Factbox-Five key challenges for the Russian economy in 2025

MOSCOW (Reuters) - The Russian economy has shown resilience during the three years of war in Ukraine and Western sanctions. However, as the war approaches its fourth year, the economy faces major challenges with key economic policymakers at odds on how to address them.

Economists describe the outlook for 2025 as an "ideal storm" with multiple negative factors simultaneously at play.

"After several years of very strong dynamics, the economy may disappoint in 2025," said Dmitry Polevoy from Astra asset managers.

The economic woes add to Russian President Vladimir Putin's case for talks with U.S. President Donald Trump on ending the war in Ukraine. Trump said on Jan. 21 that Putin was "destroying Russia" and pointed out to high inflation.

"Russia is interested in reaching a diplomatic resolution to the conflict in Ukraine based on economic considerations," said former deputy governor of the central bank Oleg Vyugin.

Below are the five key challenges for the Russian economy in 2025:

INFLATION

Russian annual inflation reached 9.5% in 2024, driven by high military and national security spending, which is set to account for 41% of total state budget spending in 2025, state subsidies on loans, and spiralling wage growth amid labour shortages.

Over the last 15 years, inflation has only been higher in 2022, the first year of Russia's invasion, and during the economic crisis of 2014-15 that followed the annexation of Crimea.

Inflation tops the list of economic woes in public opinion polls, with prices for staple foods such as butter, eggs, and vegetables showing double-digit growth last year.

It is impacting the incomes of the most vulnerable groups, with real pensions falling by 0.7% from January to November 2024.

The central bank is combating inflation by raising interest rates.

President Putin has said the interest rate should not be the sole method to combat inflation and has called on the government to ensure a stable supply of goods and services to limit price growth.

HIGH INTEREST RATES

The Russian central bank raised interest rates to 21% in October, the highest level since the early years of Putin's rule, when Russia was dealing with the chaos following the collapse of the USSR.

Critics argue that high rates hurt civilian sectors of the economy, while the heavily subsidized defence sector remains immune. Prominent business leaders say that with the current cost of capital at around 30% and profitability margins at no more than 20% across most sectors, investment has come to a halt.

High rates are increasing the risks of corporate bankruptcies, especially in vulnerable sectors such as real estate, which has been hit by measures to slow lending, including a stop to state home loan subsidies.

ECONOMIC SLOWDOWN

The government projects that economic growth rates will slow to 2.5% in 2025 from around 4% in 2024 as a result of measures to cool down the overheated economy, while the International Monetary Fund (IMF) projects growth at 1.4% this year.

The pro-government economic think tank TsMAKP estimated that many industrial sectors outside defence have been stagnating since 2023, raising prospects of stagflation, a combination of high inflation and economic stagnation.

The situation is exacerbated by acute labour shortages, which emerged as a result of hundreds of thousands of Russian men joining the army or fleeing the country, becoming a major bottleneck for economic growth.

Economists warn that continued injection of money into defence-related sectors at current rates is creating imbalances in the economy and could end with recession and bankruptcies.

BUDGET DEFICIT

Russia's budget deficit reached 1.7% of GDP in 2024, while the country's National Wealth Fund, the main source of financing the deficit, has been depleted by two-thirds during three years of war.

The government raised taxes to bring the deficit down to 0.5% of GDP in 2025, but its revenues could also fall due to the latest U.S. energy sanctions, which targeted Russia's oil and gas sector.

Some economists believe that the government will have no choice but to raise taxes further if military spending remains at the same level.

ROUBLE VOLATILITY

The rouble fell to its lowest level since March 2022 on January 2, following months of volatility linked to the impact of Western sanctions, which hindered Russia's international transactions and disrupted foreign currency inflows.

Although a weaker rouble is helping the government narrow the budget deficit, it is set to fuel inflation further in the medium term, increasing the cost of imported goods.

Russia's forex market has been transformed by sanctions, with China's yuan becoming the most traded foreign currency, while trade in dollars and euros has moved to the opaque over-the-counter market.

(Reporting by Darya Korsunskaya and Gleb Bryanski; Editing by Frank Jack Daniel)