Stagflation and an impoverished population: how the Kremlin is paying for the war against Ukraine

Russia’s invasion of Ukraine triggered massive demand from the front line that consumes vast amounts of material and human resources in the Russian economy. This demand is unproductive, as the resources effectively go up in smoke.

Over the period 2021-2024, Russia’s federal budget spending on defence and security tripled, rising from RUB 5.91 trillion (roughly US$71 billion) to RUB 16.2 trillion (US$195 billion). In 2025, defence and security expenditure is on course to hit a record high of around RUB 20 trillion (US$241 billion) given the rate of federal budget overspending from January to August.

This year Russia is set to spend over 9% of its GDP on the war, or 47% of its federal budget – that’s more than in the final years of the Soviet Union. Meanwhile, revenues have fallen sharply due to lower energy prices. Exports in January-July 2025 decreased by 11% compared with the same period in 2024, falling from US$135 billion to US$119 billion.

Before the war, Russia built up a financial cushion in the form of the National Wealth Fund (NWF), but its liquid assets have fallen from US$142 billion to US$40 billion over the past three years, and most of the remaining balance is held in Chinese yuan and sanctioned gold.

All this has upset Russia's overall economic balance, and 2025 has seen the starkest imbalance between income and expenditure. This cannot continue without harm to the economy.

What's changed in the Russian economy in 2025

The available data shows that there has been a dramatic slowdown in production in Russia. In July 2025, Russia's GDP increased by only 0.4% year-on-year, after growth of 4.1% in 2023 and 4.3% in 2024.

Although overall production is still expanding (with growth of 0.8% compared with 5.6% in 2024), for the first time there has been contraction in civilian sectors such as the food industry, light industry and wood processing. Metals output fell by 3.3%, energy equipment production by 3.2% and building materials output by 8.2%. The drop in building materials output is linked to the phaseout of subsidised mortgages, while the slump in the metals industry stems from sanctions and the slowdown in construction.

The decline in industry is being driven by the war and soaring military spending, for which the civilian economy is paying the price. Even the military-industrial complex has seen growth slow significantly despite the hefty allocations it receives from the state budget. In January-July 2025, the production of chemicals, particularly explosives, fell by 0.1% (after growing 3.3% the previous year), computers and electronics rose by 14.9% (down from 27.2%) and motor vehicles, particularly lorries and light armoured vehicles, dropped by 17.8% (after 19.5% growth the previous year).

Even industries boosted by military contracts are now losing momentum. This exposes the Russian propaganda narrative about successful import substitution after certain Western companies left the country for the fairy tale it was.

A record deficit and an impoverished population

Russia's federal budget expenditure rose by 21% between January and August 2025, from RUB 23.1 trillion (approx. US$278 billion) to RUB 27.9 trillion (US$336 billion). But revenues increased by just 3% to RUB 23.7 trillion (US$285 billion), primarily driven by non-oil and gas income. This resulted in a budget deficit not seen in decades, amounting to RUB 4.2 trillion (US$51 billion), or 1.9% of GDP, in the first eight months of 2025 – four times higher than in the same period in 2024.

And Russia no longer has savings in the form of the National Wealth Fund to offset the shortfall. The government is now covering it by issuing federal bonds (OFZs), which are primarily purchased by banks. The banks, in turn, obtain funds from the Russian Central Bank via repurchase agreements (repos). In effect, the Central Bank is issuing money to finance the deficit. Weekly repo volumes are currently just under RUB 1 trillion (US$12 billion).

As Russian budget revenues are growing at a rate three times lower than the official rate of inflation, their purchasing power has declined sharply. To maintain the current level of military spending in real terms, the government has had to increase its share of the total budget to 48.5% – nearly half of all federal expenditure.

When Russian authorities report growth in household income, they rely on the official inflation rate, which is likely understated. Officially, annual inflation is reported to be 9.05%, but alternative estimates suggest the actual rate of inflation reached 25.6% in 2025. Prices for the most essential consumer goods have jumped by 32%. Meanwhile, nominal wage growth is far below the actual inflation rate, indicating a steady decline in purchasing power.

Read also: More trouble ahead: as Russia enters 2025, how is the economy doing?

Several sociological studies have also demonstrated that Russians are becoming poorer. One study shows that the share of household income spent on basic necessities rose from 69% in 2023 to 86% in 2025. Other reports highlight a sharp drop in purchases of household appliances, electronics and cars, a rise in utility prices of 35-45% depending on the region, and fuel shortages that have caused long queues despite rising prices.

Russians who are not directly involved in the war against Ukraine are the worst affected. A Russian contract soldier earns up to RUB 5 million (approx. US$60,000) a year, including a sign-on bonus, whereas the general population earns between RUB 500,000 and 700,000 (US$6,000-8,400) a year. That said, around 20% of Russians are directly connected to the war – contract soldiers, workers in the defence industrial base, and their families.

Laws of economics

Playing fast and loose with monetary instruments could easily push Russia into stagflation or even hyperinflation – as it stands, the actual rate of inflation is already in galloping territory.

The macroeconomic faction within the Russian government clearly recognises this, which explains certain elements in its tight monetary policy such as the high key interest rate (until recently it was 20%) and an overvalued rouble (pegged at around 80 roubles to the dollar until recently). Furthermore, the Central Bank has to keep issuing roubles to cover military expenses. As a result, the money supply will continue to grow without being backed by growth in goods and services.

Between 2022 and 2025, Russia's broad money supply has increased by 58.1%, while GDP has grown by just 8.4%. Even using the official figures, a comparison shows that the growth of money supplied significantly exceeds the value added to the economy it serves. But there are doubts about whether the economy grew at all – some estimates suggest it may even have contracted.

Stagnant growth in GDP and industry combined with high real inflation: that is the definition of stagflation. Faced with a choice between hyperinflation and stagflation, the Central Bank of Russia has so far settled on the latter as the lesser of two evils. But large-scale military spending cannot be sustained in a stagflation situation without disastrous social and economic consequences.

The crisis could be averted if more workers were employed in productive activities, boosting their purchasing power and increasing the supply of goods. However, Russia will not be able to take this path while it continues its war against Ukraine.

The difference between the warring countries' economies

The Ukrainian economy has the same sort of military demand, which requires vast resources. All taxes generated by economic activity are directed towards military spending. GDP growth rates are low – around 1% for the first half of this year.

There is, however, a fundamental difference between the Ukrainian and Russian economies. Ukraine receives macro-financial assistance from the European Union and other allies, while Russia provides economic concessions to China, a country that has saved Moscow's exports but benefits from low prices for raw materials and semi-finished goods in return. Russia may be seeking a macro-financial loan, but finding a counterparty other than China willing to provide one is difficult.

Thus, Ukraine can count on extensive financial support from abroad, while Russia must rely solely on its own economic resources. This gives Ukraine a more solid foundation for economic stability.

Time is not on the Russian economy's side. The spectre of stagflation and the continuation of sanctions are creating a perfect storm that could soon engulf the economy. On top of that, Ukrainian attacks on the petrochemical sector are intensifying the strain. Russians have started to feel the social and economic consequences of instigating the war.

Author: Volodymyr Vlasiuk

Translation: Artem Yakymyshyn

Editing: Teresa Pearce