Eagle Intelligence Reports
As Russia’s full-scale invasion of Ukraine nears its fourth year, Russia has entered a new phase of permanent mobilization. What began as a military campaign has evolved into a system of governance that merges fiscal, financial, and industrial power under the logic of war. The Kremlin is no longer fighting a temporary conflict; it is managing an economy engineered for resilience, discipline, and control.
Russia is no longer just funding a war; it is organized around one. Since 2022, emergency spending has become a permanent design. Three elements anchor it: a budget with high defense and internal-security shares; a financing loop that binds banks to the state via OFZs (federal loan bonds; Russia’s primary government securities); and an industrial pipeline that prioritizes military orders and diverts capital and skills from civilian sectors.
Russia is no longer just funding a war; it is organized around one. Since 2022, emergency spending has become a permanent design
The pattern repeats every year: conservative plans, mid-year top-ups, and overspending in December. Headline numbers move, but the architecture does not. This system is built to withstand pressure and distribute rents, not to raise productivity or incomes.
Three interlocking loops anchor this system. The first is the budgetary loop. The budget fixes a persistently high allocation for defense and internal security (around 40 percent of federal outlays combined), while widening the share of secret spending to roughly 30 percent of the budget. Second, the financial loop. It channels household and corporate deposits into OFZs at double-digit yields, turning bank balance sheets into fiscal buffers and deferring interest costs for years. And third, the industrial loop. It ties entire regions to military orders, subcontractor networks, and veterans’ programs, generating employment and liquidity in exchange for Kremlin-aligned compliance.
Together, these loops do more than sustain war spending; they reshape fiscal structure, political control, and external alignment. Each stabilizes cash flow in the short term while eroding civilian capacity over time.
The announcement of new US sanctions on Rosneft and Lukoil in late October 2025 marks a structural escalation in Washington’s economic pressure campaign. These designations, coupled with secondary sanctions threats against shipping, marine insurance, and correspondent-banking channels, directly target Russia’s main cash-flow engines. They reinforce existing exclusion from dollar-clearing and extend compliance risks to yuan-, dirham-, and rupee-based payment systems, while raising transaction costs across shadow-fleet logistics. Immediate market reactions included a short-term Brent spike of roughly five percent and expectations that the Urals discount could widen toward $15–20 below dated Brent as Asian buyers reassess exposure.
For the Kremlin, these measures tighten fiscal space and force a costly reallocation of resources: budgetary or quasi-fiscal support may become necessary to offset liquidity stress and regional revenue losses. In effect, the fiscal and industrial loops now intersect directly with the external sanctions regime, compressing the margin for fiscal maneuver and shifting the baseline from stability toward costlier adjustment or disruption.
The fiscal and industrial loops now intersect directly with the external sanctions regime, compressing the margin for fiscal maneuver
Moscow has responded to the new US sanctions with demonstrative composure and familiar rhetoric of endurance. By expanding shadow logistics and accelerating the yuanization of trade settlements, the Kremlin will seek to offset the immediate losses. Yet the outcome is not the multipolar balance it proclaims, but an asymmetric dependency on China that risks turning Russia from an energy empire into a commodity appendage of its eastern patron.
Two consequences follow that set the terms of debate for 2026 and beyond. First, the wartime economy has become a domestic political instrument. Procurement, subsidies, and veterans’ benefits are targeted to reinforce loyalty among corporate elites, regional bosses, and key constituencies. Margins, exemptions, and selective enforcement reward those who align; higher consumption taxes and a weaker rouble shift costs onto those who do not benefit from state flows. Targeted transfers suppress protest at a manageable fiscal cost.
