There were no major surprises in the draft three-year budget submitted by the Russian government to the State Duma this week. The largest budget expense—defense spending—has been slightly reduced for the first time since the start of the full-scale war against Ukraine, but that is sadly not a sign of imminent peace.
Simply, as the war approaches the four-year mark, it is becoming increasingly difficult for Russia to make ends meet, and the budget looks more and more like a compromise between the war camp and economists. The former got their 8 percent of GDP for defense and security, while the latter got the least inflationary way to pay for it. Footing the bill will be the Russian people, who face further tax hikes.
Based on the baseline scenario for the socioeconomic development forecast, upon which the budget is compiled, Russia is entering a period of low growth. Economic growth will cool to 1 percent in 2025 (compared with 4.3 percent in 2024), and sluggish growth of 1.3 percent is expected in 2026, with inflation slowing to around 4 percent (compared with 6.8 percent at the end of this year).
Formally, this is a soft landing, but the price is a contraction in demand. After three years of increased spending—about 10 percent of GDP in 2022–2024—the Finance Ministry is reducing the fiscal stimulus to 1.7–1.8 percent of GDP. Under this plan, there will be a 0.5 percent decline in investment in 2026, compared with 3 percent growth the previous year. This indicates that interest rates will remain high, and private demand will effectively be displaced by the state.
The government plans to keep the budget deficit about 1.6 percent of GDP in 2026 before lowering it to 1.2 percent of GDP—not through growth, but through tax raises and increased borrowing. All these figures are calculated using a predicted average Brent oil price of $70 per barrel in 2025–2027 (down from an earlier forecast of $72).
The Finance Ministry has pledged to adhere to the budget rule according to which the threshold oil price above which oil revenues enter a reserve fund is reduced by $1 per year, gradually shrinking the proportion of oil and gas revenues in Russia’s GDP to approximately 3.5 percent in 2028, which looks fairly optimistic. It makes the budget less sensitive to oil price fluctuations, but increases its dependence on non-oil and gas revenues.
The military-industrial complex’s slice of the economy continues to grow, and is becoming a structural factor. After weak growth in 2025 (+1.5 percent), steady acceleration is projected in 2026–2028: 2.3 percent in 2026, 3.1 percent in 2027, and 2.8 percent in 2028. Overall, by 2028, the industry is expected to have grown by 10 percent compared with 2024.
Even with a nominal reduction in “defense” spending in the budget, the economy’s production profile remains militarized: industrial growth in 2026–2028 will be provided primarily by sectors in which state orders and import substitution priorities are linked to military needs.
The markets for electronics, electrical equipment, machinery and equipment, and finished metal goods are growing. Consumer industries and the infrastructure of civilian demand are growing more slowly or are stagnating: the auto industry is only expected to return to its 2024 levels in 2028.
Labor market limitations remain in place: the government doesn’t expect unemployment to rise above 2.5 percent. As a result, there is macroeconomic stability despite low growth, and the surge in output is increasingly driven by government procurement.
The nominal reduction in defense spending in 2026 is certainly not a sign that the Kremlin plans to end its war against Ukraine. Budget spending in the national defense category may be declining from 13.4 trillion rubles this year to 12.6 trillion rubles in 2026 (a decrease of 4.2 percent), but spending in an adjacent category—national security and law enforcement—is increasing from 3.46 trillion to 3.91 trillion rubles: a 13 percent increase.
Combined, that amounts to a minimal (0.6 percent) reduction in defense and security spending in 2026. And from 2027, both defense and security spending will increase again. Overall, spending in these categories remains at about 8 percent of GDP. In other words, war remains a priority.
In both of these categories, the biggest increases are for salaries and reserve contributions. The latter allows military and security forces more flexibility in managing their allocated funds.
Procurement and capital expenditure are showing virtually no growth. This may indicate a shift in focus from investment, as most new equipment has already been purchased, to serial production and maintenance. This approach reduces cash payments from the budget in a specific year, but under long-term contractual obligations, the money will simply be spent later.
It’s worth remembering the structural lack of transparency in Russian military spending. About 25 percent of budget items are classified, although not all of them are military-related. In addition, a significant proportion of military funding comes via alternative channels: regional programs, loans to defense industry enterprises with state guarantees, treasury advances, and purchases through state corporations. Some of the cost is shifted to businesses. These expenses are not formally classified as defense, but de facto they are used for military purposes.
Both the baseline and conservative budget forecast scenarios assume that sanctions pressure on Russia will not increase. In 2025, however, all the G7 countries except the United States (which threatened to do so) ramped up sanctions against Russia. The Kremlin takes Western sanctions seriously, but also knows that having weathered the initial, most powerful blow, it can tolerate further measures.
The absence of any hint of worsening sanctions in the budget forecast is an interesting sign. It indicates that the economy’s channels for adapting to restrictions—logistics, parallel imports, international payments, insurance, and the shadow fleet of oil tankers—have become institutionalized. The costs of this adaptation, including falling oil prices, discounts for China and India, and a limited geography of exports, are now built into prices and margins.
The risk of such calculations is not so much that they do not anticipate new sanctions, but that they do not allow for the tougher enforcement of existing ones, such as further restrictions on the shadow fleet, stricter export controls, and the closing of loopholes in payments and logistics.
Officials were quick to call the new budget balanced and even disinflationary. The Finance Ministry has set the goal of a zero primary budget deficit: when base expenditure, excluding debt payments, is covered by revenues. The central bank needs low and predictable inflation. Amid shrinking revenue and high expenditure, the Russian government, contrary to its own promises, has decided to increase taxes.
From 2026, VAT will increase from 20 percent to 22 percent. At the same time, the revenue threshold above which small businesses must pay VAT instead of the simplified tax system (STS) will be slashed from 60 to 10 million rubles per year. This effectively means higher taxes for all small businesses. Ten million rubles a year equates to 800,000 rubles ($8,500) per month: the revenue of a convenience store, beauty salon, or small IT company.
For the central bank, tax hikes are an acceptable alternative to an increase in borrowing because they have a disinflationary effect. Increasing the VAT rate leads to a one-off price hike, but then moderate price growth over time because purchasing power is reduced. As everything becomes more expensive, people are able to afford less, and demand declines. The other alternative, as the central bank admits, would have been to raise the interest rate forecast above 12–13 percent.
The government is effectively saying openly that it’s more convenient for it to pay military expenses out of the pockets of the general public and businesses: after all, the entire economy pays VAT. Issuing “war bonds” or simply expanding domestic borrowing is more expensive in terms of both interest rates (because debt payments rise) and inflation.
For economic officials, the current budgetary framework is more or less a victory. The economy has hit structural limitations: there’s no spare labor capacity, and production facilities, including military ones, are almost fully utilized. Without increased labor productivity, there’s simply no room for further growth.
The state is spending its resources on producing items destined to be burned on the battlefield. It generates employment and demand, but no long-term results. In these conditions, increasing government demand will only fuel inflation.
After three and a half years of war, the authorities are stabilizing war-torn public finances not through economic growth or opening up new markets, but by boosting revenue collection. The budget is reliant on tax increases, with taxes and levies on businesses and individuals rising for the third year in a row.
If previously, the Russian economy resembled a marathon runner on budget steroids, now it is transforming into a country with a low growth trajectory, moderately high inflation, persistently high interest rates, and fiscal consolidation achieved through tax increases and maintaining core spending—all against the backdrop of a gradual decline in living standards and stagnation in the private sector.
