INSUBCONTINENT EXCLUSIVE:
Moscow has been quietly pursuing a two-pronged strategy to finance its escalating war costs
In addition to the publicly scrutinized defense budget, it has set up a system of state-directed, off-budget soft loans where the Kremlin
badgers banks into making easy credits to defense-sector companies to unofficially fund its war machine.But with the soaring cost of
borrowing that is now becoming a problem that could end in a debilitating crisis, according to a report from the Davis Center at Harvard
University.This lesser-known mechanism, instituted shortly after the invasion of Ukraine, has ballooned, with the volume of loans running
into hundreds of billions of dollars
Companies that were forced to take out these loans are starting to squeal from the pain of servicing the rapidly rising interest payments
after interest rates climbed into double digits.Inflation took off, forcing the Central Bank to reverse its loosening of monetary policy in
the second quarter of 2023
Since then, prime interest rates have climbed relentlessly to the current all-time high of 21%, imposing crushing interest payments on
Russian corporates that have traditionally avoided credits, preferring to make the majority of their investments from retained
earnings.Interest payments eating into profitsThe debt burden is now eating up one ruble in four, according to Rostec CEO Sergei Chemezov,
with an estimated $210-250 billion (21-25 trillion rubles) as compulsory loans to defense contractors, said Craig Kennedy, a former
over 10 trillion rubles in 2024, this informal state-directed lending to defense companies, according to these estimates, is double all the
interest rate hikes are clearly not working, so at the end of last year she teamed up with the Finance Ministry to introduce a series
Among these was effectively reducing retail borrowing by increasing bank macroprudential limits, but she had less success with cutting
corporate borrowing, although even that started to slow in the autumn.The growth of corporate lending slowed to 0.8% year on year in
according to the official Central Bank corporate borrowing figure remains elevated at a total outstanding corporate borrowing of 86.7
trillion rubles ($852 billion) in November, up by almost two-thirds (65%) from 52.6 trillion rubles at the start of the war in February 2022
reporting.Kennedy estimates that 30% of all this borrowing is due to state-directed lending for military-related contracts.bne
funding stream is authorized under a new law, quietly enacted on Feb
25, 2022, that empowers the state to compel Russian banks to extend preferential loans to war-related businesses on terms set by the state
Since mid-2022, Russia has experienced an anomalous 71% expansion in corporate debt, valued at 41.5 trillion rubles ($415 billion) or 19.4%
The state is stealthily funding around half these costs off-budget with substantial amounts of debt by compelling banks to extend credit on
The formal budget expenditure remains the source of funds and thanks to the war boost, revenues rose again in 2024.For the January-November
2024 period, total revenues reached 32.65 trillion rubles, with oil and gas revenues up by a quarter to 10.3 trillion rubles ($103 billion),
Currently the oil and gas revenues almost cover all of the defense spending of 10.8 trillion rubles.Looking ahead, the 2025 budget indicates
a further increase in defense spending, with plans to allocate nearly 13.5 trillion rubles (13 billion euros), representing almost a third
of federal spending.The other significant source of budget funding is the approximately 4.5 trillion rubles of Russian OFZ treasury bills
The total amount of OFZ bonds currently outstanding is around 20 trillion rubles, but that is almost entirely covered by the 19 trillion
rubles of liquidity in the banking sector, which is also the main buyer of OFZ.Finally, the government can tap the National Welfare Fund
The amount of cash in the liquid portion of the fund has fallen by half since the start of the war, but in 2024 the Finance Ministry
actually managed to increase the amount in reserve slightly
The liquid part of the fund halved from a pre-war 9 trillion rubles to a low of 4.8 trillion rubles in 2023
But this year, the government started with just over 5 trillion rubles and ended the year with 5.8 trillion rubles ($580 billion), leaving
the Finance Ministry with a comfortable cushion that can cover the projected budget deficit this year twice over.Banking crisis on the
cards?Now analysts warn that the amount of accumulated debt may begin to unravel, posing risks to Russia's financial stability
By maintaining its official defense budget at ostensibly sustainable levels, the Finance Ministry has misled observers and fooled them into
significantly underestimating the strain the so-called special military operation is having on the corporate and banking sectors
The off-budget funding scheme is only fueling more inflation, pushing up interest rates, and weakening Russia's monetary transmission
has also left Moscow grappling with an emerging dilemma: delay a ceasefire and risk credit events, such as large-scale bank bailouts, or
negotiate while still retaining economic leverage
These risks are of increasing concern to Russian policymakers, who are growing wary of a potential credit crisis undermining domestic
unique opportunity to press for advantageous terms in negotiations
suggesting the long-standing independence of the central bank be undermined.And Nabiullina appeared to cave in December, giving into the
pressure, when in a rare dovish surprise decision she kept interest rates on hold at 21%, despite the very widespread expectations of a
200bp rate hike.NPLs stable but inflation risingJust before the meeting, Nabiullina defended herself in a speech before the Duma, saying
Both times the state had to assume large amounts of bad debt
Will it happen again?She also pointed to the non-performing loan (NPL) results which amount to only 4% of the loan book and which even
declined slightly in October to 3.8%, or RUB3.1 trillion, which have remained largely unchanged all year
Indeed, the level of non-performing debt is now less than 5.51% in 2022 and 6.1% in 2021.Moreover, corporate NPLs remain adequately covered
However, a few, like Gazprom, are already at risk; the state-owned gas giant has been borrowing heavily in the last year to cover historic
losses after its pipelines were blown up in 2022.The soft loans are not going to spark a crisis soon
The damage it is doing is more indirect: driving up inflation
However, if you add in an extra clandestine 20 trillion rubles of spending via the soft loans the true level of military spending is closer
inflation problem and no amount of rate hikes will make any difference, as rising interest rates are supposed to take cash out of the system
Worse still, because this lending is strategic rather than commercial in nature, the Central Bank observes that it has been largely
2024, the Kremlin had become aware of the systemic credit risks unleashed by its off-budget defense funding scheme
But the looming credit problems mean the clock is ticking for Russia too
2025 will be under growing pressure to bring the hostilities to a halt.On Oct
in nature: it has the potential to materialize suddenly, unpredictably and with significant disruptive force, especially if it becomes
is a crisis would strip away the veneer of normality carefully built up by the Kremlin, which has strived to insulate the lives of normal
Russians from the effects of the war
talks should include making it clear it is prepared to drag the conflict out as long as it takes until a Russian credit crisis arrives with
suitable commitments to a long-term support package for Ukraine
Also to refuse to even discuss sanctions relief that Russia needs to generate more revenues to deal with a mounting pile of deteriorating
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