Russia’s war economy, once surprisingly resilient against Western sanctions, is now at a critical turning point. Analysts warn of a looming recession driven by exhausted industrial capacity, acute labor shortages, and intensified U.S. sanctions targeting crucial energy revenues. This shift signals deeper structural flaws and significant long-term challenges for the Kremlin, with far-reaching implications for global investors navigating commodity markets and geopolitical risks.
Vladimir Putin’s wartime economy, which initially showcased resilience against Western sanctions following the invasion of Ukraine, is now reportedly “hitting a wall.” Experts indicate that persistent U.S. pressure, particularly on the energy sector, combined with internal economic strains, could trigger a significant recession, transforming a temporary boom into a prolonged downturn.
For investors, understanding the underlying dynamics of this economic shift is crucial. While massive defense spending has previously masked deeper issues by propping up growth, keeping factories operational, and lowering unemployment, this model is proving unsustainable, pointing to a future of increased volatility in global energy markets and elevated geopolitical risk.
The Illusion of Growth: Russia’s Disposable-Goods War Economy
A central tenet of Russia’s economic strategy has been a surge in defense spending. While this has generated short-term industrial activity, it functions as a “disposable-goods economy.” Alexandra Prokopenko, a fellow at the Carnegie Russia Eurasia Center and former Russian central bank advisor, explains that factories operate at full capacity, and workers earn wages, but “the output is designed to vanish almost immediately.” This contrasts sharply with government outlays on infrastructure, which build lasting assets like highways and power plants that enhance an economy’s long-term potential.
Prokopenko further highlights that this cycle “generates no lasting assets… or productivity gains, leaving the economy busier yet poorer with each passing year of war,” as she wrote in Foreign Affairs. The destruction of weapons and equipment on the battlefield, coupled with ongoing payments for dead and injured soldiers, represents a continuous drain on the Kremlin’s budget with no productive return.
The economic data reinforces this trend. After robust growth rates of 4.1% in 2024 and 3.6% in 2023, Russia’s GDP growth has slowed sharply, tracking at just 1.1% so far this year. This deceleration indicates that the initial boost from military spending is waning, and the long-term costs are beginning to surface.
Exhausted Capacity and Deepening Labor Crisis
One of the most pressing issues is the exhaustion of Russia’s economic capacity. The country has “exhausted its reserves of manufacturing capacity and manpower,” according to Prokopenko. To significantly increase equipment production or recruit more soldiers, Moscow would need to implement a “comprehensive war footing,” similar to World War II, by commandeering civilian production lines. However, the government has avoided such drastic measures to prevent shortages of consumer goods and the risk of social unrest.
These limitations are exacerbated by severe labor shortages. Unemployment is at a historical low of 2.3%, indicating an acute lack of available workers. This demographic challenge is compounded by a shrinking population in the 20-65 age group, decreasing by approximately 1 million people each year, as noted in a SWP Comment by Janis Kluge. Additionally, labor migration to Russia has fallen to its lowest level in a decade due to an increasingly hostile environment.
While the labor shortage has led to rapidly increasing wages—the average wage grew by 19% in 2024, with even larger hikes in the military-industrial complex—this has fueled inflation. Core inflation reached 9.7% annualized in October 2024, partly due to Western sanctions making imports more expensive and a weaker ruble. The Russian central bank has responded by incrementally raising the key interest rate to 21% in November 2024, its highest in 25 years. This creates further headwinds for the economy, leading to discussions of a potential stagflation scenario, where high inflation coexists with economic stagnation.
Sanctions and the Energy Sector’s Vulnerability
The Kremlin’s budget remains heavily reliant on oil and gas revenue, which accounts for about 30% of total state funds. The recent decline in energy prices, combined with existing sanctions, has significantly impacted these revenues. New U.S. sanctions announced on Russian energy giants Rosneft and Lukoil are poised to deepen this crisis. These two companies alone are responsible for about half of Russia’s oil exports, with Rosneft contributing approximately 17% of Russia’s budget revenue.
While Russia will likely find alternative ways to sell its crude, these “work-arounds” add to costs, and fears of secondary sanctions could deter some customers. Capital Economics warns that “the hit to energy revenues could tip the economy into recession.” This vulnerability is not new; Russia’s economy has historically been susceptible to external shocks, with major crises in 1998 and 2008 both triggered by international market turmoil and plummeting oil prices, highlighting the nation’s failure to diversify beyond its natural resources.
Indeed, there are strong indications that a recession may have already begun. Data from Russia’s central bank last month showed GDP shrank on a sequential basis in the first and second quarters, meeting the definition of a technical recession. German Gref, CEO of Sberbank, one of Russia’s top banking chiefs, characterized the economy as being in “technical stagnation,” a sentiment echoed by Economy Minister Maxim Reshetnikov, who warned Russia was “on the brink” of a recession in June, as reported by Reuters.
The Kremlin’s Economic Tightrope Walk
Facing budget deficits, the Kremlin plans tax hikes for 2025 on high-income earners, corporations, and import fees. Social expenditures are also declining due to demographic factors. However, the budget deficit is unlikely to shrink as planned, as spending has consistently exceeded projections since 2022. High interest rates further strain the budget by increasing the cost of servicing public debt.
The military-industrial complex, despite running 24 hours a day and adding hundreds of thousands of workers, is struggling to keep pace with material losses on the front. Russia has to rely on imports from countries like Iran and North Korea and is increasingly tapping into Soviet-era stocks for armored vehicles, with only about 20% of new vehicles being built from scratch. This reliance on depleting historical reserves means that maintaining production volumes could become significantly more challenging as soon as 2025.
Investor Outlook: What a Russian Recession Means Globally
For long-term investors, the deteriorating Russian economic outlook presents both risks and considerations. While direct investment in Russia remains constrained by sanctions, a deepening recession in a major global energy producer can have ripple effects. A sustained decline in Russian export revenues, especially from oil, could lead to further ruble devaluation, high inflation, and potentially increased global market volatility, particularly in commodity-linked investments.
Despite the growing economic difficulties, analysts generally see a low probability that a recession alone will force Putin to the negotiating table to end the war in Ukraine. The Kremlin is expected to resist being “strong-armed” by the U.S., implying that the economic costs for continuing the conflict will likely “ratchet up” rather than lead to a quick resolution. This suggests that geopolitical tensions stemming from the conflict, and their impact on global supply chains and energy security, will likely persist, requiring investors to remain vigilant and consider hedges against ongoing instability.
