Russia has trapped itself by boosting defence spending and turning its defence industrial base into the main driver of domestic demand.

Source: report by Foreign Intelligence Service of Ukraine

Details: The Ukrainian Foreign Intelligence Service says that Moscow cannot shift back to a peaceful economic model without a sharp downturn and expects defence spending cuts once the war ends.

Quote: “The war that Russia launched against Ukraine has reshaped the structure of the Russian economy. Over three years of militarisation the country has fallen into a trap: defence spending has risen to almost 8% of GDP and the defence industrial base has become the main driver of demand.”

The intelligence service says this has allowed the Kremlin to maintain growth in strategic sectors, but at the same time, it has destabilised the economy and sidelined private business and civilian industries.

The report indicates that Moscow will begin cutting defence spending after the war, which could leave millions of people employed in the defence industry without jobs and entire regions reliant on defence enterprises without an economic foundation.

The demobilisation of hundreds of thousands of contract soldiers will also shock the labour market, the Ukrainian foreign intelligence service predicts.

The first half of 2025 saw Moscow’s federal revenues drop nearly 17%, largely due to oil and gas being sold at heavy discounts.

Rising oil and gas revenues will not offset losses. Russia’s finance ministry is forced to raise taxes and introduce new levies, but this only increases pressure on business, the report further notes.

Sanctions and import restrictions on technology are driving the decline of civilian production. Russian companies are forced to produce cheaper and simpler goods, undermining competitiveness and depriving the country of the ability to re-enter global markets with high-tech products.

“Russia has fallen into a military rent trap. The Kremlin cannot reduce military spending drastically without causing a collapse, but keeping the war funded becomes increasingly difficult,” the service concludes.

Foreign Intelligence Service of Ukraine says that a new economic crisis in Russia is inevitable and any recovery will require a long and painful restructuring of the entire system.

Background:

The Russian Ministry of Finance has reported on a new measure designed to protect the state budget from oil price fluctuations and Western sanctions affecting Russian energy exports.The Russian government is considering raising the value-added tax (VAT) rate to curb the budget deficit and preserve reserves.Russia’s economy has more serious problems than is officially acknowledged, and there is a real risk of a systemic banking crisis during the year.

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