ECONOMY
The Economy Is Not the Soft Spot of the Putin Regime
August 25, 2025
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Vladislav Inozemtsev
PhD in economics, cofounder and expert at the Center for Analysis and Strategies in Europe (CASE) in Nicosia, Cyprus
Despite the rising budget deficit, driven higher by military spending, Russia remains capable of generating the economic resources to sustain the Kremlin’s populism, argues economist Vladislav Inozemtsev.
In recent weeks, few issues have attracted as much attention from experts as the Russian budget forecasts for 2025 and the parameters of the 2026 budget. This is unsurprising: at this point, the budget looks like the Kremlin’s main failure. Officials have long spoken of an economic slowdown, but no one expected such a sharp drop in oil and gas revenues – and even less were they prepared for a budget that had been presented as “structurally balanced” to show a RUB 4.7 trillion shortfall mid-year. Against this backdrop, some commentators are now predicting that the deficit could widen to RUB 6 trillion or even close to RUB 10 trillion.
The government can still ramp up revenues
What is the real situation and what are the authorities likely to do next? In my view, the deficit – as in 2023-24 – is the result of excessive spending, primarily defense spending, in the first two quarters of the year. The difference this time is that oil and gas revenues have failed to improve the overall picture during the summer and early autumn.
This suggests that by year-end the deficit will remain at roughly the current level of between RUB 4.0 and RUB 4.5 trillion, or about 2% of GDP. That figure is not in itself critical, but for many years the Kremlin has prided itself on maintaining a budget surplus and large reserve funds. The new reality is uncomfortable for the regime. In the coming year, therefore, the Kremlin will almost certainly make a concerted effort to reduce the deficit – and I think it stands a good chance of succeeding.
Cutting expenditures is out of the question; on the contrary, they are bound to rise. After the spring “revisions,” the 2025 budget envisages RUB 38.5 trillion in revenues and RUB 42.3 trillion in expenditures. Next year, the Kremlin will try again to hit what was the initial 2025 revenue target of RUB 40.3 trillion. This is rather achievable: inflation alone will add at least 6% (about RUB 1.5 trillion); raising the VAT from 20% to 22% could bring in up to RUB 1 trillion, and instituting a progressive personal income tax another RUB 200-300 billion; and a weaker ruble (at RUB 95-100 per $1) will lift oil and gas revenues by 7-8%, or another RUB 700-800 billion. Altogether, even without extraordinary measures, revenues could reach RUB 41.0 trillion next year. But the draft budget submitted to the Duma will almost certainly feature a more optimistic figure – at least RUB 42 trillion – as the government seeks, at least on paper, to “rehabilitate” itself after the fiscal problems of 2025.
The government can still ramp up revenues
What is the real situation and what are the authorities likely to do next? In my view, the deficit – as in 2023-24 – is the result of excessive spending, primarily defense spending, in the first two quarters of the year. The difference this time is that oil and gas revenues have failed to improve the overall picture during the summer and early autumn.
This suggests that by year-end the deficit will remain at roughly the current level of between RUB 4.0 and RUB 4.5 trillion, or about 2% of GDP. That figure is not in itself critical, but for many years the Kremlin has prided itself on maintaining a budget surplus and large reserve funds. The new reality is uncomfortable for the regime. In the coming year, therefore, the Kremlin will almost certainly make a concerted effort to reduce the deficit – and I think it stands a good chance of succeeding.
Cutting expenditures is out of the question; on the contrary, they are bound to rise. After the spring “revisions,” the 2025 budget envisages RUB 38.5 trillion in revenues and RUB 42.3 trillion in expenditures. Next year, the Kremlin will try again to hit what was the initial 2025 revenue target of RUB 40.3 trillion. This is rather achievable: inflation alone will add at least 6% (about RUB 1.5 trillion); raising the VAT from 20% to 22% could bring in up to RUB 1 trillion, and instituting a progressive personal income tax another RUB 200-300 billion; and a weaker ruble (at RUB 95-100 per $1) will lift oil and gas revenues by 7-8%, or another RUB 700-800 billion. Altogether, even without extraordinary measures, revenues could reach RUB 41.0 trillion next year. But the draft budget submitted to the Duma will almost certainly feature a more optimistic figure – at least RUB 42 trillion – as the government seeks, at least on paper, to “rehabilitate” itself after the fiscal problems of 2025.
