Enough for two more years of war: Russia's economy just won't slip into recession

The Russian economy is stagnating, but still holding on. Expert forecasts suggest the Kremlin can sustain its current war effort for at least two more years. What could finally push the Russian economy to breaking point?

Throughout the war there have been repeated predictions that the Russian economy would soon buckle under the strain of Western sanctions and heavy military spending. So far, that has not happened. Russia has avoided both stagflation and recession. Its two-speed (military and civilian) economic model has begun to slow down, but it is still functioning.

The latest assessments by Ukrainian economists are not encouraging: the Kremlin can sustain the current pace of the war for at least another two years, even if oil prices fall. Why is Russia's GDP still growing, and what could push its economy towards collapse?

Sanctions, but no recession

At the start of the full-scale war, expectations about the impact of US and EU sanctions on Russia were unduly high. Many people were taken aback when dozens of "devastating" sanctions packages failed to trigger a financial or economic crisis in Russia.

Yuliia Pavytska, head of the Sanctions Hub of Excellence at the KSE Institute, says: "In political discourse, sanctions packages are often described as unprecedentedly strong. But when you analyse the final provisions, you see transition periods or exemptions that immediately weaken their potential impact."

Despite Russia's dependence on the global economy and the ineffectiveness of its import substitution policy, Western restrictions have failed to deliver the impact many in the West had anticipated. Moscow has found ways around them by importing technology and equipment through third countries and making the most of its free access to the world's largest manufacturing hub and one of its biggest consumers of raw materials – China.

"Despite the sanctions, Russia has been able to retain a significant portion of its energy export revenue by redirecting supplies to China, India and other Asian countries," says Tetiana Bohdan, director of research at the Growford Institute.

Another factor that contributed to the overblown expectations of Russia's economic collapse was the widespread distrust of its official statistics and the hope that the reality was far worse than the figures suggested. That turned out to be wishful thinking.

Although Russia quickly overtook Iran to become the world's most sanctioned country, in the first year of the full-scale war its GDP contracted by only 1.4%. Heavy government spending and lending boosted both the war economy and civilian sectors. As a result, the Russian economy grew by 9.2% between 2023 and 2024.

In 2025, however, Russia's economic growth lost momentum, slowing down to 1%. The forecast for 2026 stood at just 0.4%. But in July, higher oil prices prompted the IMF to revise its growth forecast for Russia upwards to 1.1%, which rules out a recession this year. "The Russian economy will most likely be on the brink of stagnation, but at present we do not see any preconditions for a rapid slide into recession," adds Pavytska.

Russia's economic growth since the start of the full-scale war has been supported by significant fiscal and credit stimulus. According to the Stockholm International Peace Research Institute (SIPRI), total expenditure in 2025 amounted to RUB 42.9 trillion (approx. US$515 billion), over RUB 16 trillion (US$192 billion) of which was military spending.

In Q1 2026, military spending reached a record 65% of budget revenue. And it is the soaring military expenditure that is driving up the deficit: Russia had a budget surplus before the full-scale war.

Amid foreign capital flight and financial sanctions, Russia's Central Bank helped the government build a war economy and then prepare it for a war of attrition. "The policy pursued by Russia's Central Bank has enabled the economy to function in two spheres – military and civilian – which has helped the economy adapt to the war," says Mykhailo Dzhus, head of the Money Markets Department at the Growford Institute.

Banks were obliged to provide preferential loans to the military-industrial complex, but they also extended credit to civilian sectors that fed into the war. Business lending almost doubled as a result, rising from RUB 50 trillion (US$600 billion) in 2021 to RUB 88 trillion (US$1.06 trillion) in August 2026. Support for civilian businesses had all but dried up by then, yet the banks continued to pour money into the war machine.

"Once spare production capacity had been exhausted, the economy's labour shortages and technological backwardness were laid bare," Tetiana Bohdan says. "The boost from wartime Keynesianism began to fade, and the economy entered a period of stagnation."

Growth in industrial manufacturing slowed from 5.6% in 2024 to 1.1% in 2025 and just 0.1% in January-July 2026. All of that growth came from the production of weapons and military equipment. That said, growth in the military-industrial complex – the core of the Russian economy – fell from 20% to 3-6% over the same period, according to the Growford Institute.

The downturn is already visible across predominantly civilian sectors such as oil refining, the metals industry, chemicals, construction, transport, wholesale trade, and building materials, machinery and equipment manufacturing.

