Russia: War Related Sanctions and Shrinking Labor Force Pose Threats to Long Term Growth

Figure 1: Russia GDP Growth Forecasts to 2030 (%) 

Source: Continuum Economics/Datastream

• Shrinking population and decreasing labor force. The labor force continues to shrink particularly after 2022, due to the ongoing war. We feel that total population will go nowhere fast in the next years and will be around 146 million in 2028 (Figure 2). The normal solutions to these problems are immigration or increasing the female participation rate (an already reasonable 55%) but both will be hard during the war, the latter as the government focus is elsewhere.Less population may cause reduced demand for new housing and infrastructure investments and can be a drag on Russia growth in the 2025-30 period.

Figure 2: Russia Population Forecasts to 2030 (Thousand)

Source: Continuum Economics/Datastream

Figure 3: Russia Industrial Production Forecast to 2030 

Source: Continuum Economics/Datastream

• Ukraine-Russia War: The main accelerator for Russian growth continues to be the surge in the military spending after the war started. Since there are increasing signs of a likely pause and a frozen conflict (here) with or without a ceasefire deal for a long time, probably which will last years, this boost to growth will likely slow for the manufacturing activities and GDP growth in 2025-2028. A credible peace deal remains highly unlikely, which would be required to open up exports to DM countries again.
• Manufacturing and industrial production leads the way: The driving force behind the growth continues to be the mechanical engineering, chemical and metallurgical sectors. Despite the cloudy macro outlook, increased war related defense spending and consumer demand continue to boost industrial production modestly amid greater outlays on social support and higher wages (Figure 3). 
• Unemployment Drops: The major supply-side constraint will likely remain the tight labor conditions. Unemployment is at historically low levels, and poor geographic and cross-sectoral labor force mobility remain as the additional structural constraints. Due to limited labor resources, labor productivity growth lags further behind an increase in real wages, causing a threat for GDP growth projections. We foresee a partial slowdown is likely over the horizon due to staff shortages, and falling pattern of capacity utilization rates.
• Near-Term domestic demand remains strong but outpacing supply expansion capacity: Growth in domestic demand will likely outpace the supply expansion capacity and exceed the capabilities to expand the production of goods and the provision of services in the near future, if the domestic production focus will be the military sector. 
• Restrictions and sanctions: Sanctions on Russia’s energy sales and slowing Chinese economy will likely lead to a weakness in export revenues, coupled with growing imports, which we think jeopardize GDP growth in 2025-2028. China has also been slow to agree to a 2^nd gas pipeline from Russia, as Russia has excess gas production that it cannot now export given the collapse in European pipeline exports. Coal imports are also restrained. Russia is highly dependent on the mining and production of natural resources in order to stimulate economic growth in the country. The oil price cap coupled with a possible low demand and discounted oil price can hurt Russian economy if the war will resume and western societies will not lift sanctions. Ongoing war and geopolitical tensions affecting terms of foreign trade also creating proinflationary risks for Russia.
• Debt Hangover: Debt overhang in the corporate and government sector will also be a drag on growth despite government debt in relation to GDP is expected to slightly fall after 2024. Inflation volatility has increased with the economy less open and a tight labor market and this can boost nominal debt servicing costs and be a drag on growth. 
• Decreasing Trade Income and Structural Headwinds: Huge economic and financial sanctions imposed on Russia continue leading to a steady weakness in energy sales revenues, coupled with growing imports, which jeopardize the GDP expansion after 2024. Besides, companies mostly concentrate on military equipment production and this is a structural headwind for Russia exports growth in the 2nd half of the decade. 
• Productivity Growth: The increase in military spending risks lower productivity in economy, while innovation and smart management capabilities of the economy remain limited due to sanctions. Russia still has a lot of catch up growth and productivity momentum with advanced economies due to weak current business environment and limited technological investments, but this is unlikely to change with the focus having shifted after the start of the Ukraine war. 

Technology is also one positive driver of productivity in the 2020’s alongside increased climate change investment but Tech/AI and climate change related investments are expected to be limited for Russia since the priority will be on military security, sanctions and macroeconomics problems.