Russia’s war economy slows as sanctions enter 5th year

MOSCOW

Russia is grappling with massive state defense spending while facing deepening structural problems, including severe labor shortages and high inflation, as its war in Ukraine enters its fifth year.

Russia has managed to keep its economy afloat since launching its invasion of Ukraine on Feb. 24, 2022, despite facing unprecedented Western sanctions.

Moscow’s pivot to a war economy drove record production in heavy industries such as steel, machinery and chemicals, while defense spending is expected to account for about 38% of the federal budget in 2026.

Initial shocks, including the freezing of about $300 billion in Russian central bank reserves and Moscow’s removal from the SWIFT international payments system, were mitigated by domestic workarounds and increased use of the Chinese yuan for trade.

The military-driven growth has intensified structural pressures, including a critical labor shortage.

Russia’s unemployment rate fell to a record low of 2.4%, but economists say this reflects demographic pressures rather than economic strength.

Conscription, battlefield casualties and emigration have left high-tech, engineering and manufacturing sectors severely short of workers.

The Industry and Trade Ministry expects the industrial sector could face a shortage of 4.8 million skilled workers by early 2026.

Real wages have outpaced productivity as factories compete for workers, prompting the central bank to maintain a key interest rate of around 20% to curb inflation.

Western sanctions have also reshaped Russia’s energy sector. The European Union once accounted for roughly half of Russian energy exports, but that share fell to about 4% by the end of 2025.

Moscow has pivoted to China and India, expanding exports through the Power of Siberia gas pipeline and accelerating Arctic liquefied natural gas projects.

Greater reliance on Asian buyers has exposed Russia to steeper price discounts and higher logistical costs.

Macroeconomic forecasts suggest the economy is shifting from a period of overheating to stagnation.

State development bank VEB expects gross domestic product to contract by 0.8% in 2026, down from 4.3% in 2024.

Investment is projected to decline by 0.9% in 2026, reflecting tight monetary policy and weaker corporate credit, according to VEB.

Cooling retail demand also points to slower domestic consumption.

The contraction in investment and consumption raises questions about the long-term sustainability of Russia’s military-focused growth model, with inflation expected to reach 6.2% by the end of 2026, while the ruble is forecast to average 84 to the US dollar.

*Writing by Emir Yildirim in Istanbul