LONDON – Russia's State Duma took a step forward Wednesday towards approving its biggest-ever federal budget which will increase spending by around 25% in 2024, with record amounts going on defense.
Defense spending is expected to overtake social spending next year for the first time in modern Russian history, at a time when the Kremlin is keen to shore up support for President Vladimir Putin as Russia prepares for a presidential election in March.
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Record low unemployment, higher wages and targeted social spending should help the Kremlin ride out the domestic impact of pivoting the economy to a war footing, but could pose a problem in the long term, analysts say.
The draft budget "is about getting the war sorted in Ukraine and about being ready for a military confrontation with the West in perpetuity,” said Richard Connolly, an expert on Russia's military and economy at the Royal United Services Institute in London.
“This amounts to the wholesale remilitarization of Russian society,” he added.
Russia’s finance ministry said it expects spending to reach 36.66 trillion rubles (around $411 billion) in 2024 with a predicted budget deficit of 0.8% of Russia’s gross domestic product.
Part of the Russian budget is secret as the Kremlin tries to conceal its military plans and sidestep scrutiny of its war in Ukraine. Independent business journalists Farida Rustamova and Maksim Tovkaylo said on their Telegram channel Faridaily that around 39% of all federal spending will go on defense and law enforcement in 2024.
Analysts suggest Russia is in third place globally for defense spending behind China and the United States, which spends around $850 billion a year.
On Wednesday, during the second reading of the federal budget, the State Duma focused on the allocation of social, health and education funds, some of which are complemented by regional government spending. The third and final reading of the budget will be on Nov. 17.
The Russian finance ministry is able to table a record budget partly because the economy has held up under sanctions much better than many observers first expected. That's because Russia is still able to earn substantial government revenue from oil exports, the Kremlin’s key moneymaker.
Although shunned in in the West, the Kremlin “expects to fund expenditures in 2024 from oil and gas revenues thanks to buyers from China and India,” said Alexandra Prokopenko, from the Carnegie Russia Eurasia Center in Berlin and a former Russian Central Bank official.
Russia still sells more to the rest of the world than it buys, and because the ruble is weak, it receives more rubles for its energy sold in dollars, giving it revenue for imports including weapons components.
In recent years, the Russian finance ministry has also attempted to pivot the economy away from its dependence on hydrocarbons, raising increasing amounts from import taxes and VAT and, following the invasion of Ukraine, supposedly “one-off” windfall taxes on state and private companies.
Finance Minister Anton Siluanov said in September that Russia's economy should grow by 2.8% by the end of this year but that was in comparison to 2022, when the economy shrank as a result of the impact of Russia's invasion of Ukraine.
Analysts question whether the draft budget is based on realistic projections for growth. If it is not, or if the economic outlook changes, Russia could have to adjust its spending.
“Expecting the same rate of growth shows the degree of optimism that's underneath this,” said Connolly, adding that Russian officials seem to be aiming for levels of growth comparable to those when recovering from a recession.
The main driver of that growth is Russia's war in Ukraine, which is now as important to the Kremlin economically as it is politically.
The state and military are now playing a much bigger role in the economy than they have historically, and industries related to the war — including defense production — have helped to drive Russia's unemployment level down to a record low of 3%.
The war has also taken hundreds of thousands of workers out of the economy, either because they’re fighting in Ukraine or because they’ve fled Russia, often to escape conscription.
Defense companies and those associated with the sector are working at full capacity, leading to labor shortages as vacancies go unfilled, putting more money in the pocket of ordinary Russians as employers compete to hire them, offering higher salaries.
While this is good for the Kremlin ahead of a presidential election, against a backdrop of an already tight labor market it will be a “struggle” for the economy to keep growing while vacancies remain unfilled, Connolly said.
Over the longer term, the government’s increased defense spending also threatens to worsen inflation, as military-related factories operate around the clock, putting money into workers' pockets from where it flows into the cash registers of local businesses.
Russia's Central Bank said it expects inflation to be around 4.5% next year, falling from around 7.5% expected for all of 2023.
That has led the central bank to raise its key interest rates to 15%, a step which inhibits spending, growth and inflation for the civilian economy, in an effort to contain the fallout from inflationary government spending by the finance ministry.
While in the short term, the outlook for the Russian economy is not as bad as some predicted in the aftermath of Putin's invasion of Ukraine, shifting the economy to almost completely focus on defense could cause significant long-term challenges.
“Spending that is so skewed toward military and social needs can only be sustainable if the state is at war,” Prokopenko said.
Analysts broadly agree that the budget is sustainable for 2024 but could come under significant pressure if sanctions on Russia are increased, or if there are huge expenditures such as another round of mobilization which would also put pressure on the labor force. The longer the labor force remains tight, the more likely high expectations of wage growth also become entrenched.
If there is a reduction in military spending, or a need to reduce spending which impacts living standards, it could send shockwaves through the Russian economy and significantly impact ordinary people.
Prokopenko said she expected changes to Russia's tax rates after the presidential elections in order to raise revenue and to stave off economic and social instability because, she said, “the construction of the budget is not sustainable in the long term.”
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David McHugh in Frankfurt contributed to this report.