Russia’s overheating economy is on the verge of a significant slowdown, as years of fiscal stimulus, soaring interest rates, persistent inflation, and stringent Western sanctions take their toll. However, after three years of war, Washington may have just handed Moscow an economic reprieve.
US President Donald Trump is pushing for a rapid resolution to the conflict in Ukraine, a move that has alarmed Washington’s European allies. By sidelining both Ukraine and NATO in early negotiations with Russia and blaming Ukraine for the 2022 invasion, Trump is offering Moscow political gifts that could also translate into substantial economic relief.
Russia at an economic crossroads
Moscow is now faced with two difficult choices, according to Oleg Vyugin, former deputy chairman of Russia’s central bank.
“Russia can either curb its massive military spending as it seeks to advance on Ukrainian territory or continue with current levels of expenditure, which would result in years of sluggish growth, high inflation, and declining living standards,” Vyugin explained. “Both options carry significant political risks.”
While government spending usually stimulates economic growth, excessive military expenditure has distorted Russia’s economy. The focus on weapons production over civilian industries has led to economic overheating, forcing the central bank to maintain interest rates at a staggering 21%—a move that has stifled corporate investment and made inflation control almost impossible.
“For economic reasons, Russia is interested in negotiating a diplomatic end to the conflict,” Vyugin added. “A resolution would prevent further misallocation of resources towards unproductive military spending. It is the only viable path to avoid prolonged stagflation.”
Although Russia is unlikely to immediately scale back its defence budget—currently accounting for nearly a third of all public spending—the prospect of a peace deal could alleviate some economic pressures. Sanctions relief, and potentially even the return of some Western businesses, would offer a much-needed boost to the struggling economy.
“The Kremlin will be hesitant to cut military spending overnight due to fears of economic contraction and the need to rebuild its army,” said Alexander Kolyandr, a researcher at the Center for European Policy Analysis (CEPA). “However, by reducing troop numbers, the government could ease the current labour shortage.”
Labour and inflation challenges
The war has severely disrupted Russia’s workforce. Military recruitment and mass emigration have resulted in acute labour shortages, driving unemployment to a record low of 2.3%.
Inflationary pressures could also ease if peace talks progress, as Washington may become less aggressive in enforcing secondary sanctions on businesses from China and other non-Western countries. A relaxation of trade restrictions could make imported goods more accessible and help stabilise prices.
The Russian financial markets have already responded positively. The rouble surged to a near six-month high against the dollar on Friday, buoyed by expectations of sanctions relief and a potential diplomatic breakthrough.
A slowing economy
After recovering from a brief contraction in 2022, Russia’s economy has grown steadily. However, government forecasts suggest a sharp slowdown from 4.1% GDP growth in 2024 to just 1-2% in the coming year. The central bank remains reluctant to cut interest rates, citing the continued imbalance between demand and production capacity.
Central Bank Governor Elvira Nabiullina recently warned that sustained economic growth remains uncertain. “Demand has been outpacing supply for too long, and a natural slowdown is inevitable,” she stated.
Russia’s fiscal position is another growing concern. The budget deficit ballooned to 1.7 trillion roubles ($19.2 billion) in January alone, a 14-fold increase compared to the previous year. This surge is partly due to front-loaded spending ahead of 2025.
“The budget deficit must be controlled if we are to maintain economic stability,” Nabiullina added.
Winners and losers in Russia’s wartime economy
While some Russians have benefited from war-driven economic shifts, others have suffered. Workers in defence-related industries have seen significant wage increases, thanks to government stimulus, while those in the civilian sector struggle with skyrocketing prices for basic goods.
Certain businesses have also found success amid shifting trade dynamics. Melon Fashion Group, for example, has capitalised on booming consumer demand, with revenues rising steadily since 2022. “Our brands have significantly expanded over the last two years, and since 2023, the average size of our newly opened stores has doubled,” the company said.
More Read
However, the high interest rate environment is making it difficult for other industries to thrive.
“At current lending rates, launching new projects is extremely difficult,” said Elena Bondarchuk, founder of warehouse developer Orientir. “The number of investors willing to take risks has drastically declined, and even those still in the market are heavily dependent on banks’ lending terms.”
Internal government documents reveal that lower oil prices, budget constraints, and a growing pile of corporate bad debt are among the top risks facing Russia’s economy.
Trump’s carrot-and-stick approach
While Trump’s proposal for peace may offer economic relief to Moscow, he has also threatened harsher sanctions if Russia fails to cooperate.
“The United States holds significant economic leverage over Russia,” said Chris Weafer, CEO of Macro-Advisory Ltd. “That’s why the Kremlin is willing to engage in talks.”
“The message from Washington is clear: ‘We can ease sanctions if you cooperate, but if you don’t, we can make things much worse.’”
As Moscow and Washington navigate this delicate balance of diplomacy and economic pressure, the coming months will reveal whether Trump’s approach leads to peace—or merely extends the geopolitical standoff in a new form.
