The Long-Term Fiscal and Economic Costs of Russia's War on Ukraine

The Russian invasion of Ukraine has triggered a seismic shift in global economic and geopolitical dynamics, with profound implications for both the war-finance model sustaining Moscow's military efforts and the long-term resilience of its economy. As of 2025, Russia's fiscal and economic strategies have entered a precarious phase, characterized by a "guns over butter" prioritization, structural imbalances, and a reliance on external trade partnerships that expose vulnerabilities. For global investors, the sustainability of this model-and its cascading effects on markets-demands rigorous scrutiny.

A War-Finance Model Built on Fragile Foundations

Russia's defense budget for 2023–2025 has been underpinned by a wartime economic model that channels resources into military spending while neglecting civilian sectors. By 2025, defense and security expenditures account for approximately 8% of GDP, with the government employing military Keynesianism to sustain the war effort through direct financial injections into the defense industry and recruitment incentives. This approach has exacerbated an overheated economy, driven by inflation and labor shortages, as the defense sector absorbs resources that could otherwise bolster productivity in agriculture, manufacturing, and energy.

The Central Bank of Russia has attempted to stabilize inflation by raising interest rates to 21%, but this has stifled investment in production capacity, further straining the supply side of the economy. Meanwhile, the government has resorted to domestic borrowing, with Russian banks now the primary buyers of state bonds, to fund deficits that have already exceeded 3.4 trillion rubles in 2025. These measures highlight a fiscal strategy that prioritizes short-term military goals over long-term economic stability, creating a cycle of debt and inflation that risks deepening structural weaknesses.

Sanctions, Trade Shifts, and Asymmetric Dependencies

Western sanctions have not collapsed the Russian economy, but they have forced a strategic pivot toward China and other non-Western partners. China has become Russia's largest trading partner, absorbing Russian oil, gas, and raw materials while supplying machinery and technology. However, this relationship is deeply asymmetrical, with Russia exporting commodities and importing value-added goods-a dynamic that limits its capacity for industrial modernization.

The price cap on Russian oil exports, enforced by the European Union and the United Kingdom, has further constrained revenue streams, pushing Moscow to rely on high energy prices and barter trade to fund its war effort. While this has provided temporary relief, it has also entrenched a model of economic dependence that leaves Russia vulnerable to global commodity price fluctuations and geopolitical shifts.

Structural Constraints and the Path to Stagnation

The Russian economy faces a growing supply-side crisis, marked by labor shortages, declining productivity, and a shrinking tax base. Unemployment has fallen to a historically low 2%, but this reflects a tightening labor market where civilian sectors struggle to compete with the high wages offered in defense-related industries. The government's 2026–2028 budget projects GDP growth at 1.3% annually, yet this optimism is undermined by a projected ruble devaluation to 100–120 per dollar and the depletion of the National Wealth Fund.

Long-term projections paint an even grimmer picture. By 2030, Russia's real GDP is expected to contract by at least 20% compared to pre-war levels, with labor exodus, capital flight, and resource misallocation eroding growth potential. The overreliance on oil and gas revenues, combined with a lack of diversification, has left the economy ill-equipped to adapt to global energy transitions or technological shifts.

Global Investor Responses: Risk Aversion and Strategic Reallocation

Global investors have recalibrated their strategies in response to the war's economic fallout. The Russia-Ukraine conflict has been ranked as the top global risk in 2025, with 23% of respondents in the Global Risks Report citing geopolitical tensions as the most pressing threat. This has led to a risk-averse approach, with capital flowing toward alternative assets such as gold, oil, and cryptocurrencies to hedge against volatility.

Russian outward foreign direct investment has plummeted to 10–30% of pre-crisis levels, as international sanctions and disconnection from SWIFT have curtailed global expansion. Meanwhile, investors are redirecting capital toward the Global South and Commonwealth of Independent States (CIS) markets, reflecting a broader trend of geoeconomic fragmentation. ESG considerations have also gained prominence, with firms demonstrating stronger ESG performance showing less negative stock price reactions during the crisis.

Implications for Long-Term Investment Strategies

For global investors, the sustainability of Russia's war-finance model hinges on three critical factors: the resilience of energy markets, the trajectory of geopolitical alliances, and the ability of the Russian economy to adapt to structural constraints. While the short-term focus remains on managing inflation and stabilizing the ruble, the long-term outlook is one of stagnation or contraction.

Investors must prioritize diversification and resilience in their portfolios, particularly as trade barriers and supply chain disruptions persist. The Russian economy's reliance on military Keynesianism and high-interest-rate policies is unlikely to yield sustainable growth, and the depletion of the National Wealth Fund signals a phase of long-term degradation. Furthermore, the war's fiscal costs-estimated to strain public finances for years-will likely exacerbate inflationary pressures and erode investor confidence.

Conclusion

Russia's war-finance model, while effective in sustaining the conflict in the short term, is economically unsustainable in the long run. The combination of military Keynesianism, sanctions, and structural imbalances has created a fragile economic landscape, with global investors increasingly factoring in geopolitical risks and ESG criteria. As the war's fiscal and economic costs mount, the Russian economy faces a future of stagnation, devaluation, and deepening dependency on asymmetric trade partnerships. For investors, the path forward demands a strategic reevaluation of exposure to conflict-affected markets and a renewed emphasis on diversification and resilience.