The news
Russia’s central bank tightened its monetary policy on Friday, raising its key interest rate to 19% as Moscow’s war in Ukraine weighs on inflation.
The bank warned it could raise rates further at its next meeting in October, in a bid to bring inflation down from 9.1% to its target of 4% in 2025.
While Russia’s economy has continued to grow this year, an increasing portion has gone toward supporting the war effort. The surge in defense spending has fueled the country’s stubbornly high inflation, which the bank said shows no signs of abating.
SIGNALS
Russian war spending fuels inflation
Russian government spending has almost increased 50% since 2021while the Kremlin pumps money into its military and defense sectors to maintain the war in Ukraine. But President Vladimir Putin faces a challenge to “finance his ongoing war against Ukraine, maintain the living standards of its people and ensure macroeconomic stability“all at once,” a former employee of Russia’s central bank wrote in Foreign Affairs. Spending to keep the war going is likely to keep inflation high and worsen the country’s economic problems, the former official added. While few analysts believe current levels of defense spending are sustainable, Moscow’s substantial reserves mean it will likely be able to continue financing the war at current levels for two to three yearsaccording to an analyst at the Carnegie Russia Eurasia Center.
Invasion of Ukraine has worsened labor shortages
Unemployment in Russia is at a historic low as increased military spending has left the defense industry desperate for more workers. According to Russian media, there is a labor shortage of nearly 5 million workerswith the defense industry alone estimated to be under 400,000 employees. The lack of employees is aggravated due to several factors, including a decline in migrant workers from Central Asia, the tens of thousands of workers joining the army each month and a war-induced exodus from Russia, The Bell, an independent Russian economic outlet, reported. Companies are resorting to drastic wage hikes to lure workers, which is also fueling inflation.
Russia raises taxes to keep funding military
Russia plans to implement its first major tax reform in 20 years next year, which Moscow expects will add an estimated $30 billion to revenues. The move will “enable Russia’s leaders to balance the budget without reducing military spending,” wrote an analyst for Carnegie Politika. The tax hike targets Russia’s wealthiest citizens, allowing Putin to portray it as a “social justice” measure rather than an attempt to finance the war. But the Tax hike may not generate the revenue the Kremlin hopes forwrote a former French intelligence officer in War on the Rocks. Because the revenues of large companies like Gazprom have plummeted, companies may end up paying less tax than before, even at the higher rate.
