• Russia’s economy will be at a standstill by 2026, a think tank said this week.
• The government’s massive defense spending is costing other sectors, wrote Alexandra Prokopenko.
• Businesses are collapsing due to inflation, low labor supply and rising borrowing costs.

In figures, neither Western sanctions nor the cost of three years of war in Ukraine have undermined Russia’s growth dynamic.

The country’s GDP is expected to grow by 4% this year.

“Yet this image of resilience is misleading,” Alexandra Prokopenko wrote for Carnegie Politika this week. “Over the past two years, the Russian economy has been running like a marathon runner on fiscal steroids – and now those steroids are wearing off.”

Although it won’t end in sudden collapse, Russia’s fixation and dependence on wartime growth has created the irreversible threat of a ‘stagnation trap,’ says Carnegie researcher Russia Eurasia Center. wrote Friday.

Prokopenko believes that economic dynamics will slow down next year, giving way to social and fiscal upheavals in 2026.

Cracks appear

The economic cracks will likely come from the same thing that has kept Russia afloat since its first invasion of Ukraine in 2022: the Kremlin’s massive support for its defense industry.

Russia’s huge spending in this sector will only increase, and by 2025, defense and security spending will amount to more than 8% of GDP and 40% of all public spending, Prokopenko said.

This comes at a cost to the economy as a whole. Budgetary allocations to non-defense sectors are declining, while increased tax revenues are directed almost exclusively toward military needs.

Industries that do not contribute to defense production are hesitant, such as commodity and agricultural producers. As global coal prices fall, Russia’s coal sector is suffering real losses for the first time in four years.

It’s a big problem, Prokopenko said: With thirty-one single-industry towns involved in the sector, a single shutdown can weaken an entire community, forcing the government to step in with aid.

“But other struggling sectors – car manufacturing, non-food retailing and housing construction – are also lining up for state aid. Resources are limited because stagnant oil and gas revenues, combined with energy sanctions, limit budget inflows. “Temporarily compensating for the drop in hydrocarbon revenues, they are consumed by current expenditure, leaving no surplus,” she writes.

It remains to be seen how long central authorities can lend a helping hand, given the Kremlin’s bleak fiscal outlook. Prokopenko noted that the government’s National Wealth Fund for hard times has reached its lowest level since 2008, at $31 billion.

Request overhead

Aggressive spending has boosted domestic demand, creating a score of other problems.

On the one hand, no matter how much money the Kremlin pumps into the economy, Russian industries are already producing at near-peak levels. Prokopenko said facilities are operating at 81% capacity, while a lack of workers has left about 1.6 million jobs vacant. In some regions, salaries are increasing by double digits.

“In practical terms, the domestic economy cannot meet the demand driven by aggressive state and household spending, necessitating greater reliance on imports. This, in turn, increases the demand for foreign currencies, reducing pressure on the ruble and fuel inflation,” she wrote.

As inflation approaches 9%, corporate profitability has suffered. While the Russian central bank raised its key interest rate to 21% to counter rising prices, the results were poor. Instead, higher borrowing costs have significantly increased risks of bankruptcy among business leaders.

Alienating support

With each passing month, Prokopenko predicts that the Kremlin is moving closer to a tipping point for its population.

“The biggest losers in this overheating economy are Putin’s core supporters: public sector workers, including teachers, doctors, law enforcement, and retirees,” she wrote. “Their salaries and benefits are linked to the official inflation rate of 9 percent, but actual inflation for many households exceeds 20 percent.”

Nor will a modest reduction in defense spending after the war end all problems.

Despite inflation, war spending increased the prosperity of low-income Russians, with military service helping to increase the incomes of individuals and their families.

Prokopenko said Russia was directly spending between $16 billion and $23 billion in rubles to attract a shrinking pool of military recruits. This excludes payments to injured soldiers or compensation to those who died in combat.