Kremlin Turns to Average Russians to Fund the War
The Gazprom contagion continues to spread
The Lakhta Center in Saint Petersburg is the tallest skyscraper in Russia and Europe. Offering unparalleled panoramic views of the city and the Gulf of Finland, the 87-floor building serves as the headquarters of Gazprom. It took the Russians six years to build it.
Building the tallest structure for Russia’s crown jewel of the commodities market made a lot of sense. Gazprom was on its way to becoming a trillion-dollar company. They could have easily gotten there, until Gazprom’s future and Putin’s desires came into conflict. Instead of treating customers with respect, Gazprom gradually adopted the Kremlin’s penchant for bullying. Gazprom did not stumble into this role; they evolved into a weapon in the Kremlin’s arsenal. For years, they bullied smaller nations that bought gas from them while carefully avoiding the larger European ones.
Ukraine, Bulgaria, Lithuania, Moldova, and Poland have all experienced varying degrees of bullying from Gazprom since 2006. The situation became so dire that in 2011, the European Commission launched an antitrust investigation against Gazprom for allegedly abusing its dominant market position in Central and Eastern Europe.
However, they were notably accommodating to the Angela Merkel government in Germany because the Russians had huge dreams for Nord Stream pipelines. It was a capital intensive gas pipeline project that was set to yield billions in revenue for the Russians over a very long time.
The previous German administration turned a blind eye to Russian actions against its western neighbors. Once the first pipeline was completed, it increased Germany’s dependency on Russian oil by more than 40%. A little-known fact is that Germany was not alone in this dependency; Austria relied on Russian gas for 98%.
Yes, 98%.
Freaking crazy.
Anyway, the Kremlin’s careful bullying, where it targeted smaller nations, allowed Western Europe to increase its dependency on Gazprom, and their sales continued to soar year after year. Russians were talking about Gazprom becoming their first trillion-dollar company. They could have achieved this, but with Putin operating the levers, governance became secondary and Soviet expansionism became primary.
After Putin invaded Ukraine, Gazprom attempted to coerce Germany and Europe into submission by intentionally blocking gas supplies in 2022. Europe, however, resisted this pressure, seeking alternative energy sources globally. As a result, Putin’s strategy failed and it crushed Gazprom. Now, average Russians are starting to feel the economic repercussions of Gazprom’s decline.
Since the start of the invasion, domestic gas prices have gone up by 34%. On July 1st, the Kremlin increased gas prices by a massive 11.2%.
Since gas is used for heating, cooking, and sometimes for hot water, a 10% price hike directly increases household expenses. People will have less disposable income to spend on other goods and services. This decrease in spending power can ripple through the economy. Businesses will see a drop in demand, leading to price increases for other goods and services to maintain their profit margins.
This creates a domino effect where the initial gas price hike pushes up inflation across the board.
The Russian economy’s distress continues to expand.
In December 2023, when Russia’s central bank raised its key interest rate by 100 basis points to 16%, “hiking borrowing costs for the fifth consecutive meeting in response to stubborn inflation,” the central bank suggested that the “tightening cycle was now close to completion.”
Russian Central Bank Chief Elvira Nabiullina was either overly optimistic about the Russian economy’s trajectory or she was flat out spreading nonsense. I think it was more of the latter and a little of the former.
For almost seven months, Elvira Nabiullina kept her fingers away from the hike button until she probably realized that she couldn’t do it anymore. Last week, she softly signaled another rate hike.
So, what is it going to be? 17%?
Inflation has been stuck at more than 4%. God knows what the real-world number is. Whatever it might be, the 10% hike in gas prices is a clear indication of the growing fissures in the Russian economy. The problem is, with the way the war is going, the economy is going to experience even more stress moving forward, not less.
Authors Thomas Lattanzio and Harry Stevens, in their detailed analysis titled Wounded Veterans, Wounded Economy, write
Based on open source estimates from the governments of France and the United Kingdom as of May 2024, the Russians have likely taken around 400,000 casualties, with over 100,000 of those dead. Simple math shows that one-time payments would equate to 900 billion rubles for wounded personnel and at least 1.4 trillion for families of the dead, 2.3 trillion rubles total. This equates to 6 percent of the 2024 budget, a truly staggering amount that will continue to climb.
Let’s analyze the situation based on the provided numbers. If 500,000 casualties and dead require 6% of the 2024 budget, losing 35,000 personnel translates to:
If Russia loses 35,000 personnel in June, this adds 0.42% to the state budget. If the trend continues and Russia loses personnel at a similar rate, this means adding approximately 1% to the state budget every two months. Here’s a breakdown.
- In 1 month (35,000 personnel): +0.42%
- In 2 months (70,000 personnel): +0.84%
- In 4 months (140,000 personnel): +1.68%
- In 6 months (210,000 personnel): +2.52%
Thus, absorbing a 3% hole in the 2024 budget looms over the horizon. To cover this financial strain, the government would need to find money from somewhere. I am also assuming that the Russian casualty rate will remain stable over the next six months. There is exactly 0% chance for that to happen. So, what ever my forecasts are, they are going to be lower than baseline numbers Russia is going to be hit with.
Here are the potential impacts:
Increased Interest Rates: The central bank is likely to raise interest rates to combat inflation and stabilize the economy. This will make borrowing more expensive, impacting businesses and consumers.
Persistent Inflation: With rising costs due to increased state spending and higher interest rates, inflation is unlikely to decrease.
Higher Cost of Living: Average Russians will face a higher cost of living as prices for goods and services continue to rise.
Decreased Disposable Income: As costs rise, disposable incomes will decrease, reducing spending on non-essential goods and services.
Economic Stress: The economy will experience increasing stress as the government tries to manage the budget deficit, leading to potential cuts in public services and investments.
In summary, the ongoing conflict and personnel losses are putting significant pressure on Russia’s economy. With the need to continually adjust the budget to cover the costs, the central bank is likely to increase interest rates further, leading to higher inflation and a decreased standard of living for the average Russian. The economic dam has already broken, and the situation is likely to worsen as Putin has no path to arrest the trend line.
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