Structural Economic Strain on Russia’s War Economy

Executive summary

Russia’s economy has proved far more resilient than many predicted in early 2022. Rapid fiscal mobilization, re-routing of energy exports, forced industrial conversion, and an aggressive use of monetary and administrative controls pushed headline GDP growth above 4% in 2023–2024 even as the war continued. Yet underneath those headline numbers, strain is accumulating. Inflation remains elevated; capacity and labor are stretched; the budget’s dependence on defense spending is deepening; foreign technology and finance remain restricted; and the oil export model is more expensive and risk-prone than before. The result is a war economy that can function, and even grow in the short run, but only by sacrificing long-term productivity, private investment, and living standards. Multiple independent trackers and official releases now converge on the same story: Russia has entered a high-pressure, state-directed equilibrium whose costs compound over time.

1) From shock to mobilization: how the war economy was built

Russia’s initial post-invasion adjustment had two pillars. First, a massive fiscal pivot: “national defense” and related security lines were prioritized, procurement was simplified, and the military-industrial complex was flooded with orders and subsidies. Second, energy export revenues—buffered by high global prices in 2022 and creative logistics afterward—financed that pivot and stabilized the balance of payments. Analysts often describe the outcome as a “gas station producing tanks”: hydrocarbons pay for armaments, and armaments drive growth. That model worked in 2023–2024, but it is inherently finite because it consumes slack quickly while degrading the economy’s stock of productive capital and know-how.

A crucial enabler was the redirection of oil flows using a burgeoning “shadow fleet” of older tankers with opaque ownership and non-Western insurance. This allowed Moscow to sell crude above the G7 price cap and to capture margins otherwise blocked by sanctions. However, tighter enforcement in 2024–2025—targeting ships and service providers—has slowed the fleet’s expansion and raised costs and risks in the supply chain. Logistics that were once merely inefficient are now hazardous, regulatory-sensitive, and expensive, eating into net fiscal space.

2) The headline numbers: growth with overheating

By the authorities’ own reckoning and external observers’ estimates, GDP increased by roughly 4% in 2024, driven by state demand and investment tied to defense. That is unusually strong for a mature economy under sanctions. The Central Bank of Russia (CBR), however, has repeatedly flagged overheating: demand outpacing supply, persistent price pressures, and limited spare capacity. Its summaries note double-digit annualized inflation rates at the end of 2024 and into early 2025, the hallmark of an economy pushed beyond sustainable speed limits.

Looking ahead, the IMF’s July 2025 update projects Russian growth decelerating sharply to around 0.9% in 2025, effectively stalling once the one-off fiscal impulse and forced conversion of factories into defense suppliers run into real resource constraints. In short: the war economy can manufacture short-term growth by spending and commandeering resources, but it cannot manufacture productivity.

3) Labor: the binding constraint

The most immediate structural strain is labor. Russia’s unemployment rate has fallen to historic lows (around 2–3%), a level that signals not healthy dynamism but shortage. Mobilization, casualties, emigration of skilled workers, and the pull of defense factories have thinned the labor pool and misallocated talent. Even as the CBR loosened policy from peak crisis settings in 2025, businesses continued reporting acute difficulty hiring. That scarcity bids up wages, which feeds inflation, which in turn forces monetary tightening and financial repression to keep the budget affordable. It is a classic wage-price-policy spiral—without the productivity gains that would justify higher pay.

The quality dimension matters as much as quantity. Advanced manufacturing, IT, and services lost a disproportionate share of globally oriented professionals after 2022. Replacing those skills domestically is slow; importing them is harder than importing raw labor, and many foreign firms that once trained local staff have exited. The visible symptom is rising delivery times, bottlenecks in specialized components, and the need to retrofit older production lines to meet defense orders—good for near-term output, bad for technological frontier catching-up.

4) Budget math: guns, fewer butter, and a thinner cushion

Defense spending’s share and trajectory

Estimates by the Stockholm International Peace Research Institute suggest total planned military expenditure in 2025 around 15.5 trillion rubles, roughly 7.2% of GDP, up again in real terms despite efforts to consolidate elsewhere. Independent analyses also argue that 2024 defense outlays overshot their initial plan by a wide margin—into the 13 trillion ruble range—underscoring how quickly the war absorbs fiscal space.

Deficit dynamics and debt service

Despite robust oil receipts, the federal deficit widened through early 2025, reaching around 1.5% of GDP by May and about the full-year target (1.7%) by July. As rates rose to fight inflation and absorb excess demand, interest costs increased as a share of the budget. Russia can finance itself domestically and through captive buyers, but higher rates crowd out private credit and elevate the state’s rollover risk over time. Moreover, the liquid portion of the National Welfare Fund—once a key cushion—has been drawn down, limiting shock absorbers if oil prices soften or enforcement tightens further.

Composition effects

“National defense” plus “national security and law enforcement” lines now dominate incremental spending. That composition matters: unlike infrastructure, education, or health, a large share of defense outlays do not raise medium-term productivity. They can even reduce it if they permanently pull engineers and capital into lower-productivity state arsenals instead of export-capable industries. In effect, the budget is optimized for throughput (shells, armored vehicles, drone frames) rather than competitiveness, locking in a future of slower civilian growth.

