On 3rd September 2026, Vladimir Putin claimed that Russia's budget deficit, which grew by 40% from January to July this year, is manageable and poses no "critical" risk for the Russian economy1. The figures tell another story, as Russia's federal budget deficit has grown to 2.8% of gross domestic product, well above the official deficit target of 1.6% that has been set for this year.

The cost of the war with Ukraine, now in its fifth year, continues to place strains on public finances, despite the resilience Russia has shown in sustaining its war economy. At the beginning of the conflict military spending boosted Russia's economy despite heavy sanctions from western countries. However, with slowing economic growth alongside high rates of inflation, the government has been forced to place more reliance on heavy taxation and debt in order to finance its spending.

How Russia turned war into economic growth

In 2022 when Russia first invaded Ukraine, it was widely believed that the staggering sanctions placed on the country by the United States and members of the EU would cripple Russia's economy and lead to a hasty and embarrassing defeat for Vladimir Putin. A few of the significant measures that were undertaken included cutting off major Russian banks from SWIFT (the secure global banking and financial message system that facilitates international transactions) as well as freezing around half of the US$630 billion the central bank held in reserves2. These sanctions targeted Russia's financial sector as well as its critical energy industries, which supplied about 30% of federal budget revenue in 20243. Despite various sanctions the Russian economy grew by 4.9 per cent in 2024 on Rosstat's latest estimate, outpacing many advanced economies, before slowing to 1 per cent in 20254.

The economic isolation caused by strong sanctions meant that Russia could not freely spend dollars abroad or import a large amount of foreign goods, and foreign currency stayed in the country. This, combined with domestic controls, helped limit capital flight, stabilise the rouble and prevent a balance-of-payments crisis. Russia's reported international reserves have risen from about US$630 billion before the war to roughly US$769 billion at the end of August 2026, though that increase largely reflects the rising price of gold, and the figure still includes the roughly US$300 billion frozen in foreign banks and effectively inaccessible under sanctions5.

Following the 2022 invasion Russia suspended its fiscal rule, which had required excess oil revenues to be saved in the National Wealth Fund. This gave the government greater freedom to redirect revenues towards military spending, allowing it to increase government expenditure to support the wartime economy. A modified rule has operated since 2023, with a cut-off price of $59 a barrel above which oil revenues are saved and below which reserves are drawn down, and the Finance Ministry suspended operations under it again in March 2026 while it reviewed that threshold6. Average nominal wages rose by 19.3 per cent in 2024, with real wages and domestic investment also increasing significantly7. Government spending, through social transfers, defence contracts and subsidised lending, boosted household incomes and fuelled a surge in consumer spending and borrowing, despite the country's high interest rates.

Prior to the conflict, Russian businesses were often reluctant to invest because of state interference and an unfavourable business environment. The introduction of sanctions and capital controls changed this by making it much harder for money to leave the country. As a result, more capital remained within Russia and was channelled into domestic investment. Capital investment increased in both 2023 and 2024, although by 2025 its growth had fallen below the rate of inflation. This illustrates both the strength and the weakness of Russia's military Keynesianism: although government spending generated a substantial short-term boost to demand and employment, it did not necessarily translate into sustainable long-term economic growth.

The fiscal problem

This model has a fundamental weakness: Russia is running into the limits of its own capacity. As the demands of war grow, the Kremlin is faced with mounting labour shortages. The expansion of the military-defence complex that was once responsible for boosting the GDP has drawn large numbers of working men away from the civilian labour force8. Demand from other key sectors is rising, and the supply of labour has tightened considerably. Unemployment has fallen to a post-Soviet low of 2.1%, first recorded in 2025 and matched again in May 20269.

This rapid expansion has led to signs of overheating, which many analysts attribute to increased spending on the war in Ukraine. Federal budget funding of the war and other military spending reached about 16 trillion roubles in 2025, or 7.5% of GDP, and the 2026 budget planned a reduction to 14.9 trillion roubles, or 6.3%10. Execution has run well ahead of that plan: military spending in the first quarter of 2026 alone came to roughly 2.5% of expected full-year GDP, and on one estimate, if that pace were sustained, spending of 9 to 10% of GDP would be realistic this year11. As the economy comes under increasing pressure from high government spending and labour shortages the Kremlin has increasingly turned to taxation to manage its fiscal position.

