At this year’s St. Petersburg Economic Forum—a once-prestigious event that has grown increasingly insular—Russian economic officials faced uncomfortable questions about the country’s future. In a rare moment of candour, Economy Minister Maxim Reshetnikov acknowledged that Russia may be heading into a recession. The moment captured the tension within a system forced to sustain a militarised economy under global isolation and increasingly constrained resources.

“This recession is not a flaw—it’s a feature of Russia’s policy of militarisation,” said Elina Ribakova, senior fellow at the Peterson Institute for International Economics in a recent paper. “It reflects the trade-offs of prioritising defence, not just of national interests, but of the regime itself, over long-term development.”

Russia’s economy has shifted dramatically since its full-scale invasion of Ukraine in February 2022. An initial contraction in 2022, softened by high commodity prices and support from third countries, was followed by a rebound in 2023 and 2024 driven by state spending, credit expansion and the defence sector. But as Benjamin Hilgenstock of the Kyiv School of Economics Institute, a co-author of the same paper, noted, “this was never sustainable growth—it was overheating masked as recovery.”

Signs of strain began to emerge by mid-2023, with inflation soaring from historic lows, interest rates peaking at 21%, and growth narrowing to just 1.4% y/y in early 2025 after two years of strong 4.1% growth. “This actually meant a 0.6% contraction from the previous quarter,” said Hilgenstock. “It’s the first quarterly drop since 2022—and likely not the last.”

It now looks like the military spending stimulus has been exhausted and the economy has hit a hard ceiling. Labour markets are drum tight (at just 2.3%it is alarmingly low for any emerging market); productivity is faltering, and the budget is under increasing stress. By the end of 2024 and in early 2025, signs of economic deceleration were clear and even the military-industrial sector began to stagnate.

“Despite much talk at the June St. Petersburg Economic Forum, neither monetary nor fiscal policy can deliver the deep structural transformation that genuine reforms and investment-driven growth can achieve. However, Russia neither can, nor appears to want, to rejoin the global economy as an open, market-based system. Without a strategic pivot, the space for sustainable growth narrows,” the authors say.

Rosstat reports the contraction has been driven by falling activity in mining, trade, real estate and leisure, which growth in agriculture, manufacturing and public administration were not able to offset.

The Ministry of Finance (MinFin) has already tripled its forecast for this year's federal budget, albeit to a relatively modest 1.7% of GDP, but the federal deficit had already reached RUB3.4tn ($38.5bn) by May—nearly 90% of the full-year target.

And finances have been hit by falling oil prices after OPEC+ decided to put in a series of production hikes, largely to punish Kazakhstan that has been cheating on its quotas this year. Oil and gas revenues, which still account for about a quarter of revenues and remain crucial to the budget, dropped 14% in the first five months of 2025. The MinFin had based its revised budget on an oil price of $56 per barrel, but average prices in May were closer to $51.

“If oil prices remain moderate and sanctions enforcement tightens, the fiscal outlook worsens,” Ribakova said. “Russia is not just fighting a war—it’s trying to finance it with shrinking room for manoeuvre.”

Liquid assets in the National Wealth Fund were down to RUB2.8tn ($31.7bn) in June —less than the projected deficit— but have recently been replenished to bring the total up to around RUB4 trillion – a little more than projected deficit. Still, MinFin is increasingly reliant on the domestic bond markets to fund its spending. With foreign investors gone and banks strained by lending demands, the central bank has had to prop up demand via repo operations.

“The military sector is protected, but the rest of the economy is bearing the cost,” said Hilgenstock. “Rising rates hurt consumer spending and investment outside the defence sphere.”

Meanwhile, promised reforms remain elusive. Russian President Vladimir Putin called for structural transformation in his 2023 address, but “where is it?” asked Andrey Makarov, chair of the Duma’s Budget and Tax Committee, at the SPIEF forum. “Fewer goods, rising prices and declining quality—that’s what we see.” Moreover, there is an ongoing debate on whether the official inflation figures may be understated, raising concerns about the true scale of economic imbalances, the authors point out.

Ribakova argued that this outcome is by design, not accident. “The redistribution of wealth to regime loyalists and waves of nationalisation have crushed the investment climate. No one sees profit here anymore—not foreign companies, not even the domestic firms shielded from competition.”

Even China has approached economic engagement with caution, providing consumer goods and military inputs rather than capital investment. The defence sector, though heavily subsidised, remains unprofitable, with little benefit for broader productivity.

“Russia is not collapsing—but it is grinding itself down,” Hilgenstock said. “Its ability to continue depends on oil prices, sanctions enforcement, and whether geopolitical developments force a shift in policy.”

Ribakova added: “Sanctions relief won’t guarantee recovery, but it could let banks lend again and businesses invest. Without that, Russia faces a future of stagnation, even as it spends itself deeper into war.”

The Kremlin has been fighting back and CBR governor Elvia Nabiullina’s unorthodox experiment to bring down inflation by non-traditional and non-monetary policy methods seems to be working. From over 10% at the end of last year, inflation is not falling faster than expected to 9.2% in July. The CBR has already cut rates by a surprise 100bp in June and just cut again by 200bp at the July monetary policy meeting. The regulator says, providing inflation continues to fall, it could cut by another 300bp over the next three meetings this year. It seems that the Central bank has changed tactics and is now more worried about the slowing economy than rising prices.