Margins, exemptions, and selective enforcement reward those who align; higher consumption taxes and a weaker rouble shift costs onto those who do not benefit from state flows
Second, the promised turn to self-reliance has produced not autonomy, but rather eastward dependency. Import substitution covers some gaps, but core inputs, such as machine tools, microelectronics, optics, industrial robots, and payment rails, hinge largely on Chinese supply and compliance. India’s role is also quite significant, but rather commercial than technological: discounted crude and product arbitrage help cash flow. Moscow can assemble and refurbish at scale, but it cannot replicate a full-spectrum industrial base at an acceptable cost while isolated from advanced inputs and finance. This is the backdrop against which all near-term choices should be judged: a durable, centrally managed war economy that purchases domestic control and trades Western exposure for asymmetric reliance on China and, to a lesser extent, India.
Against this background, the open questions are: How long can fiscal and banking channels absorb high-coupon debt without crowding out the civilian sector irreversibly? How far can the center extend patronage before the tax and inflation burden generates visible social friction outside the rent circuits? And how much leverage do new external dependencies give to suppliers whose strategic aims are not Russia’s own? The answers will determine whether the current equilibrium remains a plateau or turns into a slower and costlier adjustment.
The war is not paid for by oil alone. Domestic debt is the primary adjustment instrument. With few safe assets left, banks absorb domestic OFZs, converting household and corporate deposits into government funding. High OFZ coupons improve today’s cash flow because banks roll principal and the treasury receives cash upfront, but they lock in a higher interest bill for 2026–2028 as issues are refinanced at mid-teens yields, narrowing room for non-defense spending. Following the October 2025 sanctions shock, market expectations for new OFZ tranches have risen toward 15–18 percent yields, with stress-scenario pricing exceeding 20 percent. Each additional 100-basis-point rise adds roughly 0.2 percent of GDP to projected debt-service costs over 2026–2028, effectively crowding out any scope for new non-defense discretionary spending. Each new tranche lifts the carry cost and narrows the fiscal room for anything that is not war or welfare for war-relevant constituencies. The crowding-out is subtle but cumulative: private credit is rationed by price, and investment that is not shielded by the state’s order book slips to the back of the queue. Debt service now absorbs around 5 percent of total spending, up sharply from pre-war levels.
The National Wealth Fund (NWF) now works as a pressure valve. The headline stock is bulky, the liquid slice small; much of the remainder sits in stakes and quasi-fiscal assets that cannot be sold without political damage or market dislocation. Liquid NWF assets are around 1.9 percent of GDP; the Ministry of Finance defines “liquid” as funds in treasury accounts at the Bank of Russia—cash/foreign exchange (FX)/gold—readily available to finance the deficit, with equity stakes and long-term loans excluded. When the fund “invests”, it typically underwrites losses, socializes risk, and keeps troubled champions liquid. It simply buys time. When the arithmetic still does not close, the Kremlin reaches for quiet extractive levers.
Under the new sanctions regime, this pressure valve will be tested further. Rosneft and Lukoil now face payment disruptions and refinancing constraints of varying intensity: Rosneft through blocked subsidiaries and shipping channels, and Lukoil through tightening trade-finance access. Both are systemically significant borrowers, and the Kremlin will likely deploy a mix of NWF injections, subsidized credits, and tax deferrals to stabilize them; a stopgap that drains liquidity and defers fiscal pain into 2026–2027.
Value-added Tax (VAT) already delivers roughly a third of federal revenues; lifting the rate from 20 percent to 22 percent broadens that take without touching wages directly. This hike, effective from January 2026, is projected to generate over 1 trillion roubles annually, further embedding regressive pressures into household budgets. The VAT base is broadened by lowering the revenue threshold for VAT liability, expanding the number of liable firms. The incidence is regressive: lower-income households spend a higher share on VAT-liable goods and are less able to hedge the exchange rate pass-through. A weaker rouble inflates nominal oil receipts and erodes the real value of fixed obligations such as soldiers’ bonuses, pensions, and regional transfers. For households, both instruments operate like taxes by other means: imports jump in price, domestic producers follow, and real wages lag.
