Hormuz and Donbas: The blockade of the strait has pushed the Kremlin to continue the war and pursue a risky fiscal strategy
The main economic developments of recent days are, to a considerable extent, also political. The Russian government has abandoned plans to reduce public spending this year. This decision reflects three interrelated factors: a sharp rise in oil prices driven by the war in Iran; the course of that war, which has proved unfavourable for the United States and Israel; and, apparently, Vladimir Putin’s decision, now seemingly finalised, to renew the assault on northern Donbas for the third consecutive year.
The staggering collapse in oil and gas revenues in January–February 2026, together with the risk of a complete depletion of the National Wealth Fund, has pushed the government to consider expenditure cuts and a reduction in the ‘cut-off price’. Even two weeks after the outbreak of the war in Iran, this logic remained in place, with the government intending to channel additional revenues from higher oil prices and a partial easing of sanctions into replenishing the National Wealth Fund.
However, the decision was abruptly reversed last week. The reduction of the cut-off price and spending cuts have been postponed until next year, while at a closed meeting with Russia’s oligarchic elite Putin reportedly declared his intention to capture northern Donbas at any cost and proposed additional contributions to fund the war effort.
This choice implies a vital Russian interest in the ability of Iran’s Islamic Revolutionary Guard Corps to continue resisting US and Israeli military efforts. The blockade of the Strait of Hormuz has, in a literal sense, become a lever for financing a renewed offensive in Donbas, which would otherwise have required far more difficult fiscal decisions. Numerous indications of deepening military cooperation between Moscow and Tehran fit squarely within this picture.
At present, it is difficult to forecast the economic consequences of this strategy given the uncertainty surrounding the duration and trajectory of the war and its impact on oil prices. However, Putin appears unwilling to economise on what is seen as a decisive new phase of the battle for Donbas. This strategy may prove highly risky if the war in Iran turns in favour of the US–Israeli coalition or if the renewed offensive in Donbas fails for a third time.
Between reserves and expenditure
It is worth recalling that exactly one month ago, Finance Minister Anton Siluanov announced plans to 'promptly' lower the 'cut-off price' for this year and the coming three-year period, 'to ensure the preservation of the National Welfare Fund’s resources'. This was the government’s response to the fact that oil and gas revenues in January–February were almost half the level of last year (826 billion roubles compared to 1.56 trillion), forcing the Ministry of Finance to spend almost 400 billion roubles from the fund’s reserves to support budgetary expenditure. According to estimates by Gazprombank’s Centre for Economic Forecasting, at the oil price levels observed at the start of the year and the prevailing pace of withdrawals, the National Wealth Fund would be fully depleted in just over a year.
The current cut-off price of $59 per barrel was effectively established in 2023 in response to the need for a sharp increase in budgetary expenditure, as Kommersant noted. Various sources have suggested that its revised threshold was discussed within the range of $45–55. In turn, the Central Bank warned the government that any reduction in the cut-off price should be accompanied by expenditure cuts to better align spending with revenues; otherwise, it would lead to a rapid increase in borrowing, fuelling inflation and preventing further reductions in the key policy rate.
Consequently, a week after Siluanov’s statement, the Ministry of Finance announced the suspension of the fiscal rule, under which revenues above the cut-off price are allocated to the National Wealth Fund, while revenues below that level are offset by sales of foreign currency and gold from the fund. In effect, the Ministry chose to halt further depletion of the National Wealth Fund without waiting for the more complex and politically costly decision to cut expenditure.
The government nevertheless confirmed its intention to begin spending cuts on 11 March. According to Reuters, this involved a 10% reduction in ‘non-protected’ expenditure categories, that is, all areas except defence and social welfare. According to Bloomberg’s calculations, this could yield savings of around 2 trillion roubles, or just under 5% of total budget expenditure. Even so, this would only partially contain the budget deficit.
By the end of January–February, the deficit had already reached 3.45 trillion roubles, or 90% of the full-year target (3.8 trillion roubles). While the scale of the early-year deficit is partly due to advance financing, primarily of defence spending, extrapolating the shortfall in oil and gas revenues over the first two months to the full year suggests an additional 4.4 trillion roubles in deficit. At the same time, non-oil and gas revenues, despite an increase in VAT, showed very modest growth of 4% year-on-year, below inflation, compared with a planned increase of 9%. This shortfall reflects the pre-crisis condition of the economy and, if current trends persist, could result in a further revenue gap of around 2.5 trillion roubles. Finally, expenditure in January–February exceeded the previous year’s level by 6%, compared with the 3% increase envisaged in the 2026 budget. As a result, extrapolating these revenue and expenditure trends over the full year points to an extraordinary deficit of around 11 trillion roubles, or more than 5% of GDP.
Federal budget execution in 2025, January–February 2026, and projection, billion roubles
The aims of the proposed budgetary adjustment appear clear and logical: against a backdrop of sharply declining revenues, the government would move to cut expenditure and suspend the use of reserves, thereby triggering a depreciation of the rouble, which in turn would boost reduced oil export revenues, at least in rouble terms.
More broadly, the government found itself caught between the ‘wartime’ logic of financing expenditure on a needs basis – a logic of structural deficit it has followed over the past four years – a sharp contraction in revenues, and the desire to preserve what remains of the National Wealth Fund. As noted previously, the war and sanctions have fundamentally altered the Russian authorities’ approach to fiscal policy. Over the preceding decade and a half, the government accumulated reserves during periods of high oil prices and drew them down when prices were low. However, in the second half of 2021 and especially in 2022, despite high oil prices, the government instead used reserves through various mechanisms to inject liquidity into the economy (→ Re:Russia: Twenty Years of Budget Deficits). As a result, the National Wealth Fund’s liquid assets fell from 9.7 trillion roubles as of 1 March 2022 to 4 trillion roubles as of 1 March 2026. This is a decline of almost two and a half times.
