Russia’s wartime economy loses steam as oil revenues fall and the budget deficit grows

Key Concepts

• Economic Strain: The Russian economy is experiencing pressure due to prolonged conflict and significant military expenditures.
• Inflation/Disappearing Money: Ordinary citizens are observing a noticeable decrease in their disposable income, with estimates suggesting around 30% of their money is effectively disappearing.
• GDP Growth Slowdown: Russia's economic growth is projected to be around 1% for the current year, indicating a slowdown.
• Budget Balancing Measures: The Kremlin is implementing tax increases to address budget deficits caused by increased defense and security spending.
• Value Added Tax (VAT) Increase: The VAT is set to rise from 20% to 22% starting January 2026, with the aim of generating an additional 1 trillion Russian rubles (over $10 billion) for the state budget.
• VAT Threshold Reduction: The threshold for smaller businesses to be exempt from charging VAT will be gradually lowered from 60 million to 10 million rubles by 2028, targeting companies that artificially split operations to avoid VAT.
• Increased Taxes on Specific Goods: Proposals include higher taxes on alcohol, cigarettes, and vapes.
• Resource Allocation Dilemma: The government faces a choice between maintaining military expenditures and ensuring consumer abundance due to financial constraints.
• Impact of Sanctions: Western sanctions and blocked foreign borrowing force reliance on domestic credit, further burdening households.

Economic Strain and Household Impact

Ordinary citizens in Russia are experiencing the tangible effects of an economy under pressure, largely attributed to years of conflict and substantial military spending. One individual reported that "About 30% of my money has simply started disappearing. I don't even see it. I don't even notice it. I go to the store once, buy something, and that's it. The money's gone." This sentiment highlights a significant erosion of purchasing power and financial well-being at the household level.

Economic Slowdown and Government Response

More than three years into the war in Ukraine, Russia's economy is exhibiting signs of slowing down. Government projections indicate an economic growth rate of approximately 1% for the current year. To address the widening budget deficit, exacerbated by increased defense and security expenditures, the Kremlin is resorting to tax increases across various sectors.

Tax Reforms and Revenue Generation

1. Value Added Tax (VAT) Increase:

• Rationale: The government cites the necessity of "additional expenses on defense and security" as the "main task of our country."
• Implementation: The Value Added Tax (VAT) will be increased from its current rate of 20% to 22%.
• Timeline: This change is scheduled to take effect from January 2026.
• Projected Revenue: This increase is expected to add approximately 1 trillion Russian rubles (more than $10 billion) to the state budget.

2. VAT Threshold Reduction for Small Businesses:

• Objective: This measure targets companies that engage in the practice of splitting their operations to circumvent VAT obligations.
• Methodology: The threshold for smaller businesses to be required to charge VAT will be progressively lowered.
• Timeline: The threshold will gradually decrease from 60 million rubles to 10 million rubles by 2028.

3. Proposed Taxes on Specific Goods:

• The government is also considering higher taxes on products such as alcohol, cigarettes, and vapes.

The Trade-off Between Military Spending and Consumer Welfare

The current economic situation presents a critical dilemma for the Russian government. As stated, "Putin has enough money to maintain the current war effort and the current level of expenditures. After that uh he will well he need to make a tough choices trade-offs between uh maintaining military effort or for example um maintaining consumer abundance." This underscores the difficult decisions the Kremlin must make regarding resource allocation, balancing the demands of military operations against the need to sustain domestic consumption and living standards.

Impact of Sanctions and Domestic Reliance

Western sanctions and the blockage of foreign borrowing have compelled the Russian government to rely more heavily on domestic credit markets. This increased reliance on internal financing places additional pressure on households that are already facing economic challenges.

Conclusion

The Russian economy is navigating a period of significant strain, characterized by a slowdown in growth and increased pressure on household finances. The government's strategy to address these challenges involves substantial tax increases, particularly on VAT, and a reduction in VAT exemptions for businesses, all aimed at funding elevated defense and security spending. This approach creates a difficult trade-off between maintaining military capabilities and ensuring the economic well-being of its citizens, further complicated by the constraints imposed by international sanctions.