Today we go into the fifth year of the Ukraine war which has now been going on longer than the Second World War ( 3 years and 11 months).

Ukrainian President Volodymyr Zelenskiy just gave an address to the European Parliament this morning thanking them for their ongoing support and calling for that support to continue for the protection of Europe's ideals and its democracy. He got a standing ovation and there's no doubt that Europe wants to see him triumph. However, today it's appropriate to look back and reflect on what's been done so far. And what jumps out at me is the support has been sufficient to keep Ukraine in the battle to everyone's surprise. Despite its size and power Russia has only managed to capture just under 20% of Ukrainian territory. However, the prospect of a military victory remains as far away as ever by design and some collosal blunders have been made that has left tens of thousands of brave soldiers dead in the muddy wheat fields of the Donbas.

The EU is supposed to be debating the passage of the 20th package of sanctions on Russia but as we reported it is in total disarray. Coupled to that is major mistakes that have been made of which the biggest was for the EU to continue to pay Russia for its oil and gas imports in the first year of the war. That handed Russia hundreds of billions of euros it desperately needed in order to prevent its economy from collapsing.

Contrast that with the rhetoric of the last few days about tightening the sanctions and focusing on the oil revenue on the assumption if Europe can only do a little bit more than the Putin regime will fold giving Ukraine a victory.

Running through the policy throughout the last four years and Europe in particular has been compromised between its desire to see Ukraine defeat Russia and catering to his own self interests. Nowhere is this more glaringly obvious than the decision to pay Russia for energy in 2022 when prices spiked. Brussels should have either refused to pay and faced an energy crisis of its own or at least put the money in an escrow account that would be released at the end of the war. Now it’s too late. Russia has remade its energy logistics and has replaced European customers with new ones in Asia.

A country that has both low debt (20% of GDP or around $300bn) and runs a current account surplus is almost impossible to sanction as it doesn’t need to tap the global financial system. Russia has been able to almost entirely fund its war using just internal resources. And in 2022, thanks to the energy crisis, it made twice as much money as in any year since 1991 – some $225bn. Ukraine, by contrast, depends on external funding for half its budget, a key vulnerability as the touch-and-go debate over the Reparation Loan in December and the uncertain status of a new IMF programme show.

The same is true of the sanctions regime which is riddled with exceptions and carve outs, Today the glaring example is Greece and Malta's refusal to approve the 20th sanctions package to protect European business interests, which would ban them from carrying Russian oil. The fact that EU flagged and regulated tankers are a core part of the shadow fleet is truly shocking and highlights the double standards that have left Ukraine in an impossible position. Hungary and Slovakia are also not playing ball, by threatening to cut off power exports to Ukraine unless it turns their supplies of Russian oil and gas on again.

Of course, Zelenskiy can't complain because he needs that support, otherwise he would have faced defeat within weeks but at the same time I'm amazed that he hasn't lost his temper and called Europe out for its hypocrisy.

The military support has also been marred by similar self-serving blunders. Following the astonishingly successful Kharkiv offensive in 2022 when the Armed Forces of Ukraine (AFU) smashed through Russian lines and took back hundreds of square kilometres of territory, the West dithered for a year before resupplying them giving Russia ample time to build extensive defences that rebuffed the 2023 summer offensive and resulted in stalemate from which the AFU has never recovered. This was a result of the West’s “escalation management” strategy which boils down to “some, but not enough” support to ensure the AFU do not lose the war, but are not given enough support to actually win.

The standard Western military strategy is “shock and awe” – go in with overwhelming force to ensure a short war with minimum casualties. The combined US death toll in the Afghan, Iraq and Libyan wars was a little more than 7,000 men, despite having a combined duration of 40 years – ten times the duration of WWII. The policies adopted to support Ukraine appear to be diametrically opposite: prolong the war as long as possible and maximise the casualty rate, not minimise it.

All of this has contributed to the decline of Europe, as detailed in the Draghi report, as its value-based system has been shown up as being little more than a veneer for Europe’s mercantile interest in maintaining its economic prosperity and protecting its own markets. Now in the face of adversity and accelerating deindustrialisation it is increasingly in crisis. The chronic lack of investments into both defence and innovation has led to it falling further and further behind both the US and China – a process catalysed by the enormous drain in resources from supporting Ukraine.

Where does Ukraine stand in this? Zelenskiy again just asked the parliament to set a concrete date for Ukraine's accession to the EU. Trump has suggested 2027 and as I have said repeatedly despite Europe's problems, from Ukraine's perspective nothing could be better. Every country that has joined the EU since 2003 has flourished.

Russia's economy in the “death zone”

Predictably as the anniversary passes there's been a round of pieces highlighting the economic problems that Russia faces. Alexandra Prokopenko, a political economy analyst, hit a home run with her Economist column about Russia entering the “death zone” where despite the fact she admits there is no crisis around the corner she argues that Russia is consuming resources faster than it can produce them and will eventually die, like a mountaineer trapped above 8,000m.

There's been a whole raft of these articles, and they all make valid points. Russia's economy is hurting but pointedly there's been no parallel pieces about the state of the Ukrainian economy. bne IntelliNews published a side-by-side comparison of the Ukrainian and Russian budgets last September and more recently how the Ukrainian economy is starting to shut down due to the lack of power and resources.

Ukraine's economy looks in far worse shape than Russia's. Another detail that's being skipped over is the IMF program worth about $8bn has not been approved yet and if it fails to pass then Ukraine still faces a macroeconomic collapse in April.

