Russia’s Shadow Economy Funds Military Spending
Russia is financing its record military spending through a hidden strategy that poses a major risk to its economy, according to a new analysis. Craig Kennedy, a former Morgan Stanley investment banker, described how Russian banks are being forced to provide preferential loans to military-related businesses, artificially sustaining President Vladimir Putin’s war effort in Ukraine.
Kennedy argues that this off-budget financing misleads experts into believing that Russia’s economy can sustain record defense expenditures without major consequences.
Economic Risks and Hidden Costs
Despite tough Western sanctions, Russian state media projects GDP growth of 2.5% in 2025. However, the country is battling:
- Inflation at 8.9%, worsened by a labor shortage.
- A record defense budget of $126 billion, making up 32.5% of total government spending for 2025.
- A skyrocketing key interest rate of 21%, which makes borrowing more expensive.
Kennedy’s analysis warns that Russia’s corporate and banking sectors face a growing risk of collapse due to unsustainable war financing. If Western allies maintain strong financial and military support for Ukraine, they could potentially outlast Russia’s ability to sustain the war.
How Russia is Funding Its War
According to Kennedy, Russia has adopted a dual strategy for war financing:
- Traditional defense budget expenditures.
- Off-budget financing, enabled by a 2022 law that forces Russian banks to provide low-interest loans to military contractors.
Between 2022 and 2024, corporate debt expanded by 71%, reaching $415 billion (19.4% of GDP)—a figure higher than Russia’s oil and gas revenues and defense budget expenditures combined.
Kennedy’s analysis suggests that Russia’s true war costs “far exceed” official government spending figures.
Warning Signs of a Financial Crisis
By late 2024, Russia’s off-budget defense funding triggered:
- Spiking inflation, making everyday goods more expensive.
- Higher borrowing costs, with interest rates surpassing 21% for non-defense sectors.
- A looming credit crisis, as banks face increasing risks of corporate defaults.
Putin’s forced lending strategy is propping up the war economy, but at a cost. Many military contractors receiving loans have poor credit ratings, creating risks for wider financial instability.
Experts Sound the Alarm
Kennedy describes Russia’s war financing as a “seismically disruptive” threat, warning that a credit crisis could be an immediate concern for Moscow.
“For Moscow, credit event risk—with its seismically disruptive potential—will be of far more immediate concern than slow-burn risks like declining GDP,” he said.
The Financial Times echoed these concerns, stating that Putin is sitting on a ticking financial time bomb of his own making.
Will Russia’s Economy Collapse?
Economist Igor Lipsits predicts that Russia’s financial turmoil will intensify in 2025:
- Fewer goods and services due to high borrowing costs.
- Higher retail prices, cutting into household incomes.
- A decline in real wages, worsening economic hardship for Russians.
Meanwhile, Vasily Astrov, an economist at the Vienna Institute for International Economic Studies, suggested that financial risks could be controlled if interest rates remain stable.
However, with 21% interest rates—the highest since the war began—Russia’s financial system remains under immense strain.
What Happens Next?
Putin’s economic strategy may allow Russia to sustain military spending in the short term, but continued inflation, high interest rates, and growing corporate debt suggest the long-term economic outlook is increasingly fragile.
Western allies are likely to intensify economic pressure on Russia by restricting its access to foreign capital. Meanwhile, Ukraine and its supporters will aim to outlast Russia’s war economy, potentially forcing Moscow into deeper economic turmoil.