Russian economy meltdown as tax rises loom and pensioners to be hammered by inflation

Russia's government is preparing to hike taxes and cut spending in a bid to maintain its high expenditure on defence. The country's economy is showing significant strains as the Kremlin struggles to finance its war in Ukraine, which has dragged on for over three years.

Falling oil and gas prices are exacerbating a budget deficit that is threatening to spiral out of control, as the economy cools - prompting some to warn of an imminent recession. The shortfall in government finances has grown to 4.9 trillion roubles (roughly £45.2 billion), suggesting Russia will struggle to fulfil its current obligations and keep financing the war at its current pace. Budget spending has almost doubled in nominal terms since Russia's full-scale invasion of Ukraine in February 2022.

The massive injection of cash has fuelled economic growth, but helped drive inflation and forced the central bank to hike rates to as high as 21%. This has made it much more expensive for companies to secure loans and credit from financial institutions.

Government spending on both defence and national security this year stands at 17 trillion roubles (£156bn). It represents the highest level since the Cold War, accounting for 41% of total spending, making the Russian economy increasingly dependent on the defence sector for growth.

Officials expect the new budget for next year to allocate even more funds to defence, despite Vladimir Putin saying he expected a reduction in military spending.

"Even with a ceasefire, shells and drones will still need to be made, but on a slightly smaller scale," a Kremlin source told Reuters. "There will be no return to the level that existed before the 'special military operation'," the person added.

One option to raise more funds is to reduce non-defence spending by two trillion roubles each year until 2028 and redirect those savings to the defence budget, according to Anatoly Artamonov - the head of the upper house of parliament's budget committee.

Russians can expect to see a decline in public services, as money is redirected to the military. Sergei Aleksashenko, a former deputy governor of Russia's central bank, noted that 2025 is the first year when total education and healthcare expenditure at the federal and regional level is noticeably decreasing as a share of GDP.

He added he expected the Kremlin to save money by indexing expenditure on things like pensions below the inflation rate, which is forecast to be between 6 -7% this year.

The economic outlook looks increasingly bleak, with experts predicting an extended period of sluggish growth.

Liam Peach, senior emerging markets economist at Capital Economics, warned: "Russia's economy is struggling under the weight of high interest rates and the ongoing war effort. A prolonged period of weak growth lies in store."