A Cancelled Manoeuvre: The Challenges Facing Economic and Fiscal Policy in 2026

The exhaustion of growth drivers and a bleak start to 2026

Despite the diversion of significant resources to conduct the ‘special military operation’ and restrictive economic and financial sanctions, the Russian economy has in recent years demonstrated significant growth rates. In 2023–2024, these averaged 4.5% per year, but in 2025 they slowed dramatically to 1%. Economic growth over these three years was driven mainly by two factors: the mobilisation and monetisation of previously accumulated financial and material resources, and the use by the corporate sector of various schemes to circumvent sanctions restrictions. This made it possible to avoid a sharp contraction in exports of raw materials and in critical imports, although the latter became significantly more expensive for consumers.

In 2022–2025, to finance expanded budgetary needs, in addition to current tax revenues, the authorities drew on liquid assets of the National Wealth Fund (just over $70 billion), as well as revenues from oil exports in 2022, when prices were exceptionally high (around $170 billion). In addition, part of the previously accumulated profits of the corporate sector was used to finance expenditure, along with a special dividend from Gazprom ($150 billion) and other extraordinary revenues. Over 50% of all funds raised were of a monetary nature, which made it possible to increase budgetary spending at double-digit rates (on average +15% per year over four years), while spending on the defence-industrial complex rose by multiples. However, the flip side of this policy was accelerating inflation.

Russia’s GDP in 2018–2025, billion roubles

By 2025, it had become clear that these resources were being exhausted and that economic performance indicators were gradually shifting towards stagnation. At the same time, growth in the civilian industrial sector had already moved into negative territory. In the first quarter of 2026, the downturn in industry was joined by a contraction in GDP. In January, GDP declined by 2.1% year on year, and by 1.9% over January–February. Industrial output fell by 0.8% and 0.9% in January and February respectively. Retail trade turnover dropped sharply to 0.7% in January, whereas in previous years it had grown on average by 6–7%. A sharp slowdown in fixed capital investment growth to 1.5% occurred in the second quarter of 2025, followed by contractions of 3.1% and 5.3% in the third and fourth quarters respectively.

At the same time, the decline in inflation almost came to a halt. Following a spike in January, weekly inflation in February–March stabilised at around 0.13% (5–6% in annualised terms). Demand for labour began to rise again, and wage growth accelerated. The halt in disinflation appears to be due to the combined effect of higher VAT and other taxes and levies, together with a sharp increase in borrowing via OFZs by state-owned banks, subsequently refinanced through the Central Bank. From November 2025 to March 2026, liquidity provision to banks through repo auctions amounted to 3.3–3.6 trillion roubles per month. These operations have a lagged pro-inflationary effect.

Banks’ debt under repo auctions, 2025–2026, weekly average, trillion roubles

The budget crisis and the proposed manoeuvre in fiscal and monetary policy

In 2026, despite another round of tax increases, the fiscal system entered a crisis marked by an acute shortage of funds to sustain the state’s planned obligations. Growth in non-oil and gas budget revenues in the first quarter of 2026 compared with the first quarter of 2025 amounted to 7%, of which the greater part (5 percentage points) was driven by inflation, with the remainder accounted for by higher tax collection. On the other hand, oil and gas revenues fell by almost 50%. Whereas in 2025 the consolidated budget deficit reached 8.5 trillion roubles and required recourse at year-end to quasi-monetary sources of financing, this year, without cuts to planned non-protected expenditure, it would be necessary to finance a deficit of around 10 trillion roubles (this estimate excludes potential additional oil export revenues arising from the war in the Gulf, given the high degree of uncertainty surrounding forecasts). In such circumstances, intensive use of quasi-monetary financing becomes unavoidable and, as noted, is already taking place via the repo mechanism.

As a result, the pace of the Central Bank’s rate cuts may slow relative to the initial expectations of major Russian banks, which had anticipated a decline to 10–12% by year-end. Under such a scenario, the economy will remain under pressure from the high cost of money for longer, in an environment of elevated tax rates and additional fiscal pressure on private business, including the introduction of various levies, tariffs and fines, and intensified efforts by the Federal Tax Service to extract additional revenues. One of the most recent and notable decisions in this vein has been the imposition of VAT on imports entering the country from ‘unfriendly’ nations via Customs Union countries. In this context, expenditure cuts appeared to be an unavoidable condition for maintaining control over prices and restoring growth in the commercial sector in 2027, even at the cost of a possible economic contraction in 2026.

The initial plan for the fiscal manoeuvre envisaged freezing expenditure at a level slightly above that of 2025 and increasing indirect taxes in order to balance the budget at a deficit that could be financed through market borrowing, while also extracting more income from households and thereby reducing consumer demand, which clearly exceeds lagging supply and leaves room for further price increases.

The overall design was as follows:

1) to stop using National Wealth Fund resources for budget financing by lowering the cut-off price from the current $60 per barrel, for example to $45, enabling the Ministry of Finance to resume foreign currency purchases to replenish the Fund;

2) given a weak, albeit positive, trade balance, such purchases would lead to a depreciation of the rouble, estimated at around 20%, or to 90–95 roubles per dollar; this would add approximately 2 percentage points to annual inflation, but would not prevent the Central Bank from gradually lowering its policy rate, while shifting the inflation target from 4% to 6–7%;

3) a slower pace of disinflation would allow for higher tax collection, up to 1 trillion roubles, and the unwinding of the fiscal bubble would proceed more gradually but in the right direction;

4) a reduction in non-protected budget expenditure (given that nearly 30 trillion roubles in the current spending plan are protected, only 14 trillion are subject to cuts, with a maximum effect not exceeding 1.4 trillion).

