Going into the fifth year of war in Ukraine, Russia’s prospects are deteriorating. The Russian economy is weakening with real growth for 2026 forecasted at 1.09% (source: IMF), down from 4-5% in 2023-24, despite higher government spending. Somewhat surprisingly, the Russian government even has published a dimmer view of this year’s economic growth, forecasting only 0.4% (reported numbers in this blog are highly uncertain and sometimes possibly too rosy). Growth has largely materialized in Russia’s military complex, i.e. production of weapons and ammunition and build-out of the army. Wages have risen as the economy is suffering from labour shortages (the unemployment rate is 2.4%, according to IMF), given the continuous need for “voluntary” conscription to the army and increased activity in the military sectors requiring more personnel. This might have supported growth at the start of the war, but the output is largely destroyed in Ukraine and, thus, shall not contribute to growth over the longer term. Further, the economy is facing headwinds because of supply constraints, both as a result of sanctions and of Ukrainian attacks on hydrocarbon infrastructure. The high policy rate of the Central Bank of Russia (CBR) of presently 14.25% will also depress economic activity (resulting in plenty complaints from oligarchs). The policy rate seems high compared to reported annual inflation of 5.6% as of June 15th (source: CBR) but anecdotical evidence suggests that inflation in reality might be much higher (the basket weights seem to be adjusted from time to time when certain items that make up the basket become scarce) whereas the practice of state-directed lending by banks to military sectors has weakened CBR’s (orthodox) monetary policies.
Where are my missiles…?
Gross government debt is still low at 19.1% of GDP (source: IMF) but only thanks to depleting the country’s fiscal and financial buffers. The National Wealth Fund (initially meant to support future pensioners but, of course, these days many Russians don’t get to old-age as they die on the Ukrainian battlefield, so NWF funds are now used to finance the war instead) fell from 6.5% of GDP at the start of the war to about 1.8% now. Russia’s significant FX reserves, which it had accumulated before the invasion of Ukraine in 2022, have largely been frozen. The fiscal deficit for 2026 is currently running at 2.6% of GDP, substantially above the target of 1.6%. Further, corporate debt has increased substantially as companies and banks are induced to finance the war (sorry, “special military operation”), sometimes at low rates dictated by the state, whereas taxes (e.g. VAT), mining royalties and dividends (for state-controlled companies) all have increased. The focus on military build-up has led to crowding out of financing for non-military sectors, preventing much-needed productivity growth, whereas funding has dried up as foreign demand for Russian debt has cratered (less than 5% of OFZs, sovereign bonds denominated in RUB, are held by non-residents and 10-year OFZ yields are 16.1%; source: CBR). So, even while government debt as percentage of GDP is low, servicing sovereign debt is costly and funding options are rather limited with considerable crowding-out of funds for the non-military sectors. For example, according to the Financial Times, Putin asked oligarchs for donations to finance the budget, which comes across as somewhat desperate.
The war economy can only be sustained by exporting hydrocarbons (mostly crude oil, gas, diesel). The EU was Russia’s largest client but the share of gas imports (by pipeline and LNG) by the EU from Russia declined from 40% in 2021 to 12% in 2025, even though LNG imports increased somewhat this year due to the energy crisis in the Middle East (shipments by pipeline have declined sharply). The Middle East crisis also lifted oil prices, which is good for Russia’s fiscals, but this seems to be temporary with Brent now trading at USD 73 p/b, about the same as at the start of the war, whereas Urals trade at a discount again at USD 58 p/b. By the end of 2027 all EU gas imports from Russia will be prohibited. Gas can not be easily diverted to other customers as required infrastructure must be available. Negotiations to build new pipelines from Russia (Siberia) to China drag on with China having the upper-hand and imposing the terms upon Russia. Oil can be sold elsewhere but the U.S. has imposed sanctions on buyers of Russian oil (e.g. India), though these were temporarily lifted during the Iran war. Ukraine has targeted oil refineries as well as Russian (shadow fleet) tankers (some European countries, like Finland and the U.K. are also becoming more active in disrupting Russian oil shipments). As a result, Russia faces domestic fuel shortages and blackouts, for example in Crimea which has become completely isolated from the mainland, and faces mounting challenges to sell oil abroad.
And where is my oil…?
Due to increasingly stringent sanctions Russia basically is completely dependent on China, generally considered not a very comfortable position to be in (ask Mr. Trump). China dictates prices at a deep discount for commodities purchases from Russia, which is possible because Russia has no viable alternative offtaker (India is discouraged by Trump to buy oil from Russia, although the country recently seems to have resumed oil purchases). As Russia never seriously diversified its economy away from hydrocarbons, metals and agribusiness, many components required for making military equipment have to be imported from China, guess what, at elevated prices. And the Chinese transact in yuan, not the most attractive currency for others to own (given that the yuan is not freely convertible). To paraphrase Donald Trump: Mr. Putin doesn’t hold the cards.
From Russia’s (or at least Putin’s) perspective the economic situation could be tolerable if its army would make big strides on the Ukrainian battlefield. Fortunately, the tables are turning since the start of this year with Ukraine reaching drone dominance over Russia. Drone strikes against Russian forces are becoming more successful and distances are being extended to 200km and beyond (indeed, Moscow and St. Petersburg are within reach). Logistical problems for Russia are piling up. It also lost access to Starlink, hindering military communication and intelligence. Military leaders in Russia are getting increasingly frustrated and aim to break Ukraine’s will by bombing civil targets, a clear disrespect of international law and in many cases a war crime. Even if Russia closes the gap in military (drone) technology with Ukraine, battlefield victory is far from certain.
During the first couple of years ordinary Russians could live in blissful ignorance of the war. Yes, there were dead or wounded soldiers, but these came from backward regions and received ample financial compensation. But since the start of this year the situation has dramatically changed. Airports and energy infrastructure in Moscow and St. Petersburg have been targeted, disrupting daily life and pretending normality becoming harder by the day. Financial buffers have been largely depleted, implying that going forward households will have to assume a bigger share of the financial burden that is caused by the war. Further, inflation is likely to remain elevated for years (as recently admitted by the CBR), negatively impacting real wages. About 500,000 Russian soldiers got killed since the start of the war, according to GCHQ, a U.K. spy agency, requiring the Russian military to recruit untrained Africans to serve as cannon fodder (or rather drone fodder). The total casualty count may add up to 1.5 million. The war has gone from one of attrition to one of exhaustion. Russia certainly can continue waging war for a couple more years but an increasing number of Russians may eventually question whether it is worth it. Russia’s grinding war in Ukraine seems to get nowhere…