Russian investment has been in the doldrums for five quarters in a row, falling by 9.9% in the first half of 2026. "The decline in investment points to serious problems in the Russian economy. It signals deteriorating business expectations and a high likelihood that the economy will slide into recession," says Tetiana Bohdan.

Russia's GDP contracted by 0.2% in Q1 2026, its first decline in three years. Then, buoyed by unexpectedly high oil prices, the economy grew by 1.3% in Q2. Technically, a recession requires two consecutive quarters of contraction, so the Russian economy stopped short of entering one.

Oil keeps Russia's public finances afloat

Since fuel and energy are Russia's biggest exports, the oil and gas revenues received by the federal budget are considered to be indicative of the scale of Russia's economic problems.

Growford describes the Russian economy as "quite adaptive", citing its substantial revenues from energy exports and economic ties with China, India, and Middle Eastern and Central Asian countries. Despite the sanctions, oil and petroleum product exports generated only 13.8% less revenue for Russia in 2025 than before the full-scale war.

Between November 2025 and February 2026, Russia's export revenues from oil and petroleum products fell to US$9.8-11 billion a month. This led to a 45% drop in the federal budget's oil and gas revenues in Q1 2026, particularly in the wake of sanctions on Russia's two largest oil producers, Rosneft and Lukoil. But the US-Iran war pushed oil prices up, boosting Russia's export earnings. Experts estimate that a US$10 change in the price per barrel for Urals, Russia's main crude export blend, can alter the nation's budget revenues by 1-1.5% of GDP a year.

"Between April and August, Russia earned an additional US$42.3 billion in export revenue from crude oil and petroleum products," says Pavytska.

The oil windfall has not been enough to compensate for the losses earlier in the year: oil and gas revenues for January-August were still 17% lower than last year. "But the fact that prices have rallied is giving them some breathing space in terms of their ability to finance the deficit," Pavytska says. The KSE Institute estimated in August that Russia's oil export revenues could increase by US$24 billion in 2026.

Read more: Oil superpower queues up for petrol from India. Will it help Russia?

Oil and gas revenues have become less significant for Russia over the years and now account for just 28% of the budget. "There is a stereotypical perception that the federal budget is heavily dependent on oil and gas export revenues. As those revenues have declined, the authorities are attempting to cover rising military spending by taxing consumption and income," says Kostiantyn Shvabii, an expert at the Growford Institute.

During the war, Russia has introduced progressive personal income tax and raised the corporate tax rate. As a result, consumption and income taxes accounted for 46% of budget revenue by the end of 2025, up from 30% in 2021.

The expansion of the tax burden didn't stop there. In 2026, VAT was increased by two percentage points to 22%, meaning Russians will be paying an additional RUB 1.2-1.4 trillion (US$14-17 billion).

But even this is not enough to finance the war, and the federal budget deficit continues to grow, reaching a record RUB 5.6 trillion (US$67 billion), or 2.6% of GDP, last year. In the first half of this year alone, the deficit rose further to RUB 5.7 trillion (US$68 billion), or 2.7% of GDP.

One reason is that January-August revenue was RUB 1 trillion (US$12 billion, or 16.7%) lower than in the same period of 2025. "That's about one month of war. By the end of the year, the deficit will stand at RUB 7-7.5 trillion [US$84-90 billion], or 3-3.5% of GDP," Shvabii predicts.

The Kremlin has decided to be more flexible in its response to these challenges. "Russia has permitted changes to be made to spending and deficit plans without amending the budget law. The Ministry of Finance has been given greater leeway," Pavytska says.

How Russia is financing its deficit

Before the full-scale war, Russia was running a budget surplus and putting its oil windfall profits into the National Wealth Fund (NWF). Since February 2022, the Kremlin has been drawing from the fund to help cover the deficit. The fund's assets stood at 10% of GDP at the start of the full-scale war. Now only 5.6% of GDP remains.

The NWF now holds RUB 13.2 trillion (US$158 billion), but only RUB 4 trillion (US$48 billion) in liquid assets – foreign currency and gold. "In the past few years Russia has made extensive use of the liquid portion of the fund to plug the hole in the budget. It is now being kept in reserve. Perhaps they have reached the 'red line' for liquid assets, below which it is too risky to go," Pavytska says.

What about the gold reserves? Reports of gold sales are usually seen as a sign that the Kremlin is acutely short of cash. But the 56 tonnes sold since the start of the year represent just 2.4% of Russia's gold reserves.

