Russia’s labor shortage is a double-edged sword for growth
Moscow’s strained war economy is fueling inflation. Will President-elect Trump provide a much-needed reprieve?
In a nutshell
- Trump’s win comes at a key moment for Russia’s economy
- Russia’s financial markets risk being battered by inflation
- China and India are firmly established as Moscow’s resource clients
Russia’s premier equities market, the Moscow Exchange, soared the day after President-elect Donald Trump’s stunning victory in the United States. On November 6, the index rose more than 2.6 percent, marking its strongest one-day rally in a year. This upswing came as global stock markets generally performed well following Mr. Trump’s win.
Some of the most heavily U.S.-sanctioned Russian energy companies, including PJSC Gazprom and Novatek, fared even better. Their share prices increased by 3.2 percent and 4.2 percent, respectively. The positive sentiment was attributed to Mr. Trump’s claim that he could negotiate an end to the Russia-Ukraine war in “24 hours” or resolve it before his inauguration in January 2025.
In a recent interview with media personality Tucker Carlson, just days before his election success, Mr. Trump indicated why he plans to secure peace with Russia in Ukraine. He accused President Joe Biden of allowing Russia and China to unite. “The one thing you never want to happen is you never want Russia and China uniting … I’m going to have to un-unite them, and I think I can do that,” Mr. Trump said.
Russia’s financial markets are jittery
Aside from the short-lived surge following the U.S. elections, Russia’s debt market has been in a tailspin. The yield on its 10-year government bond has been trading near a record high of 16 percent – although it is below the brief 19 percent record seen in March 2022. The current elevated level reflects growing concerns over persistently rising inflation in the country’s real economy.
The double-digit yield matches the peak reached in 2000 when Vladimir Putin first became Russian president. It is a level that does not augur well for Russian government borrowing, despite its debt-to-gross domestic product (GDP) ratio of 15 percent being exceedingly low by international standards. More significantly, it raises the specter of 1990s-style uncontrolled inflation, financial crisis and ruble devaluation, which significantly eroded Russian households’ savings.
Its stock market has fared little better. The Moscow Exchange has fallen about 20 percent over the past year. This decline starkly contrasts with most major international equity indices, which have, on average, traded upward by a similar percentage during the same period. Russian-listed companies have been hit by payment difficulties triggered by U.S. secondary sanctions on international banks dealing with Russian resource exporters. These sanctions have exacerbated the difficulty for large Russian enterprises in securing foreign exchange for their international operations.
Facts & figures
How major stock markets have fared in 2024
The ruble has also been hit. The currency weakened sharply in November, requiring more than 100 rubles per U.S. dollar for the first time in over a year on November 18. Since then, the Russian currency has been above the 100-level mark against the dollar, touching a two-year low of 113 on November 27. That forced the central bank’s hand and led to an intervention. The ruble has since corrected slightly but remains well above 100.
The more recent freefall in the ruble is primarily driven by new sanctions imposed by the U.S. Treasury on numerous Russian banks, namely Gazprombank, which handles international sales of the country’s natural gas. Furthermore, the ruble has been pressured by the pessimistic outlook surrounding the Chinese economy, ultimately limiting expectations of Beijing’s demand for imports of Russian resources.
Russia’s financial market instability is no worse than that of neighboring Turkey. While Ankara has not been embroiled in a serious geopolitical conflict, its financial market troubles have been longer and deeper. Over the past two and a half years, the Turkish lira has been hitting record lows almost daily. Turkey’s 10-year government bond yields are trading at a staggering 32 percent – double that of Russia’s – reflecting unremitting inflationary pressures at 49 percent per year.
In contrast, Russia’s annual headline inflation rate in October 2024 was 8.5 percent, albeit overshooting its central bank’s annual target of 4 percent. Households, however, feel inflation acutely in soaring prices for foods, which have risen more than 30 percent annually and are driven partly by foreign suppliers halting shipments of vegetables to Russia. The central bank’s record high and hawkish base rate policy stance of 21 percent is barely keeping a lid on inflation. A rate hike in December is likely. So, how long before the economy tanks under pressure from this high cost of borrowing and other inflationary factors?
