Stagnation Ahead: Russias Economic Challenges and the Burden of War Financing in 2026

As Western sanctions become more stringent and military budget demands due to the ongoing conflict in Ukraine show no signs of abating, Russia may transition from a state of «managed cooling» to outright stagnation by 2026, with any significant economic recovery unlikely until 2027.

The initial boost from wartime military expenditures is diminishing, and the associated costs are expected to be transferred to the public as tax increases, given the decline in revenue from lower oil prices and continued Western pressures on Russia’s energy exports.

The year 2025 is anticipated to signify the conclusion of Russia’s wartime growth surge observed in 2023-24. Following two years of over 4% growth, GDP growth in 2025 is expected to decelerate to approximately 1% or lower, with similar challenges likely extending into 2026.

The economy has largely exhausted the short-term factors that drove growth in 2023 and 2024. The rapid expansion in 2023 was largely a recovery from the economic shock of 2022, when rapid adjustments toward wartime production were necessary.

In 2024, growth was supported by a significant increase in state spending, with federal expenditures rising from 32.35 trillion rubles ($404.4 billion) in 2023 to 40.2 trillion rubles ($502.5 billion) that year, injecting additional demand into the economy.

However, these growth drivers are mostly absent in 2025, and there appears to be no clear factor to stimulate recovery in 2026.

Government expenditure is expected to reach 42.3 trillion rubles ($528.8 billion) in 2025 and 44.1 trillion rubles ($551.3 billion) in 2026, remaining relatively stagnant after adjusting for inflation.

When combined with high interest rates around 16% aimed at controlling inflation, the outlook suggests an economy at risk of stagnation, as policymakers in Moscow navigate the delicate balance between fostering growth and maintaining price stability.

Consequently, many analysts project that GDP growth will hover around 1% for both 2025 and 2026. The Economic Forecasting Institute of the Russian Academy of Sciences predicts growth of 0.7% in 2025 and 1.4% in 2026, eventually accelerating to approximately 2% in 2027. Meanwhile, the International Monetary Fund forecasts growth of 0.6% for 2025 and 1.0% for 2026.

For the first time since the pandemic began, Russia’s budget revenues in 2025 fell short of initial expectations. When the 2025 budget was proposed, revenues were estimated at 40.3 trillion rubles ($503.8 billion), but updated forecasts show actual collections may only reach around 36.6 trillion rubles ($457.5 billion).

This represents a shift from the past three years, including 2022, when revenues consistently surpassed initial forecasts.

The revenue shortfall is partly due to diminished tax collections linked to slowing economic growth, in addition to falling oil prices and Western sanctions that have widened the discounts Russia must offer buyers of its crude oil.

Oil and gas revenues for 2025 are now projected at 8.7 trillion rubles ($108.8 billion), significantly lower than the originally anticipated 10.9 trillion rubles ($136.3 billion). Given the deceleration in growth and the downward pressure on oil prices, 2026 is expected to bring another year of weak budget revenues.

The World Bank anticipates a global oil supply surplus, leading to a decline in Brent crude prices from an average of $68 per barrel in 2025 to around $60 per barrel in 2026, the lowest in five years.

In response, authorities are increasing taxes to bolster the budget. Starting January 1, the value-added tax (VAT) will rise from 20% to 22%, and more businesses will be subject to the VAT as the revenue threshold for mandatory registration is lowered to 10 million rubles ($125,000) from 60 million rubles ($750,000).

The government also plans to implement a tax on finished electronic goods, including laptops, smartphones, and lighting products.

Overall, these actions indicate a post-spending slump, with households and businesses facing higher taxes to replenish the Kremlin’s war funds, while the energy sector grapples with the impact of sanctions.

Despite the economic downturn, Russian leaders have limited flexibility to reduce military expenditures as the conflict in Ukraine persists.

President Vladimir Putin shows no inclination to ease his extensive demands, repeatedly asserting that Russia is prepared to persist until it secures control over the four regions of Ukraine it claims.

Officially, national defense spending is projected at 13.5 trillion rubles ($168.8 billion) for 2025 and 12.93 trillion rubles ($161.6 billion) for 2026, but actual spending, including classified expenditures, is likely to exceed these amounts.

Russia does not disclose its full military budget, only revealing planned figures.

Occasionally, officials provide partial insights, such as Defense Minister Andrei Belousov’s recent announcement that defense spending would constitute 7.3% of GDP in 2025.

With GDP estimated at 217.3 trillion rubles ($2.72 trillion) in 2025, this implies total defense expenditures nearing 15.86 trillion rubles ($198.3 billion), significantly higher than the amounts shown in the budget.

As the war progresses into 2026, military spending will continue to exert downward pressure on the economy and its recovery prospects.

While increasing funds are directed toward arms production and wartime efforts, this level of spending does not enhance the supply of consumer goods, thereby contributing to inflationary pressures.

The prolonged conflict means that less funding is available for civilian development, even as taxes are likely to rise in order to bridge the gap between expenditures and income.