In 2025 the government increased corporation tax from 20% to 25% and introduced higher income tax bands. In addition, a rise in VAT from 20% to 22% took effect at the beginning of 2026, a higher standard rate than in the UK, France or Germany, though several EU members sit at or above it. Though the Russian government has kept a reduced VAT rate of 10% for essential goods, the jump in VAT alongside persistent inflation in the country has driven up the price of basics12.

Russia's oil lifeline

Russia's wartime economic expansion has now slowed to a crawl amid falling oil prices and long-term demographic pressures. In January 2026 the International Monetary Fund (IMF) cut its growth forecast for Russia to 0.8%; it has since revised that up to 1.1%, where it still stood in the July update13. Growth of around 1% in 2025 was the weakest the country has recorded since the economy contracted in 2022. Russia is heavily reliant on its oil and gas revenues. In 2022 the tax take from fossil fuels made up about 40% of federal budget revenue, more than enough to pay for the war. That share fell to 23% in 2025, the lowest in two decades, and the Finance Ministry expects it to drop below 20% this year14.

Ukraine has escalated its drone campaign against Russian refineries, contributing to the country's gasoline and diesel shortages and forcing Moscow to ban exports of gasoline from April and of jet fuel through to the end of November, and to curb diesel exports over the summer. Refinery runs fell to 3.6 million barrels a day in July 2026, the lowest since May 2002 and roughly a third below the seasonal norm. Deputy Prime Minister Alexander Novak acknowledged in June that crude production was running below the level at the start of the year, attributing the decline to unscheduled refinery repairs15. Ageing reserves and limited access to Western technology could make production harder to sustain. Energy revenues still provide a significant share of government income, and a sustained decline in oil production would leave the country with fewer resources to finance its increasingly expensive war.

Footnotes

  1. Reuters, Russia can manage its growing budget deficit, Putin says (opens in a new tab), 3rd September 2026.

  2. Geographical, Russian sanctions backfire as Putin profits from war economy (opens in a new tab), 4th August 2025.

  3. Oxford Institute for Energy Studies, Fiscal Flex: Russia's Oil and Gas Revenues in 2024 (opens in a new tab), February 2025.

  4. The Bell, GDP data: what it reveals, what it conceals (opens in a new tab), 18th February 2026.

  5. Bank of Russia, International Reserves of the Russian Federation: monthly values (opens in a new tab), 2026.TASS, Russia's international reserves gain 6.76% in August to $769 bln (opens in a new tab), 7th September 2026.

  6. The Moscow Times, Russia Pauses Budget Rule Changes as Oil Price Spike Eases Pressure (opens in a new tab), 24th March 2026.

  7. The Moscow Times, Russian Wage Growth Hits 16-Year High in December 2024 (opens in a new tab), 3rd March 2025.

  8. Royal United Services Institute, Russia's Wartime Economy Isn't as Weak as It Looks (opens in a new tab), 22nd January 2025.

  9. TASS, Unemployment in Russia falls to 2.1% in November, statistics service says (opens in a new tab), 26th December 2025.Trading Economics, Russia Unemployment Rate (opens in a new tab), 2026.

  10. Stockholm International Peace Research Institute, A Budget for a Fifth Year of War: Military Spending in Russia's Budget for 2026 (opens in a new tab), March 2026.

  11. Janis Kluge, Russian military spending surges in early 2026, raising doubts about budget plans (opens in a new tab), 12th June 2026.

  12. The Guardian, The Russian economy is finally stagnating. What does it mean for the war – and for Putin? (opens in a new tab), 6th February 2026.

  13. Interfax, IMF lowers Russian 2026 GDP growth forecast from 1% to 0.8% (opens in a new tab), 19th January 2026.International Monetary Fund, World Economic Outlook Update, July 2026 (opens in a new tab), 8th July 2026.

  14. Oxford Institute for Energy Studies, The Inflection Point: Russia's Oil and Gas Revenues in 2025 (opens in a new tab), February 2026.bne IntelliNews, Russia's finance ministry to tighten budget rule as oil revenues sink (opens in a new tab), 26th February 2026.

  15. OilPrice.com, Russia Admits Oil Output Is Falling as Ukrainian Drone Strikes Hit Refineries (opens in a new tab), 4th June 2026.The Moscow Times, Russian Oil Refining Falls to 24-Year Low After Ukrainian Drone Strikes (opens in a new tab), 3rd August 2026.