The demands of war are straining Russia’s federal budget. Military spending had been projected to reach R14.7 trillion ($170 billion) in 2024, but is likely to have been higher still: official spending alone is likely to have exceeded R12 trillion (instead of the envisaged R10.8 trillion), before hidden costs are accounted for. In 2025, military expenditure is set to rise to R13.5 trillion on the official measure, and to R26.4 trillion including hidden budget items. This would mean overall military spending consuming up to 63 per cent of the federal budget. By comparison, its share was just 14–16 per cent before the February 2022 invasion.
In the ‘guns or butter’ dilemma, the Kremlin has opted for the former, with education, regional subsidies and similar expenditures cut or frozen. While inflation is exceeding 9 per cent, social expenditures this year are to be cut by 16 per cent to R6.5 trillion. In 2023, Minister of Finance Anton Siluanov called the budget for 2024 the ‘victory budget’. At that time, the prospective budgets for 2025 and 2026 envisaged some normalization of military expenditure. As it turns out, this is not to be the case for 2025, and no reduction is foreseen by the Russian Ministry of Finance for the following two years. Instead, Russians will have to adjust to a ‘new normality’ of tightening belts for their country to become one of the most militarized in the world.
Despite the high level of military spending, the federal budget deficit has remained relatively low and falling: the deficit was recorded at 2.3 per cent of GDP in 2022, before falling to 1.9 per cent in 2023 and 1.7 per cent of GDP in 2024. This trajectory reflects the impact to date of high oil prices on government revenues, as well as the artificial and temporary economic boom created by the boost in military production and the injection into the economy of large amounts of money for military salaries and compensation payments for dead or wounded combatants. However, these factors are no longer present. Conversely, despite tax hikes that were meant to reduce the budget deficit to just 0.5 per cent in 2025, the outcome is anticipated at 1.7 per cent (about R3.8 trillion). That figure may eventually be much higher. Russia’s budget deficit may seem small compared to, for example, the 3 per cent of GDP stipulated in eurozone criteria, but Russia’s lack of access to international financial markets means that even a deficit of under 2 per cent is more difficult to manage.
Further deterioration of Russia’s fiscal imbalances, coupled with no access to world financial markets, would leave the Russian authorities with hard choices if they are to maintain current state spending levels, including the following:
- Withdrawing money from the National Wealth Fund. The fund held R2.8 trillion in liquid assets as of 1 June 2025, equivalent to 1.3 per cent of estimated 2025 GDP. It contains only $21 billion net of gold that is conditionally liquid due to sanctions. This is an emergency reserve barely able to cover a one-year budget deficit. Having remained relatively stable over much of the last two years, the fund’s holdings decreased sharply in value during the last quarter of 2024 and the first half of 2025.
- Monetary emission. Also colloquially known as ‘printing money’, monetary emission would add to inflationary pressures, already exacerbated by military-related spending and by defence-industry salaries that do not contribute to the supply of marketable goods or services. Inflation could be potentially contained by selling the central bank’s remaining currency and gold reserves, but this way of upholding the price stability would further magnify macroeconomic distortions and still not last for more than two years under current conditions.
- Domestic market borrowing. The government could borrow in the domestic market to finance the deficit, and some authors consider this source abundant due to high level of assets of the Russian banking system. But more nuanced analysis suggests that the scope for doing so is limited for a number of reasons.
While bank assets are indeed abundant and growing, they are currently mostly converted to private sector and household loans and securities that are vital to keep the economy running. Deficit financing of this type crowds out private investment and thus hinders economic growth, as the government’s borrowing diverts funds that would otherwise have been available for lending into the real economy.
Although the banking system remains relatively stable, warning signs point to trends that could jeopardize its ability to purchase more treasury bills. Moreover, many loans and securities (such as those of state-owned enterprises) are very likely to become non-performing if oil export revenues are cut. (There is also the problem that many loans in Russia are concealed.) If the risk of a banking crisis materializes, the government would have to spend or lend money to bail out the systemic banks.
Even more importantly, for the Russian government to keep servicing its deficit through deposit-financed borrowing, the main interest rate and treasury yields will need to be kept well above the (already high) rate of inflation plus the rate of GDP growth. Under these conditions, new bank deposits invested in treasury bills create a semi-closed loop of government expenditure that might provide resources for deficit financing, and also partially absorb the emitted money so their emission does not result in growth in aggregate demand, hence inflation. This mechanism is effectively akin to a Ponzi scheme, in which the debt would accumulate exponentially (the so-called ‘snowball effect’), while interests paid on the deposits would add to the monetary pressure – just as happened in mid-1990s, ending with an economic crisis with severe political consequences.
Currently, the central bank’s main interest rate is 18 per cent, while Russian treasury yields are about 15 per cent for both a 20-year bond and a one-year bond. Although Russian state debt is currently low – the IMF estimates it at only 21.4 per cent of GDP – such high interest rates combined with a dramatic increase in the budget deficit may soon render that debt unsustainable. A Ponzi scheme is a finite game, as the crisis of 1998 demonstrated so clearly. Thus, even though the snowball effect takes time to gain momentum, the effect on expectations could be devastating.
- Raising taxes and cutting non-military expenditure. Both of these measures are envisaged for 2025 and beyond. Personal income tax has become progressive, with higher rates added for those on higher incomes after more than 20 years of being set at a flat rate. The corporate tax rate will rise from 20 per cent to 25 per cent in 2025. The government anticipates receiving an additional 2.5 trillion roubles through higher taxes. Meanwhile, social and other expenditures are set to decrease. These actions will be unpopular among regime supporters and members of Russia’s elites, as well as with the wider public. For instance, federal subsidies to the regions are set to decline from R3.6 trillion in 2024 to R3.3 trillion in 2025. Such a reduction has the potential to weaken loyalty to Putin and his regime, as these subsidies are the most important source of rents for elites in regions such as Chechnya.
To various degrees, Russia’s authorities are already employing, or planning to employ, the methods outlined above. But a sharp exacerbation of fiscal imbalances – for example, caused by a loss of oil revenues – could increase the pressure on the regime to take additional unpopular or unsustainable measures – maybe as soon as late 2025. Such pressures would make it harder for the Russian authorities to grow their way out of trouble or to prop up the economy with fiscal stimulus, putting the regime itself under significant pressure.
This level of pressure would disrupt the vertical of power and put it in jeopardy, unless it is quickly and deliberately replaced from the top by a non-patronal structure, as in a classic dictatorship – a task that cannot be accomplished within just one or two years. Thus, the oil-price cap would pose a credible threat to the regime if it were sealed and gradually lowered in a short timeframe. And it would do so without provoking a spike in oil prices that harms the coalition countries. In our view, if supplemented with sufficient military aid to Ukraine, a sealed cap would pose a threat to the regime’s stability comparable to that arising from a cessation of hostilities or even a withdrawal from Ukraine. Imposing precisely this kind of policy dilemma on the Kremlin should be the aim of further oil market sanctions.