Between 2014 and 2021 Russia more than doubled its gold reserves, which now stand at 73 million troy ounces. As the price of gold rose from US$1,800 to more than US$4,400 per ounce between 2022 and 2026, the revaluation of the Central Bank's reserves pushed their value up to US$333.5 billion. To put this into perspective: around US$300 billion of the Central Bank's assets are considered frozen in the West.

Excluding frozen assets and monetary gold, Russia's international reserves total US$769 billion, US$135 billion of which is held in foreign currency. Although only one in six dollars of Russia's official reserves is held in foreign currency, the figure has remained stable for almost the entire war.

Russia's gold reserves are worth RUB 33.6 trillion (US$403 billion) – enough to cover roughly two years of war spending. "The rouble equivalent is twice the estimated cost of the war in 2025. The reserves are sufficient for two years," says Dzhus.

The borrowing problem

If it's not coming from the NWF or sales of gold, where is Russia getting its money from?

In January-June 2026, Russia's budget deficit stood at RUB 5.7 trillion (US$68 billion). Net borrowing covered RUB 2.3 trillion (US$28 billion), another RUB 0.5 trillion (US$6 billion) came from the NWF, and the rest was financed from the government's own funds held in Treasury accounts. But this source of funding is being rapidly depleted, leaving the government increasingly reliant on domestic borrowing. According to KSE's calculations, around 85% of deficit financing has come from domestic debt since the start of 2025.

After foreign investors pulled out, Russian banks became the sole buyers of bonds, using customers' deposits to finance their purchases. Customer deposits have grown by 81% over the last four years, as the Central Bank's tight monetary policy has encouraged Russians to keep their money in the bank, with interest rates above 20% a year.

The inflow of funds has slowed over time, even though interest rates remain above the 6.3% inflation rate. Since February, the banking sector has been experiencing a "progressive liquidity deficit", which as of 14 September exceeded RUB 3 trillion (US$36 billion). Banks are increasingly having to turn to the Central Bank, using bonds as collateral. "Demand for cash is driving the banking sector's liquidity shortfall. Repo transactions are being used to cover it, and banks are also using them to finance the budget deficit by purchasing bonds," explains Dzhus.

Against this backdrop, borrowing is becoming more and more difficult for the Russian Ministry of Finance. In July and August most bond auctions were cancelled due to insufficient demand. "In September they raised RUB 1.1 trillion [US$13 billion], but only after offering bonds at a discount and a higher floating rate. In other words, they were forced to accept less favourable borrowing terms that will cost them more," Pavytska says.

So Russia's problem is not so much the size of its public debt, which stands at 18.3% of GDP, as the cost of servicing it, with interest payments consuming 9% of budget revenue. "We need to let this spiral continue until the cost of servicing the debt becomes so high that the government is forced to cut spending," Pavytska says.

That raises the question of which will come first – a budget crisis or a banking crisis. Dzhus is sceptical about the latter prospect: "Despite numerous reports that the banking system is already in a pre-crisis or crisis state, the statistical data gives no grounds to conclude that it could become a source of destabilisation in the near future."

Should the financial situation deteriorate further, the Kremlin would once again resort to tax hikes to raise more money for the war. "Russia is a totalitarian state, and despite everything it still technically functions as a market economy. If the country finds itself in a tight spot, it will have one card left to play: a major tax hike that would force the economy to chip in to the common pot for the war," says Pavytska.

For the moment the authorities have held off on introducing another tax rise, but Russians are already paying for the war in less obvious ways. This year regional authorities were given permission to cover the cost of recruiting contract soldiers by cutting their spending on housing and communal services. Utility tariffs are also expected to go up in October. "War spending is crowding out social spending," Shvabii says.

Two more years of war?

For now, the Kremlin can still finance the war at its current intensity, but it's becoming increasingly expensive to do so. The Growford Institute sees no signs of an "inevitable economic crisis", although macroeconomic imbalances are becoming more pronounced.

"The most likely scenario is prolonged attrition of the Russian economy, but the state will still be able to sustain high military spending for several more years," the institute forecasts.

Growford estimates that Russia will be able to maintain "the current pace of the war for at least two years" even if current conditions persist. Its assessment assumes no change in the sanctions regime, continued support from China, military spending at 2025-2026 levels, and oil prices of US$60-80 per barrel. On 23 September, however, Brent crude was trading at nearly US$100 per barrel.

