Military Finance Crisis: Why the 2026 budget has almost no chance of being implemented

Budget policy in the era of the ‘Special Military Operation’

One thing can be said with relative confidence about the federal budget draft submitted to the Duma last week: in the form presented by the government and expected to be rubber-stamped by parliament, it is almost certain not to be implemented.

Although the government and the Duma continue to annually approve the main parameters of the three-year budget plan, its projections for the following two years have never been particularly relevant. In theory, a three-year budget should demonstrate fiscal stability, but in Russian practice this has largely remained aspirational. Over the past 12 years, aside from fluctuations in resource prices, the Kremlin twice initiated military invasions of Ukraine, triggering sanctions, and three times announced changes to tax regimes (in 2018, 2024, and 2025). The budget for the upcoming year, however, generally remained a functioning tool of fiscal policy.

With the start of the full-scale invasion of Ukraine, even the figures for the next year became largely irrelevant. For instance, expenditure in 2022, the first year of the war, exceeded planned levels by 31%. Since then, revising the budget parameters during the year (sometimes multiple times) has become standard practice. The deviation of actual budget execution from initial plans averaged 9% for revenues and 17% for expenditure in 2022–2024 (see table).

The logic of budget formulation has itself changed. Each year, the draft budget is intended to demonstrate expected fiscal stabilisation for the next year, marked by constrained expenditure growth and a reduced budget deficit. However, regardless of the approved figures, expenditure is subsequently financed 'according to need,' and revenue is adjusted 'as realised.' Another key feature of wartime fiscal policy has been that unplanned expenditure increases are not offset by reductions elsewhere. In other words, political risks have come to outweigh budgetary concerns, leading the Kremlin to abandon a conservative approach to fiscal policy. This has driven a surge in spending, which in nominal terms will rise by 73% in 2025 compared with 2021 (with price growth of 41%, according to official data and forecasts).

The new budgetary logic was particularly evident in 2025. Initially, the budget deficit was projected at a relatively modest 1.2 trillion roubles (0.6% of GDP). Unlike previous years, the main problem this year has been a shortfall in projected revenue. Despite this, expenditure from January to August exceeded last year’s by 21%, resulting in an expected record budget deficit of 5.74 trillion roubles (2.6% of GDP), according to the latest, but possibly not final, estimate.

Changes in key budget parameters during the fiscal year, 2022-2025, trillion roubles

As a result, a persistent budget deficit of 10–15% has emerged over the years of war. In 2022–2024, revenues covered 90% of expenditures, while in 2025 they are expected to cover only 80–85%. The 2026 deficit is currently projected at 9%, but it is unlikely to remain within that range. In any case, it will mark the fifth consecutive year of a structural deficit, and even if the government manages to stay within plan, the cumulative excess of expenditure over revenue over five years will be equivalent to 10% of GDP.

In principle, such a scale of budget deficit (around 2% of GDP per year) does not appear extraordinary and, for example, falls within the limit adopted in the EU (3%). However, the defining feature of Russia today is its isolation from the international financial system, making external borrowing impossible for both companies and the state. Under these conditions, a persistent budget deficit can only be financed through domestic borrowing, which changes the perspective on its significance.

Soft military-style spending

The logic underpinning the draft 2026 budget is built on the same assumptions as in previous years. The government does not know the key political decisions that will be taken in the Kremlin and determine actual expenditure for the following year. Consequently, the draft budget assumes a desired halt to the unchecked growth of spending and an optimistic revenue scenario, allowing the government to demonstrate a 'theoretical' commitment to reducing the deficit.

In this framework, expenditure in 2026 is projected to rise by 4.3% in nominal terms, while in real terms it will be slightly lower than the latest 2025 projections. Revenues are expected to increase nominally by 10%, equivalent to 4–5% in real terms. Oil and gas revenues will remain at this year’s level (slightly higher nominally and slightly lower in real terms), while non-oil-and-gas revenues are projected to grow by 12% due to increased fiscal pressure. The budget deficit of 1.6% will remain manageable but will be the smallest since the start of the war.