The wartime economy is also a political instrument. Defense spending and procurement are not only about shells and drones, but they are also about discipline and loyalty. Contracts cluster where loyalty must be secured, from large conglomerates with access to the presidential center to regional champions that anchor employment in mono-cities. In several mono-industry towns, more than 50 percent of new orders since 2023 have been defense-linked, effectively turning procurement into a local industrial policy. Governors are rated on output, calm streets, and manpower delivered. Those who perform get projects and fiscal indulgences; those who don’t lose access and face selective audits. Cost-plus pricing and opaque tenders keep margins high enough to bind corporate elites, while secrecy classifications ensure scrutiny stays limited and discretionary power concentrated.
The wartime economy is also a political instrument. Defense spending and procurement are not only about shells and drones, but they are also about discipline and loyalty
On the social side, the state manufactures consent with material participation. Wartime pays and benefits are estimated at around 1.5 percent of GDP annually, with enlistment bonuses in poor regions equal to 3 to 10 times the median monthly wage. Veterans’ benefits, such as housing, health, and priority access, signal that the state rewards those who join the war’s rent circuits. The effect is twofold. First, it props up consumption in recruiting territories without building productivity. Second, it deepens dependency: local elites broker access to benefits and contracts, and populations organize their livelihood around state flows they do not control. Cohesion is maintained through budget transfers and procurement rather than ideology. The political messaging follows the money. War spending is framed as welfare: “support for families”, “housing for heroes”, and “regional development”.
The state thus recodes the budget’s coercive extraction into a distributive narrative. Where loyalty matters, the coffers open; where it doesn’t, the burden shifts through higher VAT, currency slippage, and the pass-through of logistics costs. The outcome is a stable but brittle equilibrium: purchased low protest activity at the expense of future capacity.
The geography of this economy is stark. Moscow and St. Petersburg capture headquarters, finance, and defense-adjacent services; median wages in the capital run at twice the national median, widening the pull factors for internal migration. The periphery supplies manpower and raw materials, then lives with shortages, price spikes, and out-migration.
Fuel has become the clearest stress test: refinery outages and stretched rail corridors trigger rationing first in oil-producing regions and along long logistics tails. The capitals are buffered longer by priority allocations and denser infrastructure. Since late summer, more than a dozen regions have faced intermittent fuel rationing or pump closures. Behind the macro veneer, leading indicators deteriorate. Sales of strong alcohol rose notably in low-income regions; the share of serious offenses increased even as total crime stayed flat; net population loss in select border and industrial regions reached the tens of thousands.
What stays behind is an inverted pyramid: aging populations, shrinking regional tax bases as well as higher unit costs for public services. Local budgets then lean harder on transfers from Moscow, which arrive with strings attached and political expectations baked in. Hospital staffing gaps above 10 percent and school consolidations in double-digit districts are now routine outside showcase areas. War spending deepens these splits by design. Veterans’ payments and enlistment bonuses stabilize consumption in poor districts but do not build productivity; they anchor livelihoods to state flows. Defense contracts cluster where employment must be shored up or loyalty signaled; mono-towns tied to a single plant receive orders and credit lines, while civilian small and medium-sized enterprises (SMEs) are priced out by high rates and unreliable inputs. Governors learn the new key performance indicators (KPIs): output, manpower, and quiet streets. Those who deliver win projects and indulgences; those who stumble face inspections and fiscal squeeze. Patronage maps onto geography, and geography into politics.
Official rhetoric celebrates sovereignty and import substitution, but the structure says otherwise. Russia repairs legacy kits and adds capacity where it can, yet for machine tools, microelectronics, optics, industrial robots, and payments, it leans on external pipelines, above all China, and commercially India.
China now accounts for around 70 percent of machine-tool imports and almost 90 percent of microelectronics by value relevant to dual-use lines. A double-digit share of cross-border settlements now clears in yuan, increasing exposure to compliance shifts in the Chinese banking system. Tightening by major Chinese banks immediately raises Russian transaction costs and delivery times; loosening does the opposite. This channel raises pricing and timing risk across machine tools, electronics, and payments.
