Russia's economy has irreversibly turned toward a 'stagnation trap,' think tank says

• Russia's economy will be ground to a halt by 2026, a think tank said this week.
• Massive government spending on defense is costing other sectors, Alexandra Prokopenko wrote.
• Businesses are slumping amid inflation, low labor supply, and rising borrowing costs.

By the numbers, neither Western sanctions nor the costs of three years of war in Ukraine have chipped at Russia's growth momentum.

The country's GDP is expected to expand by 4% this year.

"Yet this image of resilience is deceptive," Alexandra Prokopenko wrote for Carnegie Politika this week. "Over the past two years, Russia's economy has operated like a marathoner on fiscal steroids—and now those steroids are wearing off."

Though this won't end in a sudden collapse, Russia's fixation and dependence on wartime growth has created the irreversible threat of a "stagnation trap," the Carnegie Russia Eurasia Center fellow wrote on Friday.

Prokopenko estimates that economic momentum will stutter next year, giving way to social and fiscal upheaval in 2026.

Cracks emerge

Economic cracks will likely stem from the same thing that has kept Russia afloat since it first invaded Ukraine in 2022: the Kremlin's sweeping support for its defense industry.

Russia's huge spending in the sector is only set to grow, and in 2025, defense and security spending will account for over 8% of GDP and 40% of all government expenditures, Prokopenko said.

That comes at a cost to the broader economy. Budgetary allocations to non-defense sectors are shrinking, while increased tax revenue is directed almost exclusively toward military needs.

Industries that don't contribute to defense production are wavering, such as commodity and agriculture producers. As global coal prices slide, Russia's coal sector is suffering proper losses for the first time in four years.

That's a big deal, Prokopenko said—with thirty-one single-industry towns involved in the sector, a single shutdown can debilitate a whole community, forcing the government to step in with aid.

"But other struggling industries—automotive manufacturing, non-food retail, and housing construction—are also lining up for state assistance. Resources are stretched thin as stagnant oil and gas revenues, coupled with energy sanctions, limit budgetary inflows. While tax revenues have temporarily offset falling hydrocarbon income, they are consumed by current expenditures, leaving no surplus," she wrote.

It remains to be seen how long central authorities can lend a hand, given the Kremlin's own dimming fiscal outlook. Prokopenko noted that the government's rainy-day National Wealth Fund has reached its lowest level since 2008, at $31 billion.

Demand overload

Forceful spending has turbocharged domestic demand, setting of a score of other issues.

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 that facilities are operating at 81% capacity, while a lack of workers has left around 1.6 million jobs vacant. In some regions, wages are rising 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 demand for foreign currency, putting downward pressure on the ruble and fueling inflation," she wrote.

As inflation hovers near 9%, business profitability has suffered. While Russia's central bank has raised the key interest rate to 21% to counteract price growth, results have been lackluster. Instead, higher borrowing costs have significantly bolstered bankruptcy risks among business leaders.

Alienating support

With each passing month, Prokopenko predicts that the Kremlin is getting closer to a tipping point with its people.

"The greatest losers in this overheated economy are Putin's core supporters: public sector workers, including teachers, doctors, law enforcement personnel, and pensioners," she wrote. "Their wages and benefits are tied to official inflation rates of 9 percent, but real inflation for many households exceeds 20 percent."

A modest post-war reduction in defense spending won't end all problems, either.

Despite inflation, war spending has boosted prosperity for lower-income Russians, with military service contributing to higher incomes among individuals and their families.

Prokopenko said Russia directly spends an estimated $16 billion to $23 billion worth of rubles to attract a shrinking pool of military recruits. That excludes payments made to wounded soldiers or compensation for those who died fighting.