On the expenditure side, the 2025 budget adjustments and the 2026 draft implicitly assume the cessation of active military operations. This is indicated by the projected 2025 expenditure of 42.3 trillion roubles, which is only 5% above 2024 spending, whereas the eight-month actual overrun was more than 20%. In 2024, 43% of total annual expenditure fell in October–December, which is normal for wartime (although in pre-war years the last third of the year accounted for around 40% of spending). This year, the government hopes to spend only 34% of the annual allocation in October–December. This suggests that it does not plan a large advance payment to finance war-related expenditure at the start of 2026, as in previous years. This does not mean, however, that active military operations will cease. If they do not, the government will simply approve another increase in 2025 spending.

The 2026 expenditure plan indicates that even if military operations stop, the main 'bonus' will be a halt to expenditure growth rather than a reduction. In the past two years, unchecked spending on personnel constrained, as previously noted using SIPRI calculations, the funding available for strategic defence spending (→ Re:Russia: Budget for Military Build-up). A pause in active operations would be used to restore and build military capacity, and the military formation is unlikely to be immediately disbanded. If fighting continues into the autumn, the final four months of 2025 are unlikely to fit within the 14.4 trillion roubles projected in the September adjustment, and 2026 expenditure is unlikely to remain at 2025 levels.

However, even in a 'romantic' scenario in which expenditure remains at last year’s level, the government’s budget structure appears vulnerable in three respects. As noted, it relies on three assumptions: that oil and gas revenues remain at this year’s level (8.9 trillion roubles versus 8.65 trillion), that non-oil-and-gas revenues rise from 27.9 to 31.4 trillion roubles, and that the 2.6% deficit, as with future deficits, will be financed by increasing public debt. All three assumptions are uncertain and problematic.

Oil and gas vulnerability: discount or volume?

In projecting oil and gas revenues, the government assumes a price of $59 per barrel at an exchange rate of 92.2 roubles per dollar. This price could have been considered conservative in early summer. However, in August–September, banks and agencies began lowering oil price forecasts for next year. Goldman Sachs now forecasts average annual Brent prices in the range of $52–56, the Economy Forecast Agency (EFA) gives an average of $56 for the year, and JPMorgan gives $58. In recent months, the main forecast range has shifted from $60–65 to $50–60 per barrel. A common scenario assumes prices will drop to just over $50 at the start of the year and rise to $60–65 by year-end.

In September, the US Energy Information Administration (EIA) projected an average annual Brent price of $51 for 2026, not accounting for OPEC's September decision to increase production in October by 137,000 barrels per day. At the October OPEC+ meeting, Saudi Arabia proposed a sharp increase in production limits, two to four times above this figure. Russia opposed, and the decision was reportedly made in its favour, according to agencies. However, if oil prices do not fall, Saudi Arabia is likely to revisit the issue at the next meeting on 2 November. The aggressive stance in October indicates a strategic shift by Riyadh towards reclaiming its lost market share, which has declined over years of ‘self-restraint.’

Beyond the oil price itself, two key factors remain uncertain: Russian export volumes and the size of the 'sanctions' discount on Russian oil. From October, the EU and UK will enforce a new lower price cap of $48 per barrel instead of $60, while India continues to face US pressure on its purchases. Indian authorities have softened their position: whereas they previously insisted they would not cut Russian imports, they are now proposing to allow them to be partially replaced by Iranian or Venezuelan oil. At the same time, the current volume of Russian oil exports to India has probably already begun to decline. According to Kpler data, cited by Bloomberg, September shipments were 1.61 million barrels per day versus 1.72 million in August, a 16% drop compared with September 2024. Indian buyers also demand an increase in the discount to $10 per barrel, according to Reuters.

Two basic scenarios therefore emerge. First: Russian export volumes are broadly maintained, but discounts for Indian or Chinese consumers increase, and OPEC+ further raises production, leading to another round of price declines due to excess supply. Second: Russian export volumes fall and are replaced by other producers’ output, which increases overall supply but does not significantly reduce prices due to Russia’s reduced market share. In both scenarios, Russia’s oil export revenues decline; the question is whether the reduction comes from lower prices or lower volumes.

In this context, a moderately conservative approach to projecting oil and gas revenues today would correspond to a price of around $50 per barrel for Russian oil. In reality, however, given a surplus on the global oil market, Russian export revenues could fall to levels corresponding to a significantly lower price, either due to increased discounts or reduced volumes. According to the most common estimates, including those of the government, a $10 drop in the price per barrel results in a budget revenue shortfall of approximately 1 trillion roubles.