Platon Matakaev / Unsplash
Next year’s ‘military-first’ budget will still be optimized
Yet higher revenues will not produce a balanced budget. The deficit will likely remain only slightly below the current figure, at around RUB 3.0-3.5 trillion. The main driver of spending growth is the war. This year, actual defense expenditures will exceed the planned RUB 13.5 trillion to reach about RUB 14.5 trillion. In 2026, they are penciled in to rise another 10-15% in nominal terms, surpassing RUB 16.0 trillion. It is no coincidence that Dmitri Medvedev has already described the 2026 budget as one that puts the military first. As in previous years, the government will promise to increase defense spending “one last time” and cut it next year, in 2027 – an excuse so abused that it is hardly worth taking seriously.
I do not share the expectation that defense spending will account for 50% of revenues or that the share will rise relative to this year. More likely, it will stabilize at 40-42% of revenues (about 8% of GDP). Other expenditures, meanwhile, will only be indexed to the official inflation rate – and in many cases, not fully. Real spending in several areas, above all in the social sphere (excluding direct benefits and pensions), will therefore be lower than this year. In other words, the “budget that puts the military first” also entails squeezing out savings, with the government looking for ways to make cuts that are less visible to the public.
A key question remains: what additional sources of revenue can the authorities find? The VAT hike has already been decided on, and I would not rule out further increases before 2027. The VAT is easy to collect and hard to evade, while the inevitable 1.5-2.0% rise in prices is barely noticeable against the backdrop of falling inflation and interest rates. Other options include limiting VAT refunds on exports (especially for commodity producers), reducing or abolishing the fuel “damper” subsidy and introducing additional “temporary” taxes on natural resource sectors. These measures are politically attractive: they can be presented to the public as targeting “fat-cat corporations,” and each could raise more than a trillion rubles.
By contrast, some already announced steps, such as sharply raising the so-called “recycling fee” on imported vehicles and extracting more money from motorists starting November 1, look dubious. At best, they will bring in a few hundred billion rubles, but they risk eroding support for the Kremlin among “the broad masses.” In the first half of next year, we will see what choice the government has made: to go after the “new oil” by forcing individuals to pay more in taxes or to raid large corporations for more money (perhaps they will have to curb their investment programs).
Yet higher revenues will not produce a balanced budget. The deficit will likely remain only slightly below the current figure, at around RUB 3.0-3.5 trillion. The main driver of spending growth is the war. This year, actual defense expenditures will exceed the planned RUB 13.5 trillion to reach about RUB 14.5 trillion. In 2026, they are penciled in to rise another 10-15% in nominal terms, surpassing RUB 16.0 trillion. It is no coincidence that Dmitri Medvedev has already described the 2026 budget as one that puts the military first. As in previous years, the government will promise to increase defense spending “one last time” and cut it next year, in 2027 – an excuse so abused that it is hardly worth taking seriously.
I do not share the expectation that defense spending will account for 50% of revenues or that the share will rise relative to this year. More likely, it will stabilize at 40-42% of revenues (about 8% of GDP). Other expenditures, meanwhile, will only be indexed to the official inflation rate – and in many cases, not fully. Real spending in several areas, above all in the social sphere (excluding direct benefits and pensions), will therefore be lower than this year. In other words, the “budget that puts the military first” also entails squeezing out savings, with the government looking for ways to make cuts that are less visible to the public.
A key question remains: what additional sources of revenue can the authorities find? The VAT hike has already been decided on, and I would not rule out further increases before 2027. The VAT is easy to collect and hard to evade, while the inevitable 1.5-2.0% rise in prices is barely noticeable against the backdrop of falling inflation and interest rates. Other options include limiting VAT refunds on exports (especially for commodity producers), reducing or abolishing the fuel “damper” subsidy and introducing additional “temporary” taxes on natural resource sectors. These measures are politically attractive: they can be presented to the public as targeting “fat-cat corporations,” and each could raise more than a trillion rubles.
By contrast, some already announced steps, such as sharply raising the so-called “recycling fee” on imported vehicles and extracting more money from motorists starting November 1, look dubious. At best, they will bring in a few hundred billion rubles, but they risk eroding support for the Kremlin among “the broad masses.” In the first half of next year, we will see what choice the government has made: to go after the “new oil” by forcing individuals to pay more in taxes or to raid large corporations for more money (perhaps they will have to curb their investment programs).
Vardan Papikyan / Unsplash
What’s next for the economy?
Naturally, everyone is interested in what the future of the Russian economy might look like amid the ongoing militarization of society. In my view, the broad answer is clear: in the second half of the 2020s, neither the preconditions for accelerated growth in Russia nor those for an economic collapse will appear.
The constraints on Russian growth are significant and will be hard to overcome. There is no way to attract additional labor: in recent years, the workforce has grown only on paper – thanks to the almost-forgotten but still-ongoing pension reform. Fiscal reserves, tapped and injected into the economy in 2022-24, now stand depleted. Western technology transfer, which had underpinned much of the growth of the 2000s and early 2010s, has dried up. Export earnings have relatively stabilized.