With India, the tie is transactional. Urals oil trades at a double-digit discount to dated Brent; product arbitrage margins hinge on Protection and Indemnity (P&I) insurance availability, price-cap compliance, and routing constraints. Under the G7 price-cap regime, Western P&I cover is available only with attestation that shipments are at or below the cap; “dated Brent” is the physical North Sea benchmark used in compliance comparisons, hence the focus on the Urals–dated-Brent differential. Useful for cash flow, yes, but not a platform for technological catch-up. It locks in a commodity seller–processor-buyer hierarchy in which the price setter sits elsewhere, and the logistics chain is vulnerable to insurance and compliance frictions.
The upshot: the drive for self-reliance has produced new dependencies rather than autonomy. Russia can assemble, refurbish, and adapt at scale. But it cannot, at an acceptable price, rebuild a full-spectrum industrial base while remaining isolated from advanced inputs and finance. The longer the war economy persists, the deeper these external dependencies embed themselves in everyday operations, from a drone workshop’s bill of materials to a regional bank’s liquidity plan.
The drive for self-reliance has produced new dependencies rather than autonomy
Growth driven by fiscal stimulus in 2023–2024 has faded, while the fiscal wedge widens. A small reduction in defense outlays does not normalize the budget: the state remains the largest investor and debtor; employment is supported, but productivity is not. Debt service eats a larger slice of the budget, OFZ rollovers lock in high coupons, and a higher VAT, along with a softer rouble, shift the burden onto households. The civilian economy feels it first in the form of pricier credit, thinner margins, and postponed investment. After 3–4 percent war-stimulus growth in 2023–24, year-to-date expansion has slipped toward almost 1 percent as stimulus fades and capacity bites. High-coupon OFZ issued in 2024–2025 front-loads interest costs into 2026–2028, limiting non-defense discretionary spending. Even on a steady war footing, replenishing stocks and readiness is a 7-10-year project. A stable expenditure level extends operating capacity but does not restore parity.
Demobilization will not be a glide path. Reported labor shortfalls exceed 2 million workers; unemployment sits near record lows, masking misallocation rather than strength. Veterans return with skills that do not map cleanly to civilian demand and with income expectations set by combat pay. They will need retraining, healthcare, and predictable support, costs that rise just as war orders fall. Wartime SMEs that flourished on drones and repairs will struggle once procurement consolidates back into state conglomerates that defend their peacetime rents and political privileges. The result is stop-start conversion, not a smooth handover. Each percentage point added to VAT raises more revenue than a similar hike in profit tax under current profit compression; meanwhile, the mid-teens OFZ coupon locks in a rising interest wedge.
Veterans return with skills that do not map cleanly to civilian demand and with income expectations set by combat pay
A soft landing requires what the current model resists: real cuts to military procurement, transparent tenders, hard budget constraints for state giants, bankruptcy where necessary, and a shift of credit from protected contractors to competitive civilian firms. It also needs a targeted labor policy that prioritizes portable credentials, fast-track upskilling, incentivizes mobility, and public investment that raises total factor productivity rather than papering over shortages. Absent that, Russia gets a managed plateau: stable cash flow, eroding capital stock, rising social obligations, and a slow leak of talent to the capitals or abroad.
Russia’s managed plateau is thus internally stable but externally exposed. These operational constraints are now compounded by the behavior of Russia’s key Asian buyers. The sanctions shock has not only disrupted Western channels but also forced Moscow’s partners in the East to recalibrate risk exposure and compliance routines.
