Russia and Ukraine: two economies at war

Welcome back. The appointment of economist Andrei Belousov as the Kremlin’s new defence minister makes this a good moment to compare the wartime Russian and Ukrainian economies. More than two years after Vladimir Putin’s full-scale invasion of Ukraine, Russia’s military campaign seems to be gaining momentum — but the war is testing each side’s economic resilience as much as their battlefield tactics. I’m at tony.barber@ft.com.

First, some housekeeping. The weekend edition of Europe Express will pause next week. Normal service will resume on Saturday June 2.

Russia’s personnel changes

Understandably, Putin’s replacement of the long-serving Sergei Shoigu with Belousov as defence minister attracted headlines. However, other personnel changes lower down the Russian government deserved equal attention. An FT analysis mentioned the most important of these — the appointment of Denis Manturov as first deputy prime minister to oversee the defence industrial sector.

For valuable insights into Manturov’s promotion, please see this article by Vladimir Milov, an exiled Russian economist who served in government two decades ago during Putin’s early presidency. Milov highlights Manturov’s ties with Sergei Chemezov, an oligarch who was Putin’s colleague in the 1980s when the future president was a KGB agent in the former East Germany.

Chemezov now runs Rostec, a defence conglomerate. It is striking that Putin held a meeting in the Kremlin with him and Manturov just before the government reshuffle. Milov comments:

This is a very clear signal to the insiders within the government system: Putin has singled out Manturov as a key figure in the new cabinet, with powers nearly equal to those of [prime minister Mikhail] Mishustin, and demonstrated that Manturov has the backing of Chemezov, the most powerful oligarch directly benefiting from the war.

Milov concludes:

Generally, the newly appointed cabinet looks much more controlled by [the] oligarchic powers of Putin’s cronies than the previous version of Mishustin’s government.

Officials arrested on corruption charges

Shoigu’s removal coincided with the arrests over the past month of two high-ranking defence officials on corruption charges. The first was Timur Ivanov, a deputy defence minister closely associated with Shoigu’s 12-year spell in charge of the ministry.

The second was Yuri Kuznetsov, head of the ministry’s main personnel directorate. Law-enforcement officers raided his home and, according to Russian reports, discovered $1mn worth of roubles, foreign currency, gold coins, collectible watches and luxury items.

These alleged corruption cases are coming to light at a time when Russian defence expenditure is booming. Belousov’s appointment may therefore indicate that “Putin has serious concerns over corruption levels and misuse of funds within the Russian military”, according to analysts at the US-based Institute for the Study of War.

Putin said on Tuesday that his promotion of Belousov was “linked not least to the growth of expenditure on military matters”. He estimated that state spending on defence and security now amounted to 8.7 per cent of GDP.

All in all, Belousov’s appointment was part of a push for stronger controls over military spending and better integration of civilian and military areas of the economy, all aimed at an improved war performance. This underscores Putin’s intention that Russian forces should fight for as long as is necessary to achieve his goals of dismembering the Ukrainian state and shredding Ukrainian identity.

Arms industry boosts some Russian regions

How should we measure Russia’s economic performance? All commentators, Russian and western, emphasise the accelerating militarisation of the economy, but the impact of US and European sanctions is disputed. Elina Ribarova wrote this month for the FT:

Russia now boasts 6,000 military-industrial enterprises, a notable increase from the prewar figure of less than 2,000. These establishments collectively employ over 3.5mn individuals who operate round-the-clock, with three shifts and six-day workweeks becoming the norm.

Particularly noteworthy is that the regions benefiting most from the war are not those rich in mineral resources, but those connected to the arms industry. Ekaterina Kurbangaleeva, writing for Carnegie Politika, explains:

These are territories with significant machine-building assets that have seen an avalanche of budget funds come pouring in from state defence orders. Related industries such as food production, clothing and footwear have also benefited greatly.

China helps out

China plays an indispensable economic role in supporting Russia’s war effort. Ahead of Putin’s visit to Beijing this week, the FT’s Joe Leahy, Kai Waluszewski and Max Seddon wrote:

Bilateral trade was $240bn last year, up 26 per cent against a year earlier, according to Chinese customs, with China shipping goods ranging from cars and industrial machinery to smartphones, and buying billions of dollars of Russian energy exports.

