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Russia’s debt servicing costs are swelling, despite the low level of debt, thanks to sky high interest rates, the Ministry of Finance (MinFin) said on September 29.
Russia’s federal budget projections show that debt servicing will account for 8.8% of total government spending in 2026, overtaking combined allocations for education and healthcare, according to the Ministry of Finance. The figure marks a sharp increase from pre-war levels when debt servicing costs made up 4.4% of budget spending.
The Duma has released the 2026-2028 budget that has pencilled in a ballooning budget deficit, cuts military spending for the first time since the war started, and proposes a 200bp increase in the VAT from January 1 to fund the budget. The size of the deficit is expected to end this year in the range of 2.2% of GDP and 2.6%, or circa RUB4 trillion ($40bn),depending on the dynamics of the oil market – an estimate that has been upgraded multiple times from the 0.5% of GDP estimate set at the start of the year as the fiscal conditions rapidly decayed.
Russia’s external debt is a modest 15% of GDP, but with the prime interest rates at 17%, domestic borrowing has become very expensive: yields on benchmark 10-year Russian Finance Ministry’s OFZ treasury bills are currently around 12.0% to 12.5%.
As bne IntelliNews reporting in a side-by-side comparison of the Ukrainian and Russian budgets, Russia is entirely dependent on domestic funding. MinFin has almost doubled its OFZ issuances to circa RUB4.5 trillion ($45bn) a month (including roll-overs) to fund the deficit, from a total of circa RUB20 trillion of OFZ already outstanding. MinFin is looking to spread the load with tax hikes, spending cuts, and drawing down some RUB450bn from the National Welfare Fund (NWF) to prevent overloading any one part of the economy or exhausting its reserves completely.
The cost of servicing its debt is starting to get uncomfortably high. Typically, the OECD countries spend 2-3% of GDP on debt servicing, but in some countries, especially the UK, it has already topped 8%, threatening a crisis and an IMF bailout in both the UK and France.
Russia is also facing a swelling debt crisis as the biggest corporations start to run out of cash. The ministry expects the share of spending on debt payments to rise further to 9.1% by 2028, more than double the 4.4% recorded in 2021, before the full-scale invasion of Ukraine. According to the forecast, annual interest payments on debt will reach RUB4.52 trillion ($46.3bn) in 2028, up from RUB3.18 trillion ($32.6bn) projected for 2025 and RUB1.08 trillion ($11.1bn) in 2021.
However, Central Bank of Russia (CBR) governor Elvia Nabiullina is working hard to bring down interest rates to alleviate the pressure. She has already put in 400bp of rate cuts this year as inflation is falling faster than expected across the whole country and hopes to cut by another 200bp before the end of the year, bringing rates down to 12%-13% next year. That effort might be stymied by the 200bp increase in VAT rates at the start of next year, which is expected to add to inflationary pressures as producers are expected to pass the cost increases on to consumers.
According to bne IntelliNews interlocutors in Moscow small businesses are already feeling the pain inflicted by the war spending for the first time with sales down some 40% this year, and oligarchs are also reportedly running out of money and freezing all non-essential investment plans, bne IntelliNews sources say.
The increase in the cost of debt is attributed to the high key interest rate set by the Central Bank of Russia, which raised its benchmark rate by 5 percentage points in 2024 in response to persistent inflation and a weakening ruble. The Ministry of Finance noted that the rate hike alone has added RUB500bn ($5.1bn) in debt servicing costs.
“This trend reflects a rapid rise in debt burden,” UBN reported, citing the ministry’s analysis.
A race is now on between the speed that Nabiullina can cut rates, and the mounting stagnation of the Russian economy.
Heavy state spending has acted as a military Keynesianism boost to the economy, but that effect is now exhausted. The economy has grown strongly in the last two years at 4.3%, but the growth outlook has been downgraded several times this year already and is now in the range of 1-2%. However, Russia’s economy narrowly avoided going into recession in the first quarter of this year and was barely growing in the second quarter.
Spending on social sectors has stagnated in relative terms. Combined expenditure on education and healthcare is expected to fall below the share allocated to interest payments, raising questions about long-term budgetary priorities.
According to Ministry of Finance data, defence and national security will remain the largest components of federal spending through 2028, as the Kremlin continues to finance military operations and defence modernisation.
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