Meanwhile, the main sanctions shock is behind us. New restrictions would come at too high a cost for Western states to be significant. Russia’s trade balance remains positive, and the tax burden is relatively light: in 2025, taxes and fees will account for about 37% of GDP, below the level of most developed countries. The only factor that could provide momentum would be the end of the Ukraine war. Recent months have demonstrated how any hint of the war’s ending has generated investor enthusiasm. Yet a resolution in 2026 is far from guaranteed. Nor would a “demilitarization” of the Russian budget follow, since the Kremlin is clearly set on a long-term confrontation with the West.
In other words, the most likely scenario for the late 2020s – and perhaps even into the early 2030s – is stagnation, with no sharp acceleration in growth or slide into recession. Political stability would not come under threat. We have already seen something similar between 2014 and 2019, when aggregate GDP growth totaled just 5.5% (0.6% annualized) and real disposable income fell almost 10%, even according to official data. Despite higher defense spending, heavy losses at the front and changes in everyday life (from the availability of foreign goods and services to the use of the internet), I do not expect Russians to protest against this new reality – especially since the state’s repressive apparatus is far more effective today than it was a decade ago.
The more interesting question is whether the economic upswing in 2023-24 was merely an anomaly in a broader trajectory of stagnation dating back to 2014, or whether a new phase of the stagnation is setting in following the acceleration in recent years. Many argue that a phase of “military tension” is always followed by a slowdown. In my view, however, this question is of more academic than practical interest.
To sum up, just as I argued a year ago – when the prospect of an economic slowdown still seemed remote – I remain convinced that the economy is not the soft spot of the Putin regime. It is still capable of generating sufficient “returns” to sustain the current intensity of the war while providing for the segment of the Russian population dependent on government benefits and pensions. If needed, the Kremlin may sacrifice investment and development; however, it will make sure its geopolitical and social populism stay well resourced. Outside expectations of political change induced by economic turbulence have always been and remain unfounded.
Naturally, everyone is interested in what the future of the Russian economy might look like amid the ongoing militarization of society. In my view, the broad answer is clear: in the second half of the 2020s, neither the preconditions for accelerated growth in Russia nor those for an economic collapse will appear.
The constraints on Russian growth are significant and will be hard to overcome. There is no way to attract additional labor: in recent years, the workforce has grown only on paper – thanks to the almost-forgotten but still-ongoing pension reform. Fiscal reserves, tapped and injected into the economy in 2022-24, now stand depleted. Western technology transfer, which had underpinned much of the growth of the 2000s and early 2010s, has dried up. Export earnings have relatively stabilized.
Meanwhile, the main sanctions shock is behind us. New restrictions would come at too high a cost for Western states to be significant. Russia’s trade balance remains positive, and the tax burden is relatively light: in 2025, taxes and fees will account for about 37% of GDP, below the level of most developed countries. The only factor that could provide momentum would be the end of the Ukraine war. Recent months have demonstrated how any hint of the war’s ending has generated investor enthusiasm. Yet a resolution in 2026 is far from guaranteed. Nor would a “demilitarization” of the Russian budget follow, since the Kremlin is clearly set on a long-term confrontation with the West.
In other words, the most likely scenario for the late 2020s – and perhaps even into the early 2030s – is stagnation, with no sharp acceleration in growth or slide into recession. Political stability would not come under threat. We have already seen something similar between 2014 and 2019, when aggregate GDP growth totaled just 5.5% (0.6% annualized) and real disposable income fell almost 10%, even according to official data. Despite higher defense spending, heavy losses at the front and changes in everyday life (from the availability of foreign goods and services to the use of the internet), I do not expect Russians to protest against this new reality – especially since the state’s repressive apparatus is far more effective today than it was a decade ago.
The more interesting question is whether the economic upswing in 2023-24 was merely an anomaly in a broader trajectory of stagnation dating back to 2014, or whether a new phase of the stagnation is setting in following the acceleration in recent years. Many argue that a phase of “military tension” is always followed by a slowdown. In my view, however, this question is of more academic than practical interest.
To sum up, just as I argued a year ago – when the prospect of an economic slowdown still seemed remote – I remain convinced that the economy is not the soft spot of the Putin regime. It is still capable of generating sufficient “returns” to sustain the current intensity of the war while providing for the segment of the Russian population dependent on government benefits and pensions. If needed, the Kremlin may sacrifice investment and development; however, it will make sure its geopolitical and social populism stay well resourced. Outside expectations of political change induced by economic turbulence have always been and remain unfounded.
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