Stop, Start, Then Stop Again

The business landscape of Russia is currently in a state of flux, with activity "sputtering" as the country navigates the ongoing conflict with Ukraine. While July's Purchasing Managers' Index (PMI) readings from S&P showed improvement, reaching 50.7, this was likely due to a response to logistical challenges caused by the fuel crisis.

Companies have been rushing to place orders to secure inventory, leading to a significant decline in warehouse demand in major cities like Moscow and St. Petersburg. In response, businesses are seeking new warehouse capacity in regions like Kazakhstan to avoid the risks posed by Ukrainian attacks on Russian territory. This shift in demand away from the capital cities highlights a growing economic divide within Russia.

While the military-industrial sector has seen expansion, offering new targets for strikes by Kyiv, it has also contributed to the over-concentration of physical trade and turnover in Moscow and St. Petersburg. This geographic realignment of demand towards regions outside Moscow may potentially uplift the second- and third-tier cities economically, but without broadly distributed real wealth gains, the effect has been to widen the gap between the wealthy and the less fortunate within regions.

The high interest rates in Russia make it difficult for businesses to borrow and invest, with the Bank of Russia's key rate at 14% creating challenges for most businesses and consumers. As a result, only the most secure investments can withstand the cost of servicing debt. With the Bank of Russia's cautious approach to rate cuts, it is unclear if inflation can be controlled, as the causes of inflation ultimately lie in fiscal policy, commodity markets, and the conduct of the war.

The state is facing a significant financial burden, with the Ministry of Finance paying rates above 17% on OFZ issuances to cover budget deficits. This high cost of borrowing reflects the Russian government's struggle to fund the war, while also highlighting the lack of confidence in the ability to control inflation. The redistribution of money and demand in the wake of the conflict, through defense contracts and recruitment, is only being pulled back by the macroeconomic conditions caused by the war.

Until there is an end to the conflict, Russia's economy will continue to struggle, with regional economies hitting ceilings and being forced back down by economic design.