5) Monetary policy, the ruble, and financial repression

The CBR has swung between very tight policy to tame inflation and tactical easing to avoid strangling growth. But with both domestic demand and defense orders running hot, standard tools have limited bite. The central bank can raise rates, but that raises debt service for the state and squeezes credit to the private sector—especially SMEs that lack privileged access. It can let the ruble depreciate to absorb external shocks, but pass-through to prices is high given import dependence for technology, machinery, and many consumer goods. Result: a policy mix that leans increasingly on administrative measures—capital flow management, directed lending, export surrender requirements, and moral suasion—to hold the line. Over time, those controls distort price signals, reduce investment, and make inflation stickier.

6) Industry under strain: capacity walls and substitution limits

Defense-led manufacturing surge…

The military-industrial complex (MIC) has been on a tear since late 2022. Lines producing artillery shells, armored vehicles, missiles, and drones run at near-continuous shifts. Even estimates from 2024 suggested millions of shells per year through production and refurbishment—evidence of substantial conversion and scale-up. That surge supports aggregate industrial output and employment.

…but with civilian crowd-out and efficiency losses

The same surge means machine-tool capacity, skilled technicians, and precision manufacturing are diverted from civilian uses. Firms retrofit old equipment or cannibalize imported parts; production structures adjust for volume rather than quality. Over time, this creates dual damage: (1) capital scrappage, as modern civilian lines are idled or reconfigured for defense and (2) technological stasis, as sanctions slow the flow of high-end components and software updates. The result is a widening productivity gap with peer economies.

7) Sanctions, export controls, and the shadow logistics tax

Sanctions rarely produce sudden collapse; they produce frictions. The current mix—financial restrictions, export controls on advanced inputs, and the oil price cap with enforcement targeting ships and service chains—adds a shadow logistics tax to doing business. Russia can still import many goods via intermediaries and “friendly” routes, but prices are higher, delivery times longer, and quality less certain. A growing share of the oil trade now uses older tankers with non-standard insurance, which raises risk premia and occasional losses (detentions, accidents, denied claims). As authorities in the EU, UK, and U.S. step up enforcement, particularly blacklisting tankers and intermediaries, that tax rises—squeezing net budget revenue even when nominal export volumes hold up.

Independent energy trackers reinforce the point: the level of the price cap matters less than enforcement. When enforcement tightens, Urals discounts widen and net revenues fall; when enforcement is lax and the shadow fleet expands, Moscow recoups more. The policy path in 2025 has tilted toward stricter enforcement than in 2023, a headwind for the war budget.

8) The China factor: lifeline with limits

China has been indispensable for maintaining production: a market for discounted energy, a supplier of dual-use components and machine tools, and a conduit for consumer imports. But this role is asymmetric. China bargains from strength, enjoys better terms, and can dial exposure up or down in response to Western secondary sanctions threats. For Russia, the deeper the dependence, the narrower the policy space—especially if Beijing prioritizes its global financial relationships or domestic stabilization over subsidizing Russia’s wartime needs. Moreover, substituting Western technology with Chinese alternatives works for many mid-tech goods but is less effective at the cutting edge (semiconductors, specialized optics, avionics), where controls bite the most. Analysts widely note that this channel kept the war economy afloat in 2023–2024 while simultaneously locking it into a lower-tech trajectory.

9) Households and living standards: squeezed but compliant

For households, the war economy means tight labor markets (more jobs and higher nominal wages) but high inflation, restricted consumer choice, and deteriorating public services outside defense-related regions. The government has cushioned some groups via indexations and social transfers, but the budget’s composition increasingly favors defense and security. Over time, this real-income squeeze restrains consumption growth and stokes inequality: regions integrated into the defense supply chain fare better; others lag. Administrative controls suppress visible discontent by keeping unemployment low and mandating production—at the cost of worsening microeconomic efficiency.

10) What “resilience” really means: a bubble of state demand

Calling Russia’s recent performance “resilient” is accurate, but incomplete. The drivers—fiscal surge, forced industrial conversion, energy arbitrage—are one-off and state-driven. Once capacity is fully utilized and labor is scarce, additional spending generates more inflation than output. The CBR’s communications essentially acknowledge this: with core inflation running hot in late 2024 and early 2025, the central bank signaled overheating and the need to cool demand. The IMF’s downgrade to sub-1% growth for 2025 is precisely what a fading fiscal impulse plus binding supply constraints should deliver.

11) The five structural fault lines

(a) A militarized budget with compounding obligations

Defense procurement creates future liabilities: maintenance, veterans’ benefits, reconstruction of depleted equipment, and long supply contracts. As those obligations accumulate, the discretionary part of the budget shrinks. Debt service is rising as rates stay high (even after cuts, real rates remain positive due to inflation). The longer the war lasts, the more fixed these obligations become.

(b) A chronically tight labor market

Demographics were already unfavorable. War-related labor losses, mobilization, and emigration compound the trend. Training pipelines cannot quickly replace advanced skills. The wage bill rises faster than productivity, entrenching an inflationary bias and undermining competitiveness in tradables.

