Since the full-scale invasion of Ukraine in 2022, the Kremlin has sought to ensure that ordinary Russians do not notice the vast sums being spent on the war. Big business has borne the brunt of the burden, with the authorities also burning through financial reserves that were accumulated over many years. At the same time, high interest rates have blunted the inflationary shock of tax hikes.

Now, however, the wheels are coming off this model. The state doesn’t have any money to help the online marketplaces that have suffered from Ukrainian drone attacks. Nor has it been able to resolve Russia’s gasoline shortages. Businesses are being forced to pay for their own air defenses, as well as the repairs required following drone strikes.

In other words, the regime—which previously insisted the cost of the war was bearable—has begun to demand a contribution from millions of Russians. Going forward, the Kremlin will have to determine who exactly needs to pay, how much they need to pay, and how publicly this process will unfold. All of this will have political consequences.

Until now, President Vladimir Putin has successfully executed a sleight of hand allowing him to fund the war, maintain economic growth, and keep inflation within acceptable limits. As a result, there was no significant fall in living standards, and ordinary Russians largely believed the war was happening somewhere far away. But this no longer works. Depleted financial reserves and a shrinking tax base mean it is no longer possible to simultaneously deliver high defense spending, price stability, and economic growth.

It does not mean that the Russian economy is about to fall apart. Rather, the crisis is gradually spreading to every sector. It is already visible in everything from the erosion of state procedures and a ballooning budget deficit to ongoing gasoline shortages and declining living standards. While this crisis won’t present as a sudden collapse, it will be just as painful.

The system is not surviving because it’s in good health, but rather through inertia. Going forward, the Kremlin faces a choice: switch to a full-throated war economy with maximum repression and the forced reallocation of industrial resources, or abandon the attempt to fund the war while also preserving “normal” economic life.

Russia’s macroeconomic indicators are trending downward. For years, the labor shortage caused by demographic problems, mobilization, and emigration pushed salaries higher (causing rising consumption even as production stagnated). Now, wage growth is slowing.  

The seaborne export of Russian oil continues (thanks to Russia’s shadow tanker fleet and an army of middlemen), and the central bank has bought some time by keeping interest rates high to prevent the collapse of the ruble and runaway inflation. But none of this amounts to sustainable development. Indeed, it has only been possible thanks to the National Welfare Fund’s liquid reserves and a broad—albeit shrinking—tax base. There’s enough money left to buy the illusion of normalcy for several more quarters.

Taken separately, this year’s negative headlines look like a grab-bag of sector-specific troubles. Read together, they are the same fracture appearing in every part of the system: the state abandoning its own rules because it can no longer follow them. 

The Finance Ministry, for example, has been given the right to take on more debt than allowed in the budget law passed by the State Duma. Even an absolutely docile parliament appears to have become too much of a restriction.

A similar process has unfolded with law enforcement and property redistribution. At the end of August, Putin issued a decree that allows the transfer of critical infrastructure facilities to external management if their owners fail to properly protect them—including from drone attacks. In other words, a procedure has been established in which drone strikes can be a pretext for asset redistribution.

When it comes to savings, a reported push to nudge pension money into a single, state-controlled fund is the state reaching for a captive pool of long-term capital because the market no longer offers acceptable lending terms. This is a form of financial repression, not pension reform or financial planning.

On infrastructure, thirty-eight of the 128 data center projects announced over the past three years have been suspended. There are not enough funds to finish a railroad to the new Lavna coal terminal in Murmansk (precisely the sort of export capacity Russia was supposed to be developing in order to facilitate access to non-Western markets).

Indeed, the Kremlin seems to be improvising more and more. Oil refineries have long been paying for their own air defense. Now the authorities are trying to make small and medium-sized businesses do the same, even though they do not have the same financial resources.

Ukrainian drones are not only inflicting damage on Russia’s armed forces; they are operating all over European Russia and Siberia, striking logistics hubs used by tens of millions of Russians. Protection from external violence is a fundamental obligation for any state, and, historically, a cornerstone of the social contract between the rulers and the ruled.

While a collapse is not inevitable, we are witnessing the end of the period when it was possible to postpone hard decisions. Going forward, one scenario is military escalation accompanied by a full war economy and the suppression of any resulting dissent. That would require the Kremlin to either find new sources of income, or acquiesce in years of economic stagnation and imbalance. Both options carry political risks. And both have opponents inside the regime (for example, Moscow Mayor Sergei Sobyanin has said that the transition to a war economy would “kill the entire country”). 

The alternative is for the Kremlin to begin tightening its belt. In other words, to admit that Russia cannot simultaneously fund the war at current levels and maintain a “normal” economic life. That would require scaling back military operations, revising spending priorities, or taking diplomatic steps toward a ceasefire.

If financial repression intensifies—with banks being forced to buy government debt, the public being steered toward regional bonds, tax hikes, and restrictions on deposit withdrawals under the pretext of combating fraud—it will signal that the Kremlin has decided to opt for austerity. In other words, the system has opted to milk an already-emaciated cow to avoid acknowledging the scale of the problem. If, on the other hand, the Kremlin takes the path of military escalation and transition to a full war economy, there will be no need to read the tea leaves. It will be immediately obvious what is occurring.