Russia’s war economy, now in its third year, is facing mounting challenges, including rising inflation, labor shortages, and growing economic imbalances. While these issues strain the civilian economy, they have not been severe enough to force Vladimir Putin to halt the war. 

Instead, the Kremlin has prioritized military production and maintained high levels of spending on soldiers and defense industries, all while shielding war-related sectors from the economic pressures faced by the rest of the country. This dual-track strategy reflects Putin’s commitment to prolonging the conflict, despite the increasing costs for ordinary Russians and non-military industries.

The Civilian Economy Under Strain

Russia’s main economic issue in 2024 was inflation, which reached 9.6 percent by December on an annualized basis and shows little sign of easing, as many companies plan to raise prices further. However, mistrust of official statistics remains high: perceived inflation, according to the Central Bank, is around 16 percent, while Romir, a sociological service, reports that average household expenditures have increased by 19–21 percent compared to the previous year.

Income inequality in Russia has grown significantly. Pensions, indexed below perceived inflation, now average $150–200 per month, while public sector salaries are also lagging behind inflation. In contrast, wages in defense sector factories have surged by 30–60 percent due to labor shortages, and payments to contracted soldiers have risen sharply throughout 2024. Most recruits come from impoverished regions, where military payments and compensation to families of the deceased are deposited in local banks, areas that previously saw little financial savings. Meanwhile, the army and military factories are depleting the labor market, a decline further compounded by the emigration of anti-war workers and reduced migrant inflows due to ruble devaluation and restrictive policies.

Demand for labor has risen by 2 million (2.7 percent) from pre-war levels, while the labor supply has shrunk, driving unemployment down from 4–5 percent to 2.3 percent. Rising wages and tax burdens have reduced net profits, particularly in manufacturing and retail. Russia is no longer a country of cheap labor, as the World Bank reclassified it as a high-income country in mid-2024—not as a result of improved productivity, but because the government is prioritizing war financing at the expense of future development.

The Central Bank’s primary monetary tools now have only a limited impact on the Russian economy. It has raised the key interest rate to 21 percent to combat inflation, but this rate primarily affects the civilian sector, which lacks government funding or preferential treatment. Loans to citizens and businesses have stagnated, yet inflation persists, driven by escalating war costs. Businesses are discouraged from investing in expansion, finding it more profitable (and secure) to place funds in bank deposits earning 20 percent. The military sector, thanks to wartime budgets and interest rate subsidies, is completely immune to Central Bank pressures. As a result, to achieve any downward pressure on inflation, the civilian sector must bear almost the entire brunt of Central Bank actions.

As a result, economic activity is gradually slowing. GDP growth dropped from 5.4 percent in the first quarter to 3.1 percent in the third quarter of 2024. Military production is now the only sector experiencing significant growth. By the end of 2024, total industrial output was 10.2 percent higher than in 2021, but excluding war-related industries, it grew by 3 percent, according to a government-linked think tank. 

Military Expansion at Civilian Expense

The war has become the government’s top priority, with the army and military industries receiving growing budget allocations, low-interest loans, and an increasing share of the labor force. In 2024, budget spending rose 17 percent from 2023 levels, with military spending accounting for nearly 40 percent of the total. Meanwhile, non-military sectors face rising inflation, labor shortages, and prohibitively expensive loans. To maintain a numerical advantage in the army and avoid the backlash of forced mobilization, the government offers generous incentives to volunteers, including signing bonuses of up to 3 million rubles ($29,500), equivalent to four years’ average salary.

GDP growth persists, but it reflects an increase in military production rather than the strength of the overall Russian economy. War-related incomes are being funneled into consumer markets, driving inflation and deepening the imbalance between the military and civilian sectors.

In 2025, the Russian economy faces significant risks. First, a stagflation scenario—where inflation remains high while growth slows—is increasingly likely. Avoiding this outcome would require a sharp decline in inflation coupled with economic growth of at least 2 percent, both of which remain uncertain.

The second, less likely risk is a significant drop in export revenues, which could severely impact the economy given Russia’s continued reliance on imported technological products. This scenario largely hinges on the US's willingness to implement stricter financial sanctions to limit Russian oil revenues, as it successfully did with Iran. So far, however, Russia has been able to find buyers for its oil despite the sanctions in place.

Stagflation Risks and Export Vulnerabilities

The challenges facing Russia's economy after three years of war are as significant as the adjustments required to navigate the initial imposition of sanctions and isolation in 2022. Household incomes for those not tied to the war economy are shrinking, as are profits for non-military businesses. However, Putin appears unconcerned about the growing divide between the war and civilian economies, so long as the military-industrial complex continues to operate effectively.

The Kremlin views the Russian army’s progress and Ukraine’s recruitment struggles as evidence that time favors Russia. Additionally, the US and Europe’s push for a quick peace is seen as a sign of weakness. As a result, Putin is less inclined to to negotiate a pause or conclusion to the conflict than Ukraine and its allies, who must either pressure Putin to halt the war or increase military and financial aid to Ukraine—an increasingly difficult task politically.

While the US wants to shift much of the burden of defending Ukraine to Europe, Putin is willing to continue funding the war. Analysts believe that any agreement by Putin to freeze the conflict would likely be temporary. The key question is how European countries would use this "bought" time—whether they would increase military spending, especially as US commitment to defending Europe appears to be waning. For now, many European nations mistakenly assume that Putin’s ambitions will be satisfied with the occupied parts of Ukraine, resisting the need for a serious reassessment of their defense budgets and military strategies.

Forcing Putin to make peace will not be easy, and it would be a significant setback if the United States and Europe rewarded him for a temporary freeze of the conflict by easing sanctions against Russia. A more effective approach would be to sharply escalate sanctions against Russia now, in response to its continued attacks on Ukrainian cities. Sanctions should only be lifted once Russia adopts a less aggressive foreign policy and abandons its domestic practices of suppressing opposition, propagandistic brainwashing, and disregard for civil rights.

The opinions expressed in this article are those solely of the author and do not reflect the views of the Kennan Institute.