Running out of road

For months, Russia’s official inflation rate has hovered around 10%. In June, the Central Bank of Russia boasted that the rate had fallen to 9.4%; but it then dampened the celebration by reporting that expectations for inflation one year from now are 13% (which may well be the actual inflation rate today). Yet, on July 25, the central bank dared to cut its very high interest rate, which has weakened growth and caused a severe credit crunch, from 20% to 18%.

True, Russia’s economy appeared surprisingly dynamic in 2023 and 2024, with the official growth rate reaching 4% each year. But this was largely because the Russian government revived dormant Soviet military enterprises beyond the Ural Mountains. Moreover, real growth figures may have been exaggerated, because some inflation was hidden by state-owned enterprises selling their goods to the state at fixed prices. 

In any case, official growth has fallen this year, probably to 1.4% in the first half of 2025. Since October, the Kremlin itself has begun to report that Russia is experiencing stagflation — a message that was reinforced at the annual St. Petersburg International Economic Forum in June.

Improvement is unlikely. The country’s financial reserves are running out, energy revenues are declining, and there are increasingly severe shortages of labour and imported technology. All are linked to the war and Western sanctions.

Since 2022, Russia has had an annual budget deficit of about 2% of GDP, implying that it needs $40 billion each year to close the gap. But owing to Western financial sanctions, Russia has had virtually no access to international financing since 2014. Not even China dares to finance the Russian state openly, for fear of secondary sanctions. 

Indeed, two small Chinese banks were just sanctioned by the European Union for such sins. So, Russia must make do with the liquid financial resources held in its National Wealth Fund. Having fallen from $135 billion in January 2022 to $35 billion by May 2025, these are set to run out in the second half of this year.

Traditionally, half of Russia’s federal revenues have come from energy exports, which used to account for two-thirds of its total exports. But in the face of Western sanctions, Russian total exports have slumped, falling by 27%, from $592 billion to $433 billion, between 2022 and 2024.

The federal budget for 2025 assumed an oil price of $70 per barrel, but oil is now hovering closer to the Western price cap of $60 per barrel, and the EU has just set a ceiling of $47.6 per barrel for the Russian oil that it still purchases. In addition, the West has sanctioned nearly 600 Russian “shadow fleet” tankers, which will reduce Russian federal revenues by at least 1% of GDP.

Against this backdrop, the Kremlin has announced that while it intends to spend 37% of its federal budget — $195 billion (7.2% of GDP) — on national defence and security this year, it must cut federal expenditures from 20% of GDP to about 17%. But since the government has already cut non-military expenditure to a minimum, it claims that it will reduce its military expenditure by some unspecified amount in 2026. 

Reducing military expenditure at the height of a war is rarely an auspicious signal. As the commentator Igor Sushko noted, “The Confederacy did this in 1863-1865 (American Civil War), Germany in 1917-1918 (WWI), Japan in 1944-1945 (WW2),” and the outcome every time was “total military defeat”. 

Of course, actual economic strength is not the issue. Ukraine spends about $100 billion per year on its defence, which amounts to 50% of its GDP; but no one bothers to question this, because for Ukrainians, the war is existential. Ukraine would not survive if the war was lost. By contrast, Russia spends only 7% of its GDP on the war, but this is a war of Putin’s choice. It is not existential for Russia, only for Putin. If he had a popular mandate, Russia could spend much more on the war. But he apparently does not think his popularity could withstand devoting much more of the budget to the effort. 

Meanwhile, it is increasingly clear that something else is rotten in Russia besides the economy. Russia has fallen to 154th place out of 180 countries on Transparency International’s authoritative Corruption Perceptions Index, while Ukraine is in 105th place. Since the start of the war, a dozen or so senior Russian energy managers have fallen out of windows. And more recently, former deputy defence minister Timur Ivanov was sentenced to no less than 13 years in prison for corruption; Transport Minister Roman Starovoyt allegedly committed suicide just hours after Putin fired him; and a gold-mining billionaire was arrested, and his company was nationalised to help the treasury. 

These were senior officials. Ivanov was a top protégé to former defence minister Sergey Shoigu, and Starovoyt was the right-hand man of Putin’s close friend Arkady Rotenberg. Such developments are clear signs of Russia’s economic instability. 

Compounding the financial pain is an extreme labour shortage, especially of qualified workers. Officially, unemployment stands at only 2%, but that is partly because many Russians have left. Since the start of the war, and especially after Putin declared “partial” mobilisation in 2022, approximately 1 million people fled the country, including many young, well-educated men. He has not dared to pursue another mobilisation since. Now, labour shortages are holding back production and driving up wages, while Western export controls continue to limit Russia’s supply of high-tech goods, even if Chinese supplies have mitigated the impact somewhat. 

Russia’s economy is fast approaching a fiscal crunch that will hinder its war effort. Though that alone may not be enough to compel Putin to seek peace, it does suggest that the walls are closing in on him.