Russia’s out-of-control military spending

With spending on the war in Ukraine potentially accounting for 45% of Russia’s budget by the end of the year, what are the implications for the rest of the economy?

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Russia’s out-of-control military spending

Illustration: Anastasia Krzysztof, exclusively for Novaya Gazeta Europe

The Russian economy has been profoundly affected by the war in Ukraine, with the 37% of national spending that currently goes on defence predicted to rise to as much as 45% by the year’s end. As well as contributing to the ruble’s continuing fall, the massive increase in military spending is creating wider problems for the country’s economy that risk repeating the mistakes of the past.

Every third ruble spent on the war

Citing a classified document as the basis of its reporting following the decision to classify much of Russia’s federal budget, Reuters recently reported that 5.6 trillion rubles (€53.1 billion) was spent on national security in the first half of the year, 600 billion rubles (€5.7 billion) more than the amount originally budgeted for 2023 and a 75% year-on-year increase.

Spending on national security already accounts for 37% of this year’s budget, compared to 26% in the previous year. According to Reuters, spending on security will reach 9.7 trillion rubles (€92 billion) by the end of the year, almost twice the amount allotted by the 2023 budget.

In the first six months of 2023, total budget expenditure rose to almost 15 trillion rubles (€142.3 billion), an increase of 2.5 trillion rubles (€23.7 billion) on the previous year, with defence spending responsible for almost the entire difference, economic analyst Boris Grozovsky told Novaya-Europe.

The Russian government has simultaneously increased military spending while decreasing spending in other sectors, which is “why budget statistics are no longer being released,” Grozovsky added.

National security is not the only part of the budget used to finance the war, directly or indirectly, and all other budget spending that has been classified can reasonably be assumed to be war-related costs as well, Grozovsky believes.

If we add some 2.9 trillion rubles (€27.5 billion) of classified expenditure elsewhere in the budget to that additionally needed for national security, the actual total of Russia’s military spending could reach just under 13 trillion rubles (€123.3 billion) by the end of the year.

That’s around 45% of the country’s budget spending, and some 8% of Russia’s GDP. By comparison, the USSR officially spent 15% on defence, although the real figure was more likely to have been 30-40% of GDP, economist Konstantin Sonin of the University of Chicago said recently, while conceding that the Soviet Union’s planned economy made direct comparisons with contemporary Russia inexact.

The rise in military spending inevitably means spending cuts in other sectors of the economy. The biggest loser in financial terms was Russia’s infrastructure budget, which was slashed from 4.4 trillion rubles (€41.7 billion) in 2021 to 3.5 trillion rubles (€33.2 billion) in 2023.

Just how much is currently going on non-military spending is unclear due to the classification of key parts of the budget.

Trust deficit

Sonin blames the continuing fall of the ruble on Russia’s rapidly growing military spending, though economist Tatiana Mikhailova of PennState University told Novaya-Europe she believed the main cause of the budget deficit to be the enormous amount of waste.

By August, Russia’s budget deficit had already reached 2.7 trillion rubles (€25.6 billion), just shy of the 2.9-trillion-ruble planned deficit for the entire year. The Finance Ministry is for now able to cover the shortfall by selling federal loan bonds to Russian banks, the biggest of which are state-owned.

The militarisation of the economy and the deficit increase have resulted in much of the Russian public losing faith in both the economy and the ruble, believes Mikhailova, who also points out that debt has become more costly for the government due to higher rates on loan bonds.

When the government borrows money under normal circumstances, it’s normally spent on one form of development or another, ultimately enabling the repayment of government debt, explains Mikhailova. However, as Russia is currently wasting trillions of rubles a year on the war in Ukraine, all the while experiencing population shrinkage both on the frontline and through migration, its creditors are increasingly wary of the government defaulting on its debts, which in turn places additional pressures on the ruble.

“The government is supposed to repay these debts in the future. That could be achieved by cutting its spending on the war and giving money to its citizens. But that’s not what’s happening. Instead, the state is just printing money,” Mikhailova says.

As quantitative easing causes inflation that in turn reduces the value of Russia’s ruble debt, Russia’s creditors could end up profiting far less in real terms from their loans, even if they’re repaid in full.

Resorting to desperate measures including the hiking of the key rate and pressuring exporters to sell other currencies, the government has so far managed to keep the ruble from slipping below the key psychological threshold of 100 rubles to the dollar, but these methods can only delay the inevitable. Meanwhile, market analysts scour news from the frontlines for clues about whether or not the war will end anytime soon, Mikhailova says.

‘Rich young patriots’

At first glance, massive military spending is a good thing for the Russian economy — GDP grew 1.4% in the first half of 2023 compared to the same period last year, with second quarter growth standing at 4.6%.

Figures published by Russia's State Statistics Service also indicate that

Russia’s industrial sector is faring well overall, with growth since the start of the year standing at 2.6%, and a 4.9% bump reported in July.

However, these figures belie the structural transformation of the Russian economy from a market economy to a military one.

Industry is witnessing the continuation of a trend first seen at the start of the war. While manufacturers of vehicles, computers, and other hardware required by the military are seeing high growth rates of between 25% and 35%, non-military sectors are still trying to get back on their feet following the imposition of sanctions last year, with many still deep in the red. Some are still seeing their sectors shrink, as is the case with pharmaceutical manufacturers.

The labour market has been quick to respond to both mobilisation and the displacement of Russia’s market economy by the military-industrial complex. By the end of last year, according to the State Statistics Service, an additional 400,000 people were employed by the defence sector. At the same time, Russia’s non-military sectors had undergone the loss of anywhere between 100,000 and 300,000 employees.

The dragnet of mobilisation on top of Russia’s long-standing demographic challenges have together led to a serious shortage of staff. The fact that unemployment currently stands at a historically low 3% is actually a negative indicator rather than a positive one. The latest statistics show that salaries have grown by 16%, stoking consumer demand for imported goods, an additional factor in the weakening of the ruble.

By continuing to financially incentivise employment in the military sector, the state is bringing about the emergence of a new social class of “rich young patriots”, economist Dmitry Belousovto argues — men who survived their military service in Ukraine and have now been given generous financial rewards by the state.

The ever-increasing military budget may provide a measure of support for certain other parts of the economy in the short term, but the relief is only temporary. “This stimulus will not result in long-term development and as soon as the money runs out or the war ends it will disappear,” Mikhailova predicts, noting that Russia’s post-Soviet experience demonstrated that militarised industries cannot easily be repurposed as civilian ones.

Also looking to the Soviet collapse for what it can tell us, Konstantin Sonin speculated recently that many Russians employed in the country’s military-industrial complex today would be forced to seek new jobs in different sectors after the war, leaving millions of highly qualified specialists unemployed, just as they were 30 years ago.

Economist Vladislav Inosemtsev told Novaya Gazeta in July that he estimated anywhere between 2-3 million Russian workers would be affected by the shrinking of the military-industrial complex that will have to take place after the war.

It’s impossible to predict what will happen once the war in Ukraine ends, Boris Grozovsky says. “We have no clue about the when, the how, or the why of the military-industrial complex and the military getting less funding, whether that happens due to a budget crisis, losing the war, or something else entirely,” he says.

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