Putin's Stealth Economic Weapon Loses Punch as Recovery Falters

(Bloomberg) -- Russia’s pullback on military spending is becoming a drag on the economy after its record arms buildup helped the country through the worst of a recession three years ago.

The recovery is unsteady now that the peak of defense outlays is over. In the fourth quarter, annual growth in gross domestic product more than halved from the previous three months, according to data released this week. While Russia’s military statistics are classified, the Economy Ministry has partly blamed a decrease in arms spending for swinging industrial output into a surprise contraction during the final two months of 2017.

Putin's Stealth Economic Weapon Loses Punch as Recovery Falters

“The contribution of the military industry to output growth was negative last year,” said Vasily Zatsepin, head of the department for military economics at Gaidar Institute in Moscow. “It will remain negative in 2018-2019.”

While Russia’s 20 trillion-ruble ($347 billion) defense program -- the largest rearmament push since the Soviet breakup -- has already left a geopolitical mark from Ukraine to Syria, its economic footprint is shrinking. That’s depriving President Vladimir Putin of a stealth stimulus to the economy just as growth stagnates and fiscal policy remains tight. Defense was the federal budget’s second-biggest ticket item last year, creating a multiplier effect as a factor in key areas such as high-value-added manufacturing.

Since the army’s “cycle of saturation” with new types of weapons is past its peak, defense spending as a share of GDP will be on the decline, the Kremlin’s economic aide, Andrey Belousov, said last month. A new defense procurement program through 2027 means military expenditure will also make up a smaller proportion of the budget’s earmarks, according to Finance Minister Anton Siluanov.

What Our Economists Say...

The drag from industrial production looks short-lived, but it’s a reminder of how vulnerable the economy is to isolated weakness. One engine sputters, and it’s clear the others aren’t providing enough lift. 

--Scott Johnson, Bloomberg Economics

As an unreported component of industrial production, defense output has become a part of what VTB Capital calls the “dark matter” of manufacturing, “hindering any meaningful interpretation and creating an uncomfortable sense that the aggregates are being moved by powerful yet invisible forces.”

The challenge in assessing the economic impact of defense production is that its details remain a closely guarded secret. The Federal Statistics Service releases neither raw data on output related to the military nor production indexes for the defense industry as a whole.

Many Unknowns

Instead, to account for its output, the state agency makes an internal adjustment to production sub-indexes for sectors affected by the military, according to VTB Capital. The exact parameters of the adjustment, and even the list of the sectors involved, aren’t made public, its economists said in a report.

The Federal Statistics Service didn’t comment in response to questions about the defense sector’s contribution to GDP and industrial output and whether official data reflect its performance.

ING Groep NV says two components of manufacturing data -- “other transport and equipment” and “fabricated metal products, excluding machinery and equipment” -- provide perhaps the best clue. Last year, a significant decline in Russia’s output of “other transport and equipment” went almost hand-in-hand with a broader industrial slowdown or a contraction.

Putin's Stealth Economic Weapon Loses Punch as Recovery Falters

Excluding payments on loans, the state procurement program fell by 40 percent last year in nominal terms, Gaidar Institute’s Zatsepin said. GDP rose 0.9 percent in the last three months of 2017 from a year earlier, compared with an upwardly revised gain of 2.2 percent for the third quarter. After an annual pickup to 1.9 percent in January, the Economy Ministry estimates that GDP growth slowed again to 1.5 percent in February.

The lack of detailed data makes it difficult to assess the defense industry’s broader impact on the economy, according to Dmitry Polevoy, an economist at ING in Moscow. Still, “the military’s contribution may decrease gradually,” he said.

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