THE BUDGET TRAP IS CLOSING ON RUSSIA / GEOPOLITICAL FUTURES

The Budget Trap Is Closing on Russia

The upcoming budget will be much trickier than the past couple. 

By: Ekaterina Zolotova

Russia is about to make tough decisions as it sets its federal budget for 2026. 

In simple terms, the budget defines revenues and expenditures and, since 2022, assesses how much the state can spend on the economy without hurting the war effort in Ukraine. 

The Kremlin knows it has little room for error as it supports both civilian and military economies while earning enough money to replenish the National Wealth Fund and forestalling a major deficit. 

(The fund comprises oil and gas revenues and is used as a sort of emergency fund to ensure stability and support major infrastructure projects.) 

And as the pressure from sanctions rises, so does the pressure on decision-makers and civilians alike.

From a geopolitical perspective, the federal budget is viewed by the ruling authorities as a tool for achieving one of their geopolitical imperatives: maintaining public loyalty by setting a certain standard of living. 

The Kremlin has, therefore, traditionally earmarked the majority of its spending on economic stimulus and social services – health care, education, law enforcement and the like. 

According to the 2022 census, one in three Russians was dependent on state payments – that is, pensions, unemployment payments, social benefits, subsidies and other benefits. 

The percentage dramatically increases when it includes public sector workers.

The conflict in Ukraine, however, has turned the Russian market economy into a war economy. 

Defense and security are now the top priorities of the new Russian budget. 

National defense spending has climbed to 32.5 percent of the federal budget, up from 15 percent in 2021. 

Meanwhile, Moscow has to continue to fulfill its social obligations to Russian citizens, leading to a growing budget deficit. 

For a few years, the Kremlin was able to finance essential sectors through the National Wealth Fund, loans, and oil and gas revenue, which accounts for roughly a third of total state revenue. 

The government is no longer confident that it can sufficiently meet all its financial obligations. 

The 2025 budget was calculated back in November 2024 based on a number of now-outdated economic criteria. 

The 2026 budget is being calculated with lower gross domestic product and growth expectations, a stronger ruble, reduced export volumes and higher inflation.

 

The budget process is also complicated by the uncertainty surrounding sanctions and the war in Ukraine. 

In the absence of peace talks that would satisfy the Kremlin, and with NATO's increased activity near Russia's borders, it seems unlikely the war will end in the near future. 

That means that sanctions will probably continue, and that the next budget will be a military budget – not just something that pays for equipment and service but a fund that supports “care infrastructure” for soldiers, veterans and their families until the war ends.

It’s unclear how the Kremlin will maintain such high spending without relying on the budget replenishment and deficit financing methods used in previous years. 

Although the 2026 plan calls for a gradual decline in oil and gas revenue, this sector will still account for 25 percent of the state budget (down from 30 percent in the 2024 budget). 

And there is uncertainty in the sector too: insufficient long-term contracts, fluctations in price and demand, and logistics. 

The price of oil itself and the Russian ruble affect the amount of revenue coming into the budget. 

Given the tightening of sanctions, the strict price cap and the price dynamics of Urals (currently at around $60 per barrel), it’s unlikely that Russia will be able to secure a steady stream of oil and gas revenue, especially now with the ruble as high as it is.

Russia is concerned that new sanctions will deprive it of oil and gas revenue, but it also knows it will be difficult and painful to take Russian oil off the market entirely. 

Partly this is because there are no good alternatives for the quality and quantity of Russian crude. 

The bigger issue for Moscow is that Russia needs to prop up its National Wealth Fund, which in recent years has been partially depleted. 

In June, the fund held 11.6 trillion rubles ($16.7 billion) – 1.4 trillion rubles less than in December 2024. (Of this amount, 1.3 trillion rubles financed the 2024 state budget deficit.) 

By August, Russia managed to increase the fund's holdings to 13 trillion rubles, but the government is in no rush to spend the reserve funds it only now accumulated. 

And in any case, cash injections are one-time measures that can’t be accurately predicted, and pumping too much cash into the economy without a corresponding increase in production can raise inflation. 

Therefore, the government will give preference to funding large infrastructure projects that will boost the slowing economy and stimulate trade flows rather than allowing the budget hole to be covered again with money from the National Welfare Fund.

The government is now trying to come up with safety nets for the fund. 

Finance Minister Anton Siluanov recently noted that the oil cutoff price under the budget will be gradually reduced from the current $60 per barrel to $55 by 2030. 

(This is the number above which money goes to the National Wealth Fund.) 

This means the budget will receive less money from oil sales. 

Incidentally, it will be impossible to use incoming National Wealth Funds to cover the growing deficit once the practice is banned in 2026. 

It's no surprise, then, that the Kremlin is seeking other ways to earn revenue. 

Non-oil sectors account for up to two-thirds of the federal budget. 

Russia has already taken measures to increase personal income tax revenues, including a five-tiered tax scale that came into effect in 2025. 

This, along with rising wages, led to an increase in tax revenue but had very little impact (less than 1 percent) on the overall budget. 

A much more effective tool for containing the budget deficit could be reforms to the value-added tax, which accounts for more than half of non-oil and gas budget revenue. 

In amendments submitted to the government for consideration, the Ministry of Finance has suggested increasing the VAT rate from 20 percent to 22 percent for all VAT-paying companies and lowering the VAT exemption threshold for businesses from 60 million rubles to 10 million rubles. 

It’s unclear when this will happen, but considering the circumstances, it’s only a matter of time.

What does this mean for Russian consumers? 

The VAT increase will raise the tax burdens on businesses, which, by all the laws of economics, will pass the increase on to the end consumer. 

This means higher retail prices, accelerated inflation, and, ultimately, an increase in the key interest rate – which will place some pressure on non-defense-related businesses. 

Inflation is inevitable, but unlike the unreliable, one-time injections of funds from the National Wealth Fund into the economy, this is more predictable and accountable. 

Public discontent will rise too, but the government is counting on the increase in nominal wages over the past year to mitigate the impact and prevent protests.

The trap the state is gradually driving itself into is closing as Russia continues to channel huge cash flows to the front during a cooling economy for which there is no stable outside income. 

Uncertainty is becoming a serious challenge for the Russian economy. 

The question is how long Russia can sustain itself before it goes to the negotiating table.