Military industry becomes a driving force of the Russian economy

The war has cost Russia more than expected. The amount officially earmarked for Russia’s military spending for the whole of 2023 was already exceeded in the first half of the year. Nevertheless, funding the Armed Forces remains the Kremlin’s top priority.

Military allocations will make up at least a third of Russia’s state budget in 2024 (more than 10 trillion roubles or 102 billion euros). The actual amount is certainly much higher, as it is supplemented by classified budget allocations. The war and the military industry are now driving the Russian economy, accumulating financial, material, and human resources at the expense of the other sectors of the economy.

Russia’s economy is in better shape than expected due to high oil prices, government spending, and the ability to circumvent sanctions. Russia has not exhausted its resources or the potential of its public and private sectors. Nor is it completely isolated. As a result, it is able to meet its growing expenses and does not feel any critical pressure to change its political course.

After the large-scale invasion of Ukraine in 2022, Russia’s military industry grew mainly because of the accumulated reserves and the government’s focus on improving and monitoring production processes. The ability to import sanctioned foreign components and equipment through third countries and various schemes has mitigated the impact of international legal restrictions on Russia.

The circle of Russian supporters remains similar. China is the largest supplier of microchips to Russia, and the yuan has 2023 2024 Russia’s economy is in better shape than expected due to high oil prices, government spending, and the ability to circumvent sanctions. Russia has not exhausted its resources or the potential of its public and private sectors. Nor is it completely isolated. As a result, it is able to meet its growing expenses and does not feel any critical pressure to change its political course. RUSSIA’S WAR BUDGET, TRILLION RUB RUSSIA 20 21 become the main currency for Russia’s international transactions. Russia also imports electronics via countries of Central Asia and the South Caucasus. However, large companies from these countries avoid direct cooperation with Russia for fear of sanctions. It is usually intermediaries and smaller private companies that carry out these activities.

Only two countries, Iran and North Korea, which are themselves under sanctions, openly supply Russia with military goods. They provide Russia with the weapons and ammunition it needs to continue the war. Drones from Iran have been instrumental in depleting Ukraine’s air defences, allowing Russia to save its own missile arsenal. In 2023, North Korea beganlarge-scale deliveries of ammunition, signalling Russia’s willingness to maintain the intensity of the fighting. The shells are of low quality but sufficient for Russia’s war of attrition.

However, in order to continue the war while rebuilding its military capabilities, Russia will face structural problems that are likely to deepen over time and as the war drags on. The current growth of Russia’s military industry is driven by shortterm factors and has its limits.

Russia’s long-term negative demographic trends, exacerbated by the war, are leading to a shortage of skilled labour. High wages and protection from mobilisation are short-term solutions to attract workers, and it aggravates labour shortages in other sectors of the economy.

Industrial development is also constrained by Russia’s reliance on foreign technology, including its critical dependence on manufacturing tools. Circumvention of sanctions does not guarantee Russia a sustainable and adequate supply of electronics and equipment. New sanctions and restrictions force Russia to change acquisition schemes, raise the cost of these components, and increase Russia’s dependence on its partners.

Russia expects such dependences to be temporary. The Kremlin’s import substitution efforts have borne fruit in some areas (such as UAV production) thanks to clearer priorities and targeted funding.

However, deep structural problems would hamper the modernisation of production and Russia’s ability to establish significant technological sovereignty. As a result, the Kremlin will need to further strengthen its control over the economy in order to direct resources for solving current problems. However, Russia is likely to be able to build up its military capabilities and finance the war against Ukraine in the short term.

Russian intelligence services – the Foreign Intelligence Service (SVR), the Main Directorate of the General Staff of the Russian Armed Forces (GRU), and the Federal Security Service (FSB) – are involved in organising the import of sanctioned goods and equipment into Russia.

Companies operating in Russia’s strategic industries cooperate with intelligence services and provide them with ‘shopping lists’ containing Western high-tech equipment or components that Russian intelligence services are supposed to acquire. The procurement of sanctioned equipment and components is organised by Russian intelligence officers under diplomatic cover or by Russian and Western citizens cooperating with Russian intelligence. Russian intelligence services constantly seek for and exploit loopholes in sanctions control procedures as well as organise procurement via third countries.

Russian strategic industries will face difficulties in the near term as a result of the sanctions. It is therefore highly likely that Russian intelligence services will increase their efforts to procure and supply the necessary equipment, production or technological innovation to Russia. It is also highly likely that to achieve this goal they will use supply chains, logistics infrastructure or individuals seeking to profit from the sanctions evasion.