Challenges Mount for Russian Economy as Inflation Soars

The Russian economy is facing significant hurdles as it enters 2025, with rising inflation rates and dwindling resources for the central bank. President Vladimir Putin's focus on financing the ongoing conflict in Ukraine has diverted attention from pressing economic issues.

In December 2024, Russia's inflation rate surged to 9.5%, up from 8.9% in November, with analysts from Trading Economics projecting further increases. Economist Liam Peach from Capital Economics anticipates inflation could reach 10.5% by early 2025, indicating that the Russian Central Bank's measures to combat inflation have been largely ineffective.

The Central Bank, currently maintaining a key interest rate of 21%, has made multiple attempts to curb inflation through rate hikes. However, experts warn that the persistent inflation indicates that these measures may not be sufficient. Peach noted that inflation is spiraling out of control, with expectations for continued tightening of monetary policy given the rising inflation rates.

Some analysts predict that the Central Bank may raise the interest rate to unprecedented levels, with Evgeny Nadorshin, Chief Economist at PF Capital, suggesting it could reach as high as 25%. However, further increases may pose a risk to businesses already struggling financially, as evidenced by a report from Interfax indicating a rise in payment defaults among companies.

Concerns have been voiced by leaders of major state-owned enterprises and business lobby groups regarding the impact of higher interest rates on investment projects. Alexey Mordashov, CEO of Severstal, emphasized the need to manage interest rate increases carefully, suggesting that excessive rate hikes could be more detrimental than beneficial.

Another contributing factor to inflation is the Kremlin's military expenditures, which totaled around 10 trillion rubles (approximately 100 billion USD) in 2024. These expenditures, aimed at stimulating economic growth, are expected to continue in 2025, potentially overheating the economy and hindering sustainable investment. To effectively combat inflation, a reduction in military spending may be necessary.

A stabilization of the ruble is also critical in addressing inflation. Recent declines in the ruble's value, exacerbated by U.S. sanctions targeting Gazprombank and its foreign subsidiaries, have further fueled inflation. The sanctions have led to increased volatility in the ruble's exchange rate, driving up import prices as the Kremlin seeks costly measures to circumvent these sanctions.