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Eggs and interest rates

Naturally, western policymakers like to draw attention to shortcomings in the Russian economy. On the website of the EU’s foreign policy service, a commentary last month contended that the war effort was squeezing average Russian families, one example being a 40 per cent rise in the price of eggs in 2023.

If this seems a minor detail, the blog made a more serious argument in pointing out that Russia’s main interest rate stands at 16 per cent, about twice annual inflation. This underlines that the central bank is concerned about overheating from the militarisation effort.

The EU blog also argued that a more than 20 per cent boom in investment expenditure since 2022 was actually a sign of economic difficulties:

This jump in investment expenses reflects mostly the sharp rise in the price of the capital goods that Russia still manages to import.

In my view, the best summary of Russia’s wartime economy and the impact of sanctions comes in this article by Alexandra Prokopenko:

Every day, Russia lags further behind technologically. Every day, its economy becomes less competitive. And every day, the economic bloc [of professional policymakers] continues to manage the harmful effects of new challenges with a mix of market acumen and a decent track record of cleaning up the mess left behind by the Kremlin’s foreign policy misadventures.

Ukraine’s losses and recovery bill

What about Ukraine? One thing is for sure: the authorities in Kyiv are eager users of the latest technology to defend their state and assert its separate identity from Russia.

One eye-catching example is the introduction of an artificial intelligence-generated spokesperson for Ukraine’s foreign ministry. “She” goes by the name of Victoria Shi — the surname being an abbreviation for the Ukrainian words for AI.

A useful summary of Ukraine’s wartime economy appears in this blog from Finland’s central bank. It estimates that Ukraine’s GDP collapsed by about 29 per cent in 2022, before recovering somewhat last year. GDP growth is projected to be 4.3 per cent this year and 5.4 per cent in 2025 (other estimates are lower).

It’s clear that the ravages of war have hit Ukraine much harder than Russia, and large-scale western financial and military aid is essential to keeping the Ukrainian economy afloat. The World Bank says that Ukraine’s reconstruction and recovery bill will amount to $486bn over the next decade.

The all-important agricultural sector

Russia’s intensifying missile and drone attacks on Ukraine’s energy and transport infrastructure strike at one of the economy’s main strengths — its role as one of the world’s largest agricultural producers and exporters. According to this report by S&P Global Commodity Insights, port facilities in the Odesa region have suffered considerable damage, but Ukraine should be able to maintain grain exports.

On the other hand, Ukraine’s war effort continues to be hampered by EU curbs on Ukrainian food exports. As the FT’s Alan Beattie observes, this illustrates how difficult it will be to accommodate Ukraine as a future member, without far-reaching changes to the EU’s methods of subsidising agriculture and funding regional development in low-income countries.

Another problem in the agricultural sector, outlined in this article in The Economist, is tax evasion. It quotes Taras Kachka, Ukraine’s deputy agriculture minister, as saying that two out of every five tonnes of grain harvests now make little or no contribution to state revenues.

Power struggles

My final point is that, just like Russia, Ukraine has recently reshuffled its government — but in ways that have caused concern among its western backers. The dismissal of Oleksandr Kubrakov as the minister responsible for infrastructure and reconstruction was seen as a bad sign, because he stood for transparency and close co-operation with Ukraine’s western allies, according to Josh Rudolph, writing for the German Marshall Fund of the US.

This episode was a reminder that Ukraine’s war against Russia must go hand in hand with a no less determined effort to root out corruption at home and rid itself of its post-1991 image as an unreformable country — an image that suits the Kremlin’s interests perfectly.

More on this topic

Ukraine’s budget for 2024 — an analysis by Daniil Monin for the Kennan Institute

How will the European parliamentary elections change the EU? Join FT journalists and experts on June 12 for a subscriber-exclusive webinar. Register and put your questions to our panel here.

Tony’s picks of the week

• Iran is making careful preparations for the eventual appointment of a successor to Ayatollah Ali Khameini, the Islamic republic’s supreme leader, the FT’s Najmeh Bozorgmehr reports from Tehran

• Europe’s interests are more intertwined with Taiwan and its security than the lack of geographical proximity would suggest, Niklas Swanström, Agust Börjesson and Yi-Chieh Chen write for the Stockholm-based Institute for Security & Development Policy