Russian economic growth driven by industry not services

The industry is contributing to the Russian economy's growth this year. Notably, the manufacturing sector has demonstrated consistent growth, setting new records for two consecutive years. Historically, the most significant growth has consistently been driven by oil and gas production. The question arises as to why this situation has changed so dramatically and whether industry will be able to support the economy in the new year.
The First Deputy Prime Minister, Denis Manturov, has stated that industrial growth has exceeded 4% for the past 11 months and is expected to be maintained at this rate throughout the year. Concurrently, the manufacturing sector is projected to expand at a rate of at least 7% throughout the year.

In 2023, industrial growth also reached 3.5%. This ongoing expansion marks the second consecutive year of robust growth, with the exception of 2021, which was a recovery year.

The industry has experienced various periods. Notably, 2009 marked a particularly challenging year for both the industry and the economy as a whole, with industrial production in Russia declining by 10% and the Russian GDP by 9%, largely attributable to the global economic crisis. More recently, a decline in industry was observed in 2020 (-2.1%) due to the impact of the Coronavirus pandemic, as noted by Natalia Milchakova, a leading analyst at Freedom Finance Global.
However, Russian industry demonstrated resilience by swiftly recovering from the forced downtime in 2020 and the subsequent crisis in 2022, when it faced significant sanctions.
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Historically, the most significant growth periods for Russian industry were in 1999 and 2003, when it expanded by 9% annually. In 2004, industry grew by another 8%.

However, it should be noted that these impressive results in 1999 and 2003 were largely driven by the robust performance of the extractive industry, particularly the oil and gas sector, which was further supported by the high prices of oil and gas in 2003. However, after 2022, a radical shift occurred, with the manufacturing industry emerging as the leading sector, while the extractive industry experienced a notable decline, primarily due to the reduction in oil production as part of the OPEC+ agreement.

The manufacturing industry has shown robust growth, with an annual increase of 7-8% over the past two years. What factors have contributed to this significant growth?

"Undoubtedly, the state defence order has been a significant catalyst for this growth, as it has provided increased budget financing for the manufacturing industry in 2023-2024 compared to the previous period. The import substitution process is also associated with industrial growth. National projects focused on transport and road infrastructure development also contributed to this growth. Large-scale construction projects invariably generate orders in metallurgy and the production of building materials, among others. This has a positive effect on growth in the relevant industries and on GDP as a whole," says Milchakova.
In 2024, the industry achieved a significant positive result thanks to the development of the general trend of import substitution by Russian enterprises, the reorientation of sales markets for their products from Western countries to Eastern ones, as well as state support for domestic orders and budget financing. This year, the National Welfare Fund of Russia allocated almost 1.3 trillion rubles for budget spending," says Nikolai Vavilov, a specialist in the strategic research department of the TR company.

The mechanical engineering, automobile manufacturing, shipbuilding and defence industry enterprises demonstrated the strongest growth, i.e. those market sectors focused on government orders and domestic consumers, according to the expert.

The production of electricity and water supply also demonstrated a modest growth of 4%. However, the extractive sector exhibited a decline of 0.3%, as highlighted by Vavilov.
Export-oriented companies have encountered significant financial constraints in their foreign trade this year due to sanctions. In response, Russia has taken steps to legalise cryptocurrency mining and facilitate its use in external settlements. The head of the Russian Ministry of Finance, Anton Siluanov, has confirmed that Russian companies have already begun using bitcoins and other cryptocurrencies in international payments following the adoption of relevant legislative norms. He also highlighted that the recent amendments to the legislation have enabled Russia to effectively counteract the impact of Western sanctions.

Despite the positive developments in the industry, there are still challenges to be addressed. Nikolai Vavilov highlights a number of challenges, including reduced free production capacity (a point repeatedly emphasised by Elvira Nabiullina, the head of the Central Bank), a shortage of personnel, increased sanctions pressure from Western countries, higher interest rates on loans and market factors such as the decision of OPEC+ to extend the obligations of its member countries to reduce oil production, and a decrease in demand for coal in the countries of the Asia-Pacific region.

However, it is unlikely that the same rate of growth will be achieved in the new year. The Ministry of Economic Development anticipates a deceleration in industrial growth to 2-2.5% compared to 2024, with a potential uptick to 3% by the close of the year, driven by an increase in energy exports and the revitalisation of domestic consumer demand, as Vavilov notes.

"We do not expect that the same high growth rates as this year will be maintained in 2025, because they are limited by the high key rate and high bank interest rates, as well as a shortage of qualified personnel and the continued dependence of many sectors of Russian industry on imports – only now on parallel imports or on imports from friendly countries.
In our opinion, the production of computers and electrical equipment will continue to show growth, while the industry will be pulled back by the ongoing decline in oil production, and possibly in the production of petroleum products, for obvious reasons," says Milchakova.

"We do not expect industrial production growth to accelerate next year, because mining and exports are stagnating due to external restrictions and subdued external demand. The growth of mechanical engineering, despite the subdued budget next year, is unlikely to be significant. Investment demand is under pressure due to the high rate. There are currently no sources of financing that could accelerate industrial production," said Ilya Fedorov, chief economist at BCS World of Investments.

"The trend towards a slowdown in development rates next year will most strongly affect the manufacturing industry. A slowdown is also expected in such industries as the production of computers, electronic and optical products, the production of metal products (except for machinery and equipment), and the production of electrical and electrotechnical equipment," Vavilov notes.