(c) Technology denial and capital scrappage

Export controls on high-end inputs, software, and machine tools slow the diffusion of frontier technology. Workarounds exist but are costlier and riskier. Over time this produces capital shallowing (lower quality capital per worker) and misallocation (capital stuck in low-productivity defense uses).

(d) A riskier energy export model

The shadow fleet and non-Western services are expensive substitutes for the previously cheap, frictionless access to Western tankers and insurers. As enforcement tightens, netbacks decline. Shipping incidents, legal seizures, and insurance disputes add tail risks that markets price in.

(e) Institutional opacity and commandism

Wartime secrecy increases; statistical releases are delayed or reclassified; procurement is shielded; and price controls proliferate. These measures preserve stability but repel private investment, particularly foreign direct investment, which is crucial for productivity catch-up.

12) Scenarios for 2025–2026

Baseline: slow grind, high pressure

Under continued hostilities and current sanctions enforcement, growth slows toward zero to 1%, inflation stays above target, and the budget channels more to defense while trimming non-priority programs. Oil revenue remains adequate but subject to discount and logistics costs. Households experience real income stagnation and periodic goods shortages in specific categories. This is the scenario embedded in many mid-2025 projections.

Upside: price windfall, enforcement slippage

If oil prices spike and sanctions enforcement ebbs (e.g., fewer tanker designations, more service leakage), budget revenues improve, allowing more defense spending without immediate austerity. Growth could edge higher temporarily. But structural problems—labor, tech, productivity—still cap the upside and raise medium-term costs.

Downside: enforcement bite, oil softness, or financial shock

A tighter clamp on transport and services, combined with softer global oil prices or a shipping disruption, would widen the deficit and force harsher domestic financing (more debt at higher rates) or spending cuts elsewhere. In this scenario, the state may rely more heavily on financial repression—captive savings, credit quotas, and stricter capital controls—further undermining private sector vitality.

13) Implications for Russia’s post-war transition

The longer the war economy runs, the harder the post-war transition becomes:

Reconversion costs: Plants retooled for ammunition and armor must be reconverted or closed; workers must be retrained; inventories of specialized inputs become stranded assets.
Debt and entitlement overhang: Veterans’ care, pensions, and maintenance commitments persist; debt service remains elevated if inflation expectations stay unanchored.
Technological backwardness: Years without frontier tech inflows leave a larger gap to close; replacing Western standards with alternatives creates compatibility issues and sunk costs.
Geopolitical dependence: A deeper tilt toward China and a smaller set of “friendly” partners reduces bargaining power and amplifies exposure to any change in those partners’ calculus.

14) What to watch: leading indicators of strain

Budget revisions and sequestration: Mid-year top-ups to defense lines, cuts elsewhere, or fresh taxes on “excess profits” would signal intensifying pressure. Independent trackers flag 2024’s overshoot relative to plan as a cautionary precedent.
CBR guidance and real rates: If the central bank keeps real rates high despite slowing growth, it implies entrenched inflation and overheating. Conversely, aggressive cuts would risk a weaker ruble and even higher inflation later—both signs of limited policy room.
Labor market tightness: Watch vacancy-to-unemployment ratios, wage growth, and mobilization waves. Persistent 2–3% unemployment with rising wages and flat productivity is not healthy; it is scarcity.
Sanctions enforcement on shipping/insurance: New designations of tankers and intermediaries, tighter due diligence by insurers, or seizures will widen Urals discounts and cut net budget inflows.
NWF drawdown and domestic bond demand: Deeper use of fiscal buffers and heavier reliance on state banks and pension funds to absorb issuance indicate rising financing stress.

15) Bottom line: durable capacity vs. wartime throughput

Russia’s war economy solved the short-run problem of keeping the front supplied and the home front employed. It did so by maximizing throughput, not by expanding durable capacity. The policy regime—heavy fiscal mobilization, administrative control, trade and payments improvisation—trades away future growth to buy present firepower. Now the bill is arriving:

Productive capacity is stretched (labor shortages, full utilization) and cannot grow fast under sanctions.
Inflation pressure persists, forcing a policy mix that crowds out private investment and deepens dependence on state banks.
Defense spending is locking in as a structural share of GDP and of the budget, even as financing buffers thin.
The energy-for-arms bargain depends on fragile logistics and sanction-sensitive arbitrage, which is becoming costlier and riskier to sustain.

“Resilience” was not a mirage—but it was bought on credit against Russia’s future productivity. With growth projected to slow toward stall speed in 2025, the structural strains of militarization, labor scarcity, and technological isolation are no longer background noise; they are the macro story. Unless the policy mix pivots toward rebuilding civilian capacity and re-opening channels to high-end technology and finance, the war economy’s internal contradictions—high spending needs, tight labor, sticky inflation, and falling net oil margins—will keep tightening the vise.

Final thought

In macroeconomics, the difference between capacity and utilization is destiny. Russia’s war economy has maximized utilization. The structural strain shows up where capacity should grow—skills, technology, institutions, and trust. Unless those recover, the near-term ability to fund and feed the war effort will slowly erode the foundations of future prosperity.

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