The monetary policy manoeuvre envisaged a reduction in the Central Bank’s rate as the disinflationary effects of fiscal adjustment materialised. In its baseline forecast, assuming implementation of the disinflationary fiscal plan, the Central Bank projected a year-end policy rate of 12–13% and warned that the 4% inflation target would be reached only in 2027.

This was the general framework of economic policy and the set of measures outlined by the Ministry of Finance at the end of February following hours of ‘discussions’ within the government, as described by Prime Minister Mikhail Mishustin.

The scrapping of the fiscal manoeuvre and its consequences

However, the war in the Gulf and the associated rise in energy prices appear to have created the illusion that these measures could be postponed. In March, public calls for fiscal restraint gave way to a large-scale expansion of spending. Against the backdrop of expectations of additional oil and gas revenues linked to the conflict in the Middle East, the government abandoned the fiscal rule, and budgetary expenditure began to rise rapidly on the back of borrowing. By the end of March, federal budget expenditure amounted to 12.9 trillion roubles, or 29% of the annual plan (44.1 trillion). While in January–February spending had increased by 5.8% year on year and broadly reflected the ‘new seasonality’ of 2024–2025 (characterised by the advance payment of military expenditure at the start of the year), March expenditure represented a significant deviation even from this new norm. Expenditure in March rose by 44% compared with March 2025, and total spending in the first quarter of 2026 increased by 17% relative to the first quarter of 2025. As a result, the federal budget deficit (4.6 trillion roubles) grew by a factor of 2.3 compared with the deficit in the first quarter of 2025 (1.9 trillion).

The fiscal rule was designed to decouple Russian fiscal policy and the exchange rate from oil prices, making them more stable and predictable and thereby reducing country-level macroeconomic risks. Its abandonment once again ties the rouble to oil prices and sharply increases volatility in the foreign exchange market. In effect, the exchange rate begins once more to ‘follow’ oil. If oil prices exceed $100 per barrel in the second quarter of 2026, then in the absence of the fiscal rule this would act as a factor strengthening the rouble. At $100+ per barrel, the resulting exchange rate could lead to substantial losses in budget revenues.

At the same time, the scope for reducing the key policy rate will narrow sharply, as the shift in fiscal policy is inflationary. Without fiscal consolidation and constraints on the deficit, the trajectory of rate cuts is likely to be pushed back by six to nine months, and during preparation of the 2027 budget the authorities will face the same set of problems: a double-digit policy rate and the need for fiscal consolidation against a continuing trend of economic slowdown.

The Ministry of Finance is counting on a substantial increase in oil and gas revenues, which prior to the new Gulf war had looked extremely bleak due to sanctions and falling oil prices (standing at 50% of the previous year’s receipts and the budget plan). It is now anticipated that additional revenue will be generated not only through rising oil prices, but also through the lifting of sanctions against Russian tankers and the elimination of the discount on the price of Russian Urals crude relative to Brent. In April, the Ministry of Finance could receive two or more times as much oil and gas revenue as in January and February.

This appears to explain the decision to return, temporarily or for the remainder of the year, to the previous policy configuration, under which the full utilisation of oil and gas revenues allowed the budget to be replenished and high levels of expenditure to be financed. Since abandoning the reservation of part of these revenues under the fiscal rule is inflationary, the Ministry of Finance also expects to collect an inflation adjustment on non-oil and gas revenues over the course of the year. This counter-manoeuvre, instead of the previously envisaged consolidation, can be seen as a temporary easing of fiscal policy to support the economy. Political considerations appear to have outweighed the need for a rapid reduction in inflation. At the same time, it cannot be ruled out that the Ministry of Finance may return to the budget rule once it has allocated the additional oil revenues generated by the Gulf war.

If, however, as part of a more accommodative fiscal policy, the Central Bank maintains a high policy rate or delays its reduction, this will place the economy on a path of temporary inflationary growth. In effect, the task of combating inflation will be postponed, which may help to avoid a sharp deterioration in economic conditions in the short term and to finance elevated budgetary expenditure in nominal terms. Given persistently high inflation expectations, which according to Central Bank surveys remain stable at around 13%, any easing of monetary policy would likely trigger a rapid, almost lag-free acceleration in price growth.

Any further tax increases, implemented as part of a deliberate intensification of fiscal pressure on business in conditions of weak economic activity and high interest rates, will continue to restrain economic growth, while the Ministry of Finance will keep losing the tax revenues needed to balance the budget without extensive reliance on monetary sources of deficit financing.

By mid-2026, a choice in favour of short-term inflationary stimulus and increased budgetary spending may leave little hope for even modest but sustainable economic growth in 2027, while the need to return to combating inflation will become more acute than ever. This will no longer be a technocratic decision but an overtly political choice between continuing to finance the ‘special military operation’ and reaching a peace agreement. A decision to continue the ‘special military operation’ will require another round of tax increases as part of preparations for the 2027 budget. At the same time, a further decline in the country’s economic potential will become unavoidable, along with a high likelihood of restrictions on the use of assets in the civilian sector, implying an expansion of state intervention in private-sector activity.