In principle, Russian economic authorities could offset the shortfall in oil and gas revenues through a weaker rouble, but this would lead to higher inflation and an automatic increase in nominal budget expenditures.

Non-oil and gas vulnerability: growth or decline?

The main budgetary manoeuvre for 2026, as is well known, is that any reduction in oil and gas rents is intended to be compensated by increasing the tax burden on the Russian economy. The bulk of the projected growth in non-oil-and-gas revenues for 2026 – 1.7 of 3.2 trillion roubles – is expected to come from higher taxes: raising the VAT rate from 20% to 22% (+1.2 trillion roubles) and expanding the number of VAT payers by lowering the threshold for the simplified tax system (+200 billion). Overall, VAT receipts are expected to rise by almost 3 trillion roubles, reaching 17.51 trillion, or 44% of all budget revenues. In addition, vehicle recycling fees are expected to increase by 1.5 times to 1.65 trillion roubles, effectively an additional tax on middle- and high-income groups.

These revenue projections are based on the assumption that the Russian economy will grow by 1.3% next year. Such growth rates appear doubtful even for the current year and are extremely unlikely for 2026. VAT increases generally have a depressing effect on developing economies, although some of the impact on the private sector is offset by expanded government demand. For example, the Estonian government, which is currently raising VAT in two stages to fund defence, expects a significant reduction in GDP as a result (→ Re: Russia: Military-style VAT). The logic is that diverting funds to defence spending reduces private demand, which is not fully compensated by growth in the defence sector. In the Russian budgetary system, the same mechanism is effectively at work, and there is little reason to assume that the fiscal multiplier of military spending (its stimulatory effect on the economy) is significantly higher here.

The key factor for Russian economic growth in the coming years, according to the new forecast by the Ministry of Economic Development, is domestic demand: corporate investment and private consumption. The Minister of Finance also is counting on growth in real household incomes to drive economic expansion. However, according to the Ministry’s forecast, investment activity in 2026 is expected to decline by 0.5% compared to the previous year, and household consumption growth will be minimal at +1.2%. Increases in income or consumption taxes reduce disposable income and may constrain consumption in certain segments, according to analysts at the Higher School of Economics in a review of household behaviour. They estimate that the transition to a five-tier personal income tax in 2025 will reduce the growth rate of real disposable income by 0.4%. Meanwhile, the Ministry’s baseline forecast already assumes a slowdown in growth from 7.3% in 2024 to 3.8% in 2025, and further to 2.1% in 2026 (or even 1.6% under a conservative scenario). Private consumption is therefore expected to make a minimal or even negative contribution to growth if export revenues fall further.

Overall, the dual shock of higher taxes in 2025 and 2026 is unlikely to leave business activity unaffected. The ratio of total budget revenues to GDP does not adequately reflect the fiscal burden on the economy when a substantial share of revenues comes from rents. A more informative measure is the ratio of non-oil-and-gas revenues to GDP, showing how much the government extracts from the non-resource sector. From 2012–2018 (before the first VAT increase), non-oil-and-gas revenues averaged 9.5% of GDP; in 2019–2023 they rose to 11.5%, in 2024 to 12.7%, and they are expected to reach 13.5% in 2026. Given that the non-oil-and-gas sector accounts for roughly 80–85% of the Russian economy, the level of extraction has increased by about a third compared with the 2010s.

A further negative factor in 2026 will be the continued decline in export revenues, as discussed above. In addition to reducing budget income, this also reduces overall investment resources and domestic consumption. The loss of 2.3 trillion roubles in oil and gas revenues in 2025, with further reductions in 2026, will significantly curb potential growth and is likely to push the economy into contraction, regardless of other factors.

Thus, expectations for growth in non-oil-and-gas revenues may also be substantially overstated. Higher inflation could improve the budget’s accounting figures but will not enhance the economic well-being of households and businesses.

Debt vulnerability: noose or emission?

The issue of increasing public debt as a means of stimulating the economy has been present in Russian macroeconomic discussions since the early 2010s. Russian public debt is indeed extremely low by global standards – a point often repeated by economists and businesspeople. President Putin reiterated this view in early September, emphasising that the rise in the budget deficit is not particularly dangerous and can be financed through borrowing; he has repeated this at least three times over the past year.

However, the context for this assertion has changed fundamentally. It is not just that public debt has nearly doubled since the early 2010s, from 10% to 18–19% of GDP, but also that, in the 2010s, the Russian financial system was not yet isolated from external markets. At the time, growing reliance on them was an important counterargument in debt discussions.