Capacity-strained domestic economy
Over the past couple of years, despite heavy sanctions, Russia’s economy has persistently outperformed expectations. In 2023, full-year GDP growth was 3.6 percent, with the annual growth rate accelerating to 5.4 percent in the first quarter of 2024 and slowing to 4.1 percent in the second quarter.
Russia’s unemployment rate has dropped to record lows, falling to 2.4 percent in September for the fourth consecutive month, down from 3 percent a year earlier. This decline can be attributed to strong economic growth and an exodus of about 1 million working-age men from Russia following the Kremlin’s surprise military mobilization in 2022. Additionally, another 1 million men have joined the armed forces to fight in Ukraine since then.
The ensuing labor crunch has prompted the central bank to note that it may continue to raise borrowing costs, pointing to worsening trends in inflation expectations. This situation arises as strong demand continues to outstrip the limited availability of goods and services, raising concerns that the economy is overheating. Moreover, the central bank stated that expansionary fiscal policy in 2024 has also contributed to inflationary pressures.
Various surveys have similarly pointed to capacity constraints stemming from higher-than-expected growth. The Standard & Poor’s (S&P) Russia Manufacturing Purchasing Managers Index (PMI) increased to 50.6 in October 2024 (50 represents neither growth nor contraction), driven by export orders rising the most since January 2008, the height of the global credit boom.
Facts & figures
Russian ruble to U.S. dollar exchange rate, Feb. 3, 2021 to Dec. 4, 2024
In line with this export-driven demand growth, employment has continued to rise. In the manufacturing sector alone, job numbers have surpassed 3.5 million – a sector the U.S. State Department has described as the Kremlin’s “war economy.” However, labor shortages have increased backlogs while order flows rose in October. Meanwhile, business sentiment has improved and is fueled by planned investments in automation and new product development. On the other hand, output cost inflation accelerated to the highest in a year as manufacturers passed their higher costs onto customers. Input cost inflation climbed to a three-month peak, driven by the declining value of the ruble, increasing supplier prices and rising wage bills.
Due to high labor demand and significantly rising nominal and real wages, consumer demand is expected to stay strong. In September 2024, retail sales increased by 6.5 percent year over year, following a 5.1 percent rise the previous month. This exceeded the forecast of 6 percent growth. It marked the 17th consecutive month of retail sector expansion and the most robust growth since May 2024.
Long-term economic prospects depend on external trade
The extent to which Russia’s externally dependent commodities sector integrates with the rapidly growing economies of China and India over the rest of this decade will be pivotal to the Kremlin’s economic survivability or even prosperity going forward. By the end of the decade, China and India are projected to become the world’s second- and third-largest economies, respectively (first and third in purchasing power parity). Such an outcome will likely more than compensate for the economic setbacks from losing the European Union as Russia’s largest trading partner and source of direct investment.
Total trade between China and Russia surged to a record high of $240 billion in 2023. In the first 10 months of 2024, bilateral trade rose by 4 percent annually to $203 billion, and it is on track to surpass the previous year’s total.
India has taken significant advantage of its access to discounted Russian crude oil to power its fast-growing economy. Before the full-scale invasion of Ukraine in 2022, trade in seaborne crude oil with Moscow accounted for less than 2 percent of India’s total oil imports. By June 2024, that figure skyrocketed to over 40 percent. As a result, their overall trade even eclipsed India’s two-way trade with the EU in the last financial year (April 2023 to March 2024). President Putin and Indian Prime Minister Narendra Modi have agreed to increase bilateral trade from $68 billion this year to $100 billion by 2030.
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Turkey and Brazil have also emerged as important and regular buyers of Russian energy exports. According to the Center for Research on Energy and Clean Air, their purchases primarily consist of oil products and chemicals, pipeline gas and coal, collectively exceeding the EU’s purchases by over 50 percent each week.
In 2023, natural resources contributed just over 11 percent to Russia’s GDP, making it the third-largest sector after manufacturing (12.4 percent) and retail and wholesale trade (12.1 percent). However, their contribution to government revenues is disproportionately far greater, representing nearly half of the federal budget.