At the start of 2026, the Russian authorities thus found themselves in what might be described as a ‘perfect storm’: a sharp fall in oil and gas revenues, near depletion of reserves, and an economy sliding towards recession as a result of structural imbalances. At the same time, preserving the remaining resources of the National Wealth Fund would have required expenditure cuts on a scale the government has been unable to implement.
Within the wartime paradigm
On 24 March, exactly one month after Siluanov’s statement on revising the cut-off price, his deputy at the Ministry of Finance, Vladimir Kolychev, stated that the cut-off price would not be changed this year. This implies, in particular, that the government will not need to undertake significant expenditure cuts, while the fiscal rule will remain, in Siluanov’s words, effectively suspended until the summer, meaning that National Wealth Fund resources will not be spent.
It is clear that this shift in budgetary policy is linked to the surge in oil prices and the easing of US sanctions following the outbreak of war in the Middle East. Four weeks into the conflict, and against the backdrop of a partial blockade of the Strait of Hormuz, through which a substantial share of Middle Eastern oil and gas exports passes, Brent crude is trading above $100 per barrel (around 70% higher than at the start of the year), whilst the price of Urals in Russian ports on the Black and Baltic Seas, according to Bloomberg estimates based on Argus Media data, exceeds $60 per barrel, i.e. already higher than the budget benchmark of $59. According to the Platts pricing agency, on 17 March the price of Urals delivered to Indian ports exceeded $100 per barrel, including freight costs, which have also risen by 30–40% and reached over $20 per barrel, marking the first time it has traded above Brent.
Rise in Brent oil prices in January–March 2026, dollars per barrel
It is worth noting that after the first two weeks of the war the Russian authorities still adhered to their previous approach. The government was planning a limited sequestration of budget expenditure, while at a meeting on 9 March with the heads of Russian oil and gas companies, Vladimir Putin warned that ‘the current high commodity prices are undoubtedly temporary in nature’. At that stage, the government intended to use the unexpected windfall from rising prices and the easing of US sanctions to replenish the National Wealth Fund. Kolychev’s statement, however, marks a decisive shift: additional revenues will now be directed towards current expenditure, while the reduction of the cut-off price has been deferred to 2027.
This shift broadly aligns with changing oil price expectations. Most analysts, according to a Reuters review, place the average Brent price for 2026 in the $70–90 per barrel range. The cost of this decision, however, is the abandonment of efforts to rebuild the National Wealth Fund, even though current forecasts suggest that in most scenarios an oil market surplus from 2027 onwards will once again exert downward pressure on prices. At the Russian Union of Industrialists and Entrepreneurs congress on 26 March Putin once again called on business and government officials to ‘remain prudent’ and not to ‘squander’ windfall profits amid high oil prices. In reality, the Russian authorities appear set to follow precisely such a course, using additional revenues to cover current needs.
The political rationale behind the cancellation of the budget sequestration became fully apparent in Putin’s remarks at a closed meeting with large businesses. According to The Bell, citing its sources, Putin announced his intention to continue the war and to seize the part of Donetsk region not under Russian control, and proposed that business should make ‘chip in’ to support the war effort. Some participants, possibly forewarned, reportedly agreed immediately. In particular, Suleiman Kerimov, the principal owner of the largest gold mining company ‘Polyus’, promised to contribute 100 billion roubles, according to The Bell’s sources, effectively setting a benchmark for others.
In other words, the rise in oil prices appears to have pushed Vladimir Putin towards a decision to continue the war and to attempt, at any cost, to capture northern Donbas. This will most likely require higher expenditure in 2026, as has been the case in each year of the current war, against a backdrop of weak non-oil and gas revenues. To this end, the Kremlin is planning to extract an informal windfall tax from large businesses, the second such measure during the war in Ukraine. The first, in 2023, yielded a relatively modest 319 billion roubles, according to the Ministry of Finance.
Thus, the budgetary policy decisions adopted this week suggest that the Kremlin no longer expects to reach a ‘deal’ with the United States and Ukraine involving the voluntary transfer of northern Donbas to Russian control, and instead intends to commit resources to another decisive offensive. At the same time, this approach implies a vital Russian interest in the capacity of Iran’s Islamic Revolutionary Guard Corps to continue resisting US and Israeli military efforts and to sustain pressure in the Strait of Hormuz.
This interpretation is consistent with numerous reports that Russia is supplying Iran with upgraded Russian ‘Shahed’ drones under the ‘Geran-2’ designation (as reported by the Financial Times) as well as components for them (The Wall Street Journal), and has provided advice to the Islamic Revolutionary Guard Corps on drone tactics (according to CNN reports). Moreover, the 2023 decision by Moscow and Tehran to establish Shahed drone production in Russia now appears a prescient investment, enabling Tehran to access drones produced at a facility effectively shielded from US and Israeli strikes. The interconnection between the two wars is therefore becoming even more pronounced (→ Re:Russia: Where The Tracks Cross). In this sense, the war in Iran and the blockade of the Strait of Hormuz have become a direct source of financing for a renewed offensive in Donbas, which would otherwise have required far more difficult budget adjustments.
At present, it is difficult to assess the economic consequences of this decision given the profound uncertainty surrounding the duration and trajectory of the war in Iran and its impact on oil prices. What is clear, however, is that Putin is not prepared to economise on the next phase of the Donbas campaign, or at least seeks to project such determination. This strategy could prove highly risky if the balance in the Middle East conflict shifts in favour of the US–Israeli coalition or if the renewed offensive in Donbas fails for a third time.