In a developed financial market with a significant capital market, most government debt is typically issued domestically. In developing countries, a larger share is externally sourced due to weak domestic financial systems. In Russia today, with an isolated system, increasing public debt via domestic borrowing simply redistributes resources from the private sector to the state. Limited resources make this more expensive than in an open economy. In 2025, debt servicing costs are projected at 3.2 trillion roubles (almost 9% of budget revenues, or 1.5% of GDP), rising to 3.9 trillion in 2026 (almost 10% of revenues, 1.7% of GDP).

Under the current budget law, public debt is set at 38.553 trillion roubles (18% of GDP) at the end of 2025. Domestic borrowing will raise this to 43.668 trillion (19% of GDP) in 2026, 48.431 trillion in 2027, and 53.761 trillion in 2028. While this is not high by global standards, the Ministry of Finance has repeatedly stated that ‘safe’ public debt for Russia is no more than 20% of GDP. This position was justified by the former head of the Ministry of Finance's budget department, economist Ilya Sokolov. His calculations, along with co-authors, suggest that for middle-income countries, debt above 24% of GDP negatively affects growth, while exceeding 29% accelerates interest expenditure growth in response to any further borrowing. In the context of wide-ranging sanctions and double-digit interest rates, Sokolov and co-authors argue that 20% remains the safe threshold. Economist Yuri Danilov notes that the critical factor is not the nominal debt size but the cost of borrowing relative to its economic effect. Rising debt and servicing costs without an increase in revenues leads to a debt trap.

The IMF's sustainable debt standards are considerably more lenient. The Fund sets the debt ceiling at 35% of GDP for countries with low income levels and institutional quality, and 55% for middle-income countries. However, the IMF does not consider cases where countries lack access to external financing. In this sense, the current Russian situation bears some resemblance to the late Soviet period.

Against this backdrop, President Putin’s statement, which is undoubtedly informed about the debates on the 'safe' level of public debt and the Finance Ministry’s stance, represents yet another step away from the principles of conservative fiscal policy and serves as a warning to the Ministry that its previous position will need to be revised in the near future. However, the problem is not only that borrowing risks in an isolated financial system look very different from those in a 'normal' economy. Another issue in an economy with an underdeveloped financial market and an oversized state sector is the quasi-market nature of borrowing.

Current budget plans envisage covering almost the entire deficit in 2025 and 2026 through government borrowing. This will require a sharp increase in the issuance of Federal Loan Bonds (OFZs). According to Raiffeisenbank analysts' estimates, daily placements would need to rise by 75% compared with Q3, from 120 billion roubles per day to 210 billion. Analysts describe this as ambitious but feasible, noting that at the end of 2024 the Ministry of Finance was able to sell two issues worth 2 trillion roubles in just two auction days.

According to calculations by the Telegram channel Truevalue, approximately half of the total domestic public debt is held by two banks (the Central Bank does not disclose their identities, but these are clearly Sberbank and VTB). Data from the Central Bank shows that, in 2025, systemically important banks purchased 30–60% of new issuances. They played a key role prior to the war as well, but after the exit of non-residents – who accounted for around 20% of the market in 2021, and about a third in earlier years – their role has increased even further. At the same time, banks’ appetite for OFZs is limited, as yields are roughly equal to funding costs, explains Sergey Konygin, chief economist at Sinara Investment Bank.

As a result, to sell those two large issues at the end of last year, the Ministry of Finance had to turn to the Central Bank, notes economist Sergey Aleksashenko. State banks bought a significant portion of the first issue, immediately pledged it to the Central Bank, and received around 1 trillion roubles, which they then used to purchase the second issue, according to data from the regulator itself. In other words, there was effectively a hidden issue. If the Ministry of Finance resorts to the Central Bank's help again this year, inflation will inevitably accelerate, warns Aleksashenko.

This case, however, clearly exposes the government’s overarching dilemma in financing a growing deficit through borrowing. The current OFZ mechanism does not provide sufficient market appeal for government debt to economic agents in the volumes required to cover the budget deficit. Consequently, economic authorities face a choice: either create a market-based instrument to attract funds, which would cause debt servicing costs to rise rapidly, or accept that domestic borrowing will remain quasi-market in nature, carrying more or less an element of money creation.