Russian economy on the verge of overheating due to military spending

In September 2023, Russian inflation rose to 6%, up from 5.3% in August 2023. This increase in inflation was driven by rising prices for consumer goods, particularly food and fuel. High inflation could lead to increased costs of financing Russia's war in Ukraine.

According to UK intelligence, the Russian Central Bank has responded by raising its prime interest rate by 2 percentage points, bringing it to a new level of 15%. This base rate is the highest since May 2022.

It is now likely that the Russian Central Bank will maintain high interest rates for the next few years, possibly until 2024. This will consequently lead to higher borrowing costs for Russian consumers, as well as affect the Russian government's debt service costs.

"This is likely to keep inflation in Russia above the 4 percent target in 2024. Prolonged high inflation is likely to reduce real government spending, especially in areas such as social security, where spending is growing below the rate of inflation," the report said.

Rising demand, partly due to a significant increase in defense spending and ongoing labor market tightening pressures, could lead to an overheating of the Russian economy.

Although the ruble's decline stopped after the Russian Central Bank raised its key interest rate by 350 basis points from 8.5% to 12%, analysts largely agreed that the move would not have a long-term impact.

"As long as the war continues, things are only getting worse for Russia, the Russian economy and the ruble. Raising rates won't solve anything - they may temporarily slow the rate of ruble devaluation at the cost of slower real GDP growth - unless the underlying problem of war and sanctions is addressed," said Timothy Ash, senior EM sovereign strategist at Bluebay Asset Management.

In addition, the Russian government has decided to encourage exporters to give back more of their foreign earnings to help stabilize the ruble. Ukraine has also banned Western companies selling goods to the country from paying in Russian rubles, which has dealt another blow to the Russian economy.