Russian inflation is too high. Does that matter?

While inflation has cooled almost everywhere, in Russia it is hotting up. Consumer prices rose by 9.5% year on year in December, up from 8.9% the previous month and uncomfortably above the central bank’s target of 4% (see chart). The prices of fruit and vegetables have risen by more than 20% on average in the past year. In a normal country, this sort of high inflation would be unsustainable. But Russia is not a normal country.

The latest bout of inflation is the product of both external and internal factors. In recent months, as the West has tightened sanctions, the rouble has depreciated, raising the cost of imports. Russian importers hoping to supply customers with American phones or Italian handbags have to be increasingly creative, which adds to their costs. There is circumstantial evidence that French vintners are skirting sanctions by selling to unscrupulous middlemen in Austria and Greece, among other places. Even so, the price of a bottle of the 2006 Clos de Tart, a blowout Burgundy at White Rabbit, Moscow’s finest restaurant, has risen by close to 30% since Vladimir Putin invaded Ukraine.

Conscription, meanwhile, has created a labour shortage, exacerbated by the fact that many Russians have fled the country. Unemployment, at around 2% of the workforce, is the lowest on record. This, in turn, has forced employers to compete hard for workers. In 2024 nominal pay rose by an astonishing 18%, putting further upward pressure on prices. The government has also implemented enormous fiscal stimulus, lifting spending on defence, welfare and infrastructure. Strong demand, says the central bank, “still exceeds companies’ capacities to expand supply”.

A tussle is now under way in Russia’s policymaking establishment. The central bank—stuffed with orthodox economists—is desperate to cool prices. On February 14th, following a monetary-policy meeting, it is expected to keep interest rates at 21%, their highest since the early 2000s. It has also tightened credit rules. But those close to Mr Putin have other ideas. The vast military budget keeps coming in much higher than planned, and now equals around 7% of GDP. The government is doling out huge sums, including as signing-on bonuses to soldiers and compensation to families when their relatives are killed in action. It is also pressganging the private sector into funding the armed forces, which amounts to a form of stimulus.

Is Russia’s high inflation sustainable? In a typical emerging market, one of three problems arises. Sometimes high inflation can make it difficult for a country to service its foreign debts, as the currency depreciates. Yet Russia runs a large current-account surplus and has a healthy stock of net foreign assets, making such a scenario unlikely. Alternatively, spiralling inflation can push up interest rates, which raises the cost to the government of servicing its debt. Although Russian rates have indeed risen, the government’s debt is low, making debt-service costs manageable.

A third potential problem is politics. People, fed up with inflation’s impact on their quality of life, demand change. It is an open question whether Russia’s authoritarian rulers would switch course in the face of such grumbles. Regardless, people seem reasonably content with the economy, at least for the time being. In the past year household incomes have risen by 10%, after adjusting for inflation, with government payments and wages easily outpacing rising living costs. According to the Levada Centre, an independent pollster, consumer confidence is near an all-time high (see chart), while complaints about inflation are no higher than the long-run average. This is translating into how people spend their money. Real household consumption is at least 6% higher than it was a year ago, according to our analysis of official data.

Whether this confidence can last is another question altogether. Russians may eventually reach their limit, and start to complain about rising prices. Meanwhile, the prospect of peace talks, as suggested by Donald Trump on February 12th, raises a fresh economic challenge. Russia is producing a lot of goods and services, not least weapons, that a peacetime economy does not need. Adjusting to the end of war may therefore be a surprisingly difficult process. Unless the West lifts sanctions, Russia’s long-term outlook is bleak—whatever happens with inflation. ■

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