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War Economy Drags Russia into Prolonged Slump
At a glance
- •Russia's GDP fell 1.8% in the first two months, contradicting earlier central bank growth forecasts.
- •Multiple sectorsmanufacturing, freight, industry, constructionare in decline, with insolvencies expected in construction.
- •High central bank rates (around 15%) and sanctions suppress domestic investment despite stabilising the ruble and curbing inflation.
- •The wartime reorientation of the economy initially masked civilian weakness, but defence spending now offers diminishing support.
- •Structural problems (low productivity, skills shortages) are exacerbated by labour being drawn to the front.
- •Higher global energy and fertiliser prices have temporarily boosted budget revenues, but this is unlikely to spur sustained growth.
Market Analysis
Moscow Russia's economy is showing fresh signs of strain and President Vladimir Putin is pressing his cabinet to act. At a recent government meeting he read out bleak statistics: Russia's gross domestic product fell 1.8 percent in the first two months of the year. That was a surprise after the central bank had only recently forecast 1.6 percent growth for the first quarter. Even allowing for calendar effectsmore Sundays and holidays than a year earlierPutin demanded measures to revive the economy.
The downturn is broad-based. Manufacturing output, freight traffic, industrial production and construction are all weakening. One of the country's largest developers, Samoljot, reportedly asked the government in February for a subsidised loan worth more than 550 million euros (conversion reported), but the request was unsuccessful. VTB, the state-controlled bank and one of Samoljot's chief creditors, warned it could take several years to return the builder to health, and experts predict additional bankruptcies across the construction sector.
Several interlocking factors are driving the slump, most of them rooted in the war in Ukraine ordered by Putin. Western sanctions have severed critical supply chains for technology and foreign investment. The central bank's policy rateabout 15 percenthas been maintained to curb inflation and support the ruble, but at the cost of stifling domestic investment: at such high rates borrowing exceeds the expected returns on many projects.
In fact, monetary policy has been juggling contradictory pressures since 2022. Early in the conflict the primary objective was to stop a run on savings and an exodus into foreign currencies. Later, the bank had to counteract inflationary effects from large state transfers into the defence sector. Those transfers helped sustain GDP growth in the early wartime yearsstate defence orders buoyed outputbut that wartime-growth model is no longer masking weaknesses in the civilian economy. By 2025 the defence-sector boom could only partially obscure civilian decline, and this year even that cushion has largely disappeared.
Structural shortcomingslow labour productivity and skills shortagesremain unresolved and in some areas have worsened. Economist Dmitri Nekrassow told the independent portal Meduza that the front acts like a vacuum cleaner, drawing more workers away from the civilian economy. At the same time, the state has financed the war through large borrowing and new taxes, including higher corporate and value-added taxes introduced at the start of the year. Official inflation runs a bit above five percent, but households feel the pinch more acutely because food and daily essentials have risen disproportionately.
New shocks are emerging. Ukrainian drone strikes on Russia's oil infrastructure have inflicted heavy damage and exposed vulnerabilities that are difficult to counter. Recurrent internet shutdowns have created further problems, especially for already digitalised sectors.
In the short term, geopolitical developments can give Moscow relief. The Iran conflict triggered by actions connected to US policy under President Donald Trump briefly pushed up global energy prices. In April, oil-tax receipts for the federal budget more than doubled and were expected to reach the equivalent of roughly 8 billion eurosproviding the finance ministry with breathing room. Higher global prices for oil, gas and fertiliser have helped narrow an eye-watering first-quarter budget deficit of about 50 billion euros, although economists warn this effect is temporary.
Despite the revenue boost from the oil price shock, many analysts contacted by the newspaper Kommersant said the broader economic outlook remains muted. A stronger ruble, persistently high borrowing costs and subdued investment will likely prevent a meaningful rebound in growth.
Conclusion
Russia faces a prolonged balancing act: defending the ruble and containing inflation while trying to avoid strangling investment and growth. Absent a meaningful change in sanctions, fiscal strategy or the trajectory of the conflict, policymakers are likely to confront several more difficult years of sluggish economic performance and painful structural adjustments.