China and India now face sharper compliance dilemmas. Chinese state-owned refiners and banks have begun tightening due-diligence procedures and delaying settlements in yuan-clearing channels to mitigate secondary sanctions’ exposure. Indian refiners, while still taking discounted cargoes, have reduced spot purchases and introduced additional attestation clauses to meet price-cap compliance requirements. These measures create delays in trade financing and raise working-capital needs for Russian exporters, amplifying rouble volatility and fiscal uncertainty. The Kremlin’s dependency on Beijing thus deepens not only technologically but financially: each episode of Chinese over-compliance reverberates through Russia’s liquidity chain.
This evolving compliance environment adds a new layer of fragility to Russia’s fiscal equilibrium, a vulnerability that will increasingly shape the contours of its war economy through 2026.
Three scenarios outline the potential evolution of Russia’s war economy: each grounded in fiscal realities and external dynamics. Their probabilities shape the margin for Western action in 2026:
Plateau Scenario (Probability: 45 percent): Sustained war financing via VAT hikes and yuan-denominated trade maintains stability, but inflation creeps to 8–10 percent, eroding civilian purchasing power without triggering unrest.
Adjustment Scenario (Probability: 35 percent): Rising Chinese compliance costs or oil price volatility force procurement cuts, sparking localized social friction in peripheral regions as patronage thins.
Disruption Scenario (Probability: 20 percent): A sharp OFZ yield spike (over 20 percent) overwhelms debt service, accelerating demobilization and exposing labor mismatches, potentially amplifying Western leverage if timed with multi-year aid commitments.
These scenarios underscore the need to monitor Russian fiscal buffers and dependency metrics closely. The combined effects of restricted energy revenues, higher OFZ yields, and constrained refinancing elevate the risk of a multi-channel fiscal shock by mid-2026. Unless oil prices rise sharply or China provides explicit liquidity support, Moscow’s fiscal buffers will erode faster than planned, narrowing the Kremlin’s capacity to sustain simultaneous war-level spending and domestic patronage.
Russia’s war economy is robust in cash flow but brittle in structure. It buys domestic order by deferring structural costs, not by generating lasting capacity. The Kremlin trades productivity for control and long-term viability for short-term resilience. This is not a model built to win, but to endure. With the October 2025 sanctions tightening the external vice on Russia’s energy backbone, the trade-off has become even starker: every rouble allocated to stabilization is one not invested in production.
Waiting for collapse is not a strategy. It is a bet on internal failure that external actors cannot time and should not rely on. Time inconsistency currently favors Moscow: a regime that can shift VAT rates, command domestic banks, and direct procurement flows can sustain war-level spending longer than a fragmented West that debates, delays, and disperses responsibility.
Time inconsistency currently favors Moscow: a regime that can shift VAT rates, command domestic banks, and direct procurement flows can sustain war-level spending longer
To counter this, Western actors must act rather than react on three fronts: First, shorten production cycles and secure throughput. Munitions and dual-use capacities must be funded in multi-year lots, insulated from political calendar swings, and scaled for cost efficiency.
Second, enforce sanctions through operational nodes, not headline declarations. Compliance gaps, especially in logistics, re-export, and dual-use components, must be closed through persistent micro-frictions, not episodic crackdowns.
Third, exploit asymmetric dependencies. Russia’s pivot to China and India opens leverage points the West has barely tested. Visibility into yuan-denominated transactions, pressure on CNC and optics supply chains, and tighter oversight of parallel trade can raise Russia’s costs incrementally but decisively. The new Rosneft-Lukoil sanctions show that calibrated financial pressure can amplify internal costs without provoking immediate systemic collapse. The challenge now is endurance, maintaining coordinated enforcement until the cumulative fiscal and logistical drag constrains Russia’s war economy from within.
The goal is not shock, but sustained attrition. The West need not mirror Moscow’s coercive model, but it must match its stamina. Outlasting Russia’s war economy will require more than resolve; it demands precision, endurance, and the political will to raise the structural costs of war faster than the Kremlin can internalize or displace them. Waiting and hoping for Russia’s war machine to collapse is not a plan. Strategic pressure is.