters, to feed its war machine.

The spending spree has propped up the Russian economy against the most deleterious effects of Western sanctions, allowing the Kremlin to tout a return to overall economic growth, forecast by the Russian Central Bank at 1.5 to 2.5 percent, and by the International Monetary Fund at 0.7 percent, following a contraction of 2.1 percent last year.

But it is also creating a huge imbalance in the Russian economy, exacerbating inflation as defense enterprises work round-the-clock and worsening labor shortages caused in part by the mobilization of conscripts to the front in Ukraine and by the hundreds of thousands of Russians fleeing abroad since the start of the war.

A survey conducted by the Gaidar Institute in Moscow found that 42 percent of enterprises surveyed complained of a lack of workers in July. In a sign of increasing desperation, Putin last week decreed that restrictions on employing teenagers as young as 14 should be lifted, to cope with the labor shortages, according to a list of presidential orders published on the Kremlin’s website.

“Past assertions that sanctions would bring the Russian economy crashing down were wrong then and remain so,” said Mark Sobel, who served as deputy assistant secretary for international monetary and financial policy at the Treasury Department and is now a senior adviser at the Center for Strategic and International Studies, a D.C.-based think tank. “But the impact of Western actions against Russia has been crippling, and will be long-lasting.”

Despite the impact of oil export curbs, the Biden administration is resisting pleas from the Ukrainian government to slash the oil price cap from $60 to $30 per barrel, because it fears that could prompt Russia to cut oil production and cause gas price spikes, roiling the global economy just as the United States heads toward presidential elections in 2024, according to people familiar with the matter who spoke on the condition of anonymity to discuss internal deliberations. Any such maneuver would also require the support of European lawmakers, and risks undermining support for the Ukrainian war effort, these people said.

“That is the central tension they are wrestling with,” one of the people said.

A Treasury Department spokeswoman declined to comment.

Oleg Ustenko, an economic adviser to Ukrainian President Volodymyr Zelensky, said it is imperative for the West to take collective action. “We need significant downward pressure on the price cap, or the Russians will have enough cash on hand to continue this war,” Ustenko said.

Elina Ribakova, a senior fellow at the Peterson Institute and director of International Programs at the Kyiv School of Economics, said that without further pressure on Russian oil revenue, the Russian authorities would probably weather any inflation spike, even if the rate heads toward low double digits.

“I don’t think inflation is going to be a big issue unless the government has to start printing money to support the budget,” Ribakova said. “If there is some success in tightening Russia’s evasion of the oil price cap, and Putin wants to hike social spending, then that will be challenging. If we see the budget deficit for next year is going to be around 6 to 7 percent of GDP, then that is going to be challenging.”

Others said the inflationary impact was already raising questions about the longer-term sustainability of Putin’s tactics. In a sign of the nervousness, Deputy Trade and Industry Minister Viktor Yevtukhov met with retail chiefs this month and demanded that they limit any price hikes, Russian newspaper Izvestia reported.

The increasing inflationary pressures risk turning Russia’s economic woes into political ones, Kluge said. “The question is how much inflation is the Russian population going to tolerate?”