At the same time, prioritising military spending means diverting more resources away from the civilian economy. "Russia will still be able to fund high military spending, but this will come at the cost of recession, deepening economic imbalances, and less public tolerance for the war," Bohdan predicts.

"At the moment Russia has enough money to maintain the status quo: wage the war, put pressure on the Ukrainian economy and keep its own economy more or less afloat. But it doesn't have enough to significantly expand its military capabilities and change the situation on the battlefield," Pavytska says.

In her view, the era of cheap war financing is already over for Russia: "All the other options are either very expensive or painful."

Russia's weak economy and fiscal vulnerability open up further scope for sanctions pressure. However, even though Lindsey Graham's Sanctioning Russia Act has entered into force, the US is not expected to immediately impose a 100% tariff on goods from Russia's biggest oil buyers, China and India. Experts believe that sanctions on Russian banks and businesses in the military-industrial complex will come first.

"Given that global oil prices have rallied, we cannot expect any of our partners – the US, the EU – to voluntarily impose new energy sanctions that would significantly reduce the supply of Russian crude oil and petroleum products on the global market," says Pavytska.

What Ukraine should do

Expectations of the Russian economy's imminent demise are still prevalent in the media. "But how can the Russian economy collapse if it is not isolated from the rest of the world? At the very least, China and India are still buying Russian energy, and China supplies over 70% of the critical components that Russia imports," Pavytska says.

What's needed is a rethink of how economic pressure should be applied to Russia and what Ukraine aims to achieve. "We need to move the emphasis away from expecting the aggressor's economy to shortly collapse, and towards a medium-term strategy to exhaust its economic potential and fuel social unrest," says Tetiana Bohdan of Growford.

Ukraine's strategy of "bringing the war home – to Russia" is aimed precisely at making the war more unbearable for Russians: from fuel shortages and airport chaos to a worsening socio-economic situation caused by inflation and the freeze on social spending.

It is crucial that the Armed Forces of Ukraine keep up their campaign of strikes on Russian oil refineries and maritime export infrastructure. At the height of the attacks, 45% of Russia's refining capacity was either offline or disrupted, and petrol production fell by 25%. The resulting fuel crisis has already led to a ban on exports of petroleum products and limited Russia's ability to maximise windfall profits.

Read more: A new front in the oil war: how Ukraine is disrupting Russia's maritime logistics

"We support Ukraine's kinetic sanctions," Pavytska says, referring to the campaign of strikes on Russia's energy infrastructure. "Last spring Russian oil and gas export revenues were an average US$21 billion a month, but in July and August [Ukrainian] drones got that down to US$13.5-13.9 billion, because Russia has drastically reduced its petroleum product exports. Crude exports also fell in August."

However, the escalation in the Middle East conflict has pushed oil prices back up, boosting the Kremlin's export revenues. In the first 20 days of September, Urals crude was trading at US$93 per barrel on average, compared with $66-68 in August. "Kinetic sanctions are helping to curb excess export revenue," Pavytska says.

Priority should be given to any measures that make oil and agricultural exports less profitable, increase the cost of evading sanctions and disrupt logistics. "Strikes by the defence forces should focus on the targets that will impact the public the most. In this context, a strategy of destroying oil refineries, maritime export infrastructure and e-commerce facilities can be considered justified," says Bohdan.

Read more: Drone strikes on "Russia's Amazon": the story of Wildberries

Growford recommends starting to conduct strikes on Russian energy infrastructure. "Coordinated strikes are needed on energy infrastructure in the Moscow metropolitan area and regional capitals within reach. The aim should be to disrupt energy supplies to densely populated civilian areas and industrial zones," says Bohdan.

The next step is to disrupt air traffic in European Russia. "And another possible course of action is launching cyberattacks on the digital rouble's infrastructure to increase public demand for cash and worsen the financial position of the banks," Bohdan suggests.

This would exacerbate the liquidity shortage and could trigger further crises if the actual share of non-performing loans in Russian banks turns out to be higher than the official figure of 11.8%, particularly among large corporate borrowers and mortgage holders. "The true level of toxic debt could be significantly higher," says Dzhus.

As long as Moscow has sufficient oil export revenues, it will keep on fighting the war. "We need to make the war as costly as possible for Russia in terms of resources – financial, human and time – and in terms of the painful political decisions it has to make to keep the war going each and every day," Pavytska explains.

Viacheslav Sadovnychyi

Translated by Artem Yakymyshyn

Edited by Teresa Pearce