Europe

The Bank of Finland’s Institute for Emerging Economies (BOFIT) expects Russia’s annual GDP growth to slow to around 2 % this year and about 1 % in 2026 and 2027.

Russian growth in recent years has been driven by surging government spending on the war in Ukraine. We expect government spending to increase further this year, but production is already stretched to capacity, limiting potential for further output gains. The country’s labour shortage has grown more acute, inflation is accelerating and sanctions are limiting Russia’s foreign trade. Although a full-blown economic crisis in the immediate future is unlikely, Russia’s economic development is subject to exceptionally high risks as long as it continues the prosecute its war in Ukraine.

• Output growth is expected to slow even with the expected increased government spending. Labour shortages and production capacity constraints mean that growth levels of earlier years are now out of reach, so inflation will accelerate.

• Investment possibilities are limited by decreasing earnings, rising labour and material costs, as well as an increased tax burden from higher tax rates. Total investment, however, will be sustained by budget financing and other government support measures.

• The outlook for private consumption is also bleaker. Purchasing power has been eroded by lower wage growth and rising inflation, and consumer expectations have dimmed. Consumer credit has become more costly and harder to get, and the extensive interest-support programme for housing loans has ended. Despite distinctly lower growth, full employment, modest improvement in purchasing power and spending of household savings should be enough to sustain private consumption this year. The role of the public sector in driving consumption will also become more pronounced.

• The vigorous growth in government spending during the war on Ukraine has driven Russia’s government finances into deficit, with deficits running at roughly 2 % of GDP a year since the start of the war. The current budget framework calls for a reduction in the annual deficit to around 1 % of GDP during 2025‒2027. This framework relies on rather optimistic assumptions, however, so the deficit could again turn out higher than planned.

• Oil prices, Russia’s relations with China and sanctions are among the most significant external factors affecting the outlook for the Russian economy. A significant tightening of sanctions would weaken Russia’s economic development. A sharp and prolonged drop in oil prices would also significantly curtail Russia’s government finances and ability to make war. Russia’s economy could severely suffer if relations between China and Russia degrade. Russia has become highly dependent on China in recent years.

• War has degraded the Russian economy’s long-term growth possibilities, and output gains have relied upon government spending on branches connected to the war effort. Investment in war also diverts assets that could otherwise go to sustained economic growth that promotes national well-being.

What would a ceasefire mean?

• If the fighting in Ukraine ends, [Russian] spending needed to sustain the war effort is unlikely to diminish [...] as it would go to stockpiling and regenerating resources for future conflicts.

• If no lasting peace agreement is achieved, the temporary truce or ceasefire agreement would give Russia an opportunity to rebuild its economy for making war later. Russia’s re-arming possibilities are most solid in scenarios involving a truce that leads to a partial lifting of sanctions (even briefly). Larger export earnings would enable Russia to build up new economic buffers. Loosening restrictions on imports would allow Russia to build up its stores of critical import goods and components for the future needs of its military-industrial complex.