In this regard, export taxes on resources will likely raise much-needed revenue in 2024 to fund the escalating defense budget, which now accounts for 40 percent of total spending. This is particularly true as energy exports are expected to reach $268 billion in 2024, up from $239 billion in 2023.
Scenarios
More likely: Russia’s economy to advance strongly over the short term
Despite facing unprecedented Western sanctions, Russia’s economy has exceeded the growth expectations of global institutions, including the International Monetary Fund (IMF). In October, the IMF forecasted that Russia’s real GDP would grow 3.6 percent in 2024, driven by rapid growth in private stock capital and consumer spending. This estimate was upwardly revised from the previous projection of 3.2 percent made just months prior.
The higher growth forecasts appear to be supported by key monthly private surveys, including the S&P’s PMI readings for Russia’s manufacturing and services sectors. Both gauges indicate accelerations in growth. The European Bank for Reconstruction and Development (EBRD) provides further support for the surprising resilience and expansion of Russia’s economy. The report shows Russia’s GDP increased from 3.6 percent in 2023 to 4.7 percent in the first half of 2024. According to its analysis, the growth was driven by an estimated 10 percent rise in oil export prices and strong trade with non-sanctioning economies.
Military spending has also been high in the context of the ongoing full-scale invasion of Ukraine. War-related costs have surged by nearly 24 percent over the first 10 months of the year, and Moscow has recently approved a further 25 percent annual increase in defense spending for 2025.
Despite rising defense outlays, the government managed a small budget surplus of $2.2 billion (0.2 percent of GDP) during January to October 2024 compared to a budget deficit of $10 billion (0.8 percent of GDP) over the same period in 2023. This turnaround was driven by state revenues expanding at 28.4 percent annually to $297 billion, bolstered by even faster-growing oil and gas revenues at 32.3 percent. The driving force behind this growth has been the willingness of non-Western countries like China, India and Turkey to pay above the $60 per barrel price cap set by the G7 economies.
Lastly, since his reelection, Mr. Trump has reportedly engaged in dialogue with President Putin, an initiative that could lead to peace talks. Such a development, albeit highly speculative given Moscow denied it even happened, would have occurred for the first time since the early months of the Ukraine war. While it is too early to overanalyze the Trump factor, the new U.S. administration’s apparent push for peace may boost the Kremlin’s economic growth prospects in the medium-to-long term and allow for inflationary pressures to subside.
Somewhat less likely: Manpower constraints could drive inflation higher and hinder growth
The shortage of working-age labor is emerging as the Kremlin’s principal Achilles heel. Contrary to the expectations of Western governments, which hoped that their sanctions would cause stagnation or a deflationary spiral, buoyant demand in the domestic private and state sectors amid strengthening overseas demand are severely stretching the economy to its extreme limits. According to the EBRD report, Russia’s growth is projected to decelerate to 3.6 percent in 2024 and 1.5 percent in 2025, reflecting these constraints, especially from labor shortages.
The workforce supply has been further constrained by the 2 million or so working-aged men who have exited the labor market to fight in Ukraine. Moreover, the terror attack in Moscow earlier this year, carried out mainly by Tajik nationals living in Russia as migrant workers, has prompted the Kremlin to clamp down on the traditionally abundant supply of cheap labor from ex-Soviet republics in Central Asia.
To address the ongoing personnel shortages, the arrival of thousands of North Korean troops to the battle frontlines of Russia’s Kursk region could be just one aspect of a longer-term strategy of importing labor from alternative sources. This could involve bringing in workers from other so-called “friendly” Asian states to alleviate some of the skilled manpower requirements.
As a result, workers from China, Vietnam, India and other countries with which Russia has recently established economic and strategic partnerships could be brought in to fill labor market gaps. This policy is particularly evident in the new investments in plants and factories across the country undertaken by China, India and Vietnam.
However, until the Russian labor shortage is comprehensively addressed, the risk of an economic implosion from surging inflation, currently held in check by harmfully high short-term interest rates, is bordering on a full-blown economic crisis.
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