Russia's looming economic crisis: High defence costs threaten collapse

At first glance, the Russian economy appears surprisingly resilient to Western sanctions. In 2023, the gross domestic product grew by 3.6%, and in 2024, growth of 3.9% is expected. Unemployment dropped from 4.4% before the war to 2.4% in September 2024. Moscow has significantly expanded its military forces and defence production, adding more than 500,000 workers to the defence industry and about 180,000 to the armed forces.

Despite impressive statistics, the reality is not so optimistic. 1,000 days of war are costing the Moscow regime significantly. The question of the Kremlin's further capabilities is particularly relevant in the context of the conflict's escalation. This was triggered by reports of Ukraine being allowed to attack deep into Russia using ATACMS missiles. Vladimir Putin reacted to these reports by threatening nuclear war.

Meanwhile, Russia is unable to produce enough weaponry to offset battlefield losses. About half of all artillery shells used by Russia in Ukraine come from North Korean stockpiles. According to analysts from "The Economist," in the latter half of 2025, the country will encounter serious shortages in several categories of weaponry.

The challenge with producing barrels for large-calibre guns is particularly significant. Based on video documentation, it has been determined that the Russian military loses more than 100 tanks and approximately 220 artillery pieces on average each month. Producing barrels requires special rotary forges, each weighing about 20 to 30 metric tonnes, which can only produce about 10 barrels per month. Russia has only two such forges.

In October, Russia's central bank raised interest rates to 21%, the highest level in two decades, and market analysts predict they could rise to as much as 23% by the year's end. This is an unusual situation during wartime when central banks typically avoid stifling economic activity. Defence expenditures have officially risen to 7% of GDP and are expected to consume over 41% of the state budget next year.

According to The Economist, the real scale of military expenditures is much higher. Nearly 560,000 internal security force soldiers, many of whom have been deployed in occupied Ukraine, are financed outside the defence budget. The same applies to private military companies that have sprung up across Russia.

China has become Russia's most important trading partner, supplying one-third of all imported goods and over 90% of the microelectronics used in drones, missiles, and tanks. However, this support is not offered for free. Russian officials have to monitor their currency's value against the yuan closely. This year, the ruble lost 10% of its value, nearing its lowest point since the war began.

Until recently, the Russian government was mitigating the impact of high credit costs on the economy. Various programs allowed households to suspend debt repayments and firms to take loans at lower, subsidized interest rates. The state compensated banks for lost income. However, there are signs that such programs are becoming too costly.

The mortgage credit subsidy program, which allowed borrowing at a cost of just 8% when official rates were much higher, ended on July 1. In the following month, the volume of mortgage loans decreased by half. Business bankruptcies have increased by 20% this year. The Russian Union of Industrialists and Entrepreneurs estimates that investment plans for next year are being put on hold due to high borrowing costs.

According to "The Economist," the authorities in the Kremlin face difficult choices because Russia will not be able to continue the war at the current level after 2025. It will then begin to feel a shortage of key weapon systems. However, reaching a peace agreement creates a different set of issues. If it reduces the size of its armed forces and defence industry, it could trigger a recession that could threaten the regime, analysts from the British newspaper evaluate.

In their opinion, if Russian policymakers maintain high defence spending and an oversized army during peacetime, it will suffocate the Russian economy, displacing civilian industry and stifling growth. With the memory of the Soviet Union's collapse due to similar economic reasons, Russian leaders will likely want to avoid this scenario.

However, there is a third option that may seem tempting to Russian leaders. Instead of demobilization or bankruptcy, they could use their army to acquire the economic resources needed to sustain it. "The Economist" claims that conquest and the threat of its use could be leveraged to fund the army.

Significant gas deposits have been discovered in the Black Sea in Ukraine and Georgia's internationally recognized exclusive economic zones. As Western countries are occupied with other priorities, Russia could resume aggression against Ukraine to seize control of its agricultural resources, gas, and rare earth elements. Moscow could also use threats of force to pressure European countries into lifting sanctions, unlocking Russian assets, or reopening gas and oil pipelines.

Higher interest rates will limit spending by both businesses and consumers. The World Bank expects Russia's economic growth to slow sharply to 1.3% next year. Even the state development bank VEB has lowered its growth forecast to 2%. The combination of lower investment and labour force loss on the front lines impacts.

Maintaining the ruble's value to pay for key imports is a serious problem for Vladimir Putin. This may soon impact his ability to wage war. The leader of Russia may be counting on Donald Trump to keep his promise to end the conflict. Waging war with interest rates at 3% is one thing, but 21% is a completely different matter, assesses "The Economist."