Russia`s Economic Slowdown: Forecast and Consequences of «Cooling»
In late 2024 and early 2025, high inflation was the primary challenge for the Russian economy. As inflation began to moderate, the main vulnerability shifted to low GDP growth rates. Experts identify two key negative factors contributing to the current downturn in certain sectors: the persistently high key rate of the Central Bank of Russia, which restricts access to credit for businesses and the public, and a general lack of financing from other sources.
According to Rosstat data, Russia`s GDP growth significantly decelerated: from 4.5% in Q4 2024 to 1.4% in Q1 2025, and a mere 1.1% in Q2. Declines were observed across various sectors: wholesale trade contracted by 4% in January-March, and water supply indicators fell by 2%. Mineral extraction, which accounts for about 15% of Russia`s GDP, decreased by 1%. Overall freight turnover for the first half of the year reduced by 0.3% year-on-year, with rail freight dropping by 6.6% and maritime port traffic by 5.4%. These figures directly reflect a downturn in Russia`s crucial mining and manufacturing industries. It is unsurprising that freight transportation declines when raw material extraction and production decrease. Adding to these alarming figures is the very weak growth in retail trade, a mere 2.1% year-on-year in the first half due to weakening consumer demand, along with a sharp 22% year-on-year reduction in new housing construction, makes it clear that the current economic situation does not inspire optimism.
Russia`s Ministry of Economic Development hastily described the current situation as being «on the brink of recession.» However, we consider this assessment premature. For a recession to be officially recognized, it requires not only a statistical decline in GDP over two consecutive quarters (which has not yet occurred) but also other clear signs of deterioration across economic sectors and a decline in living standards. Classic indicators of recession include mass unemployment, a sharp drop in incomes, a collapse in consumer demand, and currency devaluation. Currently, such phenomena are not observed. The current economic state is more accurately described as a «cooling» after a period of robust growth that some analysts perceived as «overheating.»
According to Rosstat, investments in fixed capital grew by only 4.3% year-on-year in the first half of the year, despite a higher 8.7% in Q1 and 7.4% for the entire year 2024. It is worth noting that prior to 2022, the average annual growth of such investments in Russia did not exceed 4%, which limited GDP growth to 0.2-2.8% during 2013-2020. The exception was 2021, with a 5.6% growth attributed to post-pandemic recovery. In the manufacturing industry, positive dynamics are mainly sustained by the production of military or dual-use goods, funded by a «budgetary impulse.» This impulse, while crucial for supporting the defense industry and other sectors, ultimately leads to a significant increase in the budget deficit, which reached 1.7% of GDP by late summer against a planned 0.5%. Sustained financing of the economy solely from the budget is unsustainable, especially amidst declining oil prices and reduced revenues. Excessive growth in government spending also increases the money supply and fuels inflation, potentially forcing the Central Bank to halt its current monetary easing cycle, keeping credit expensive and hindering economic growth.
We believe that Russia has prospects for resuming more dynamic GDP growth, largely because the positive impact of the Central Bank`s key rate reductions (from 21% to 17% annually between June and September of the current year) has not yet fully materialized in the real sector, despite an observed decrease in bank lending rates. It should be recalled that in October 2024, the key rate was set at 21% and maintained at this level for seven months. The economic slowdown in spring and summer 2025 is likely a direct consequence of these prohibitive interest rate barriers. The full effect of the key rate reduction on industry and the economy as a whole is expected to be most evident next year. Consequently, a faster GDP growth rate is anticipated in Q1 2026 compared to the overall results for 2025.
By the end of the current year, increased budgetary spending is expected to have a positive impact on the economy, particularly in several manufacturing sectors. The ongoing slowdown in inflation, coupled with reduced consumer loan interest rates, should stimulate consumer demand and, consequently, retail trade growth. A moderate budget deficit (up to 2-2.5% of GDP) does not pose a serious threat, especially given Russia`s low public debt level (around 18% of GDP, one of the lowest globally). When state funds are allocated strategically to the real sector, increased government spending can foster future production growth. This helps alleviate economic «overheating» by narrowing the gap between production volume growth and demand increases. Under such conditions, even moderate inflation, slightly exceeding the Central Bank`s target (4% per annum in Russia), is not critical for the economy. The primary goal of monetary policy is precisely to prevent uncontrolled consumer price growth and the economy from spiraling into hyperinflation.
Historical data indicates that in modern Russia, from 2000 to 2008, consumer price inflation often remained in double digits, yet GDP grew by an average of 7-8% annually. This high inflation, primarily driven by continuous increases in tariffs set by natural monopolies, did not impede growth in production and real incomes. The robust economic development during that period was a result not only of high oil prices but also of the launch of major investment projects, particularly in the oil and gas sector. Another significant growth factor was the reduction of the corporate profit tax rate to 20%, a rate that has been increased to 25% in the current year.
We anticipate that Russia`s economic growth will gradually recover as the key interest rate decreases. While exceptionally high GDP growth rates are unlikely under current geopolitical conditions, the economy could expand by approximately 3% over the next two years, provided the key rate is reduced to at least 12% by 2026. Such a monetary policy is expected to help contain inflation acceleration and create favorable conditions for industrial development and mortgage borrowers.
The current slowdown in economic growth, a consequence of the high interest rates from late 2024 to early 2025, is more akin to a typical autumn chill than an unexpected January frost hitting in September. To prevent the economy from «overcooling,» no extraordinary measures are needed. It would suffice for major businesses, and possibly the government, to more confidently urge the monetary regulator to continue lowering the key interest rate.