This war needs to stop. The talks in Geneva which resumed this week need to come to a conclusion. That can only be done with a face-to-face meeting between Zelenskiy and Putin which happily has been proposed to happen in Geneva and will need to happen before mid-May when Trump's deadlines for both a referendum and presidential election come up.

There is no guarantee of a deal. If the talks fail, thanks to the €90bn EU loan, Zelenskiy has the option of fighting on for another two years. But as I pointed out before that would only exacerbate what already is the worst demographic crisis in the world and jeopardise Ukraine’s long-term recovery.

All the talk of Russia’s looming economic collapse if only it can be cut off from its oil revenues is another mistake made by EU policy makers. They are focusing on the wrong tax.

While energy exports were key to the Russian economy at the start of the war, that is no longer true. The reality is that some 80% of Russian budget revenue is now earned from non-oil and gas exports with VAT accounting for half of that. The sales tax the government earns from every bottle of vodka sold in a Moscow kiosk earns it more money than each barrel of Urals blend shipped to India. And of course you can’t sanction vodka bottle sales.

The two-percentage point hike to the VAT rate in January bringing it to a still pretty pedestrian 22% rate will go a long way to funding the expected budget deficit this year.

“Energy exports have supported tax revenues, limiting the size of the federal budget deficit and the need for even larger tax increases to sustain the war effort. Russia’s total exports are still running at more than $450bn per year,” Liam Peach, the senior emerging market economist with Capital Economics said in a paper today.

Four years on and oil revenues are falling and that does cause pain however the Ministry of Finance has had plenty of time to readjust and has put through root and branch reforms in order to improve tax revenues. Before the war, Prime Minister Mikhail Mishustin implemented what can only be described as a revolution at the tax service. The tax burden has only gone up by 2% but the tax take has expanded a whopping 20%. Few are talking about the root and branch reforms to improve budget spending efficiency and the drive to stamp out the corruption and schemes that plagued the service pre-war. Russia's economy has become far more resilient than most commentators are prepared to admit.

That's not to say sanctions have not done their damage - they have. Nevertheless, thanks to the liquidity in the banking sector the Kremlin has been able to fund its budget purely from domestic borrowing.

"The key issue in our view is that sanctions have not sufficiently targeted the core of Russia’s economy: its energy sector. Nonetheless, sanctions have reduced Russia’s access to advanced technology and weighed on its potential growth,” says Peach.

So, the twentieth sanctions package plan to just tighten sanctions a little more in order to hit the oil revenues is becoming increasingly irrelevant as each year passes. The Kremlin is less and less reliant on oil revenue to pay for anything and the Ministry of Finance (MinFin) itself is planning to adjust the budget, so the country runs with oil and gas revenues contributing only 15% of total revenues.

Another way of looking at just how big a problem the falling oil and gas revenues are is to look at the non-oil and gas deficit – the deficit the budget would actually have if you magically made all the hydrocarbons disappear.

Russia’s non-oil and gas federal budget deficit has widened markedly since the invasion of Ukraine and is now running at roughly 7–8% of GDP in 2024–2025. Before the war, the gap was significantly smaller, averaging around 4–5% of GDP between 2019 and 2021. In other words, the Kremlin used the oil revenues to subsidies the economy which is why taxes are so low and the economy boomed in the noughties.

However, even 8% of GDP is not excessive. The NOGD’s historical peak was reached during Great Financial Crisis, when the non-oil deficit ballooned to approximately 13–14% of GDP in 2009 following the collapse in oil prices and aggressive counter-cyclical spending. In other words, the US sub-prime financial crisis cost Russia a lot more money than the war in Ukraine has done. Likewise, the 2020 pandemic saw the NOGD blow out to 9% of GDP, which was also more expensive than the Ukraine war.

Another point gleefully reported is the end of the military Keynesianism boost. GDP growth accelerated to 4-5% p.a. over 2023-24, driven in large part by the war effort. The economy is now 8% larger than it was in 2021. By comparison, Ukraine’s economy shrank by 21% in 2025 as its own military Keynesianism effect wore off.

Russia’s military spending fuelled expansion phase is exhausted and the economy has moved into a period of stagnation, according to CBR governor Elvia Nabiullina. Household incomes and consumption are still growing strongly, but that will soon change and investment is already contracting outright, according to Capital Economics. A period of GDP growth at or below 1.0% lies ahead.

But the commentary misses that this recession was induced by the Central Bank of Russia (CBR) on purpose. Nabiullina stamped on credits and growth in an unorthodox experiment to bring down sticky inflation of over 10%.

She has been trying to soft land a Russian cargo plane where the throttle of military spending is stuck on full. She decided to do that by landing the plane without putting the landing gear down. It was always going to be messy. But so far, it's working. Last year inflation fell faster than expected allowing the CBR to put through 500bp of rate cuts adding another surprise 50bp in February. From a monetary policy point of view, Russia’s economy has already passed its nadir. The race is now on between the rate of the fall in inflation and cutting the central bank’s policy rate in order to reboot growth. But if Nabiullina gets it wrong then recession or even stagnation looms.

Quality of life

Another point missed by most commentators is that the last four years have been amongst the most prosperous and pleasant for most Russians since 1991. A new war middle class emerged, while studies found that Russia’s poorest regions have been the biggest winners from the war, partially undoing the massive inequality.

Since Putin launched the modernisation of the military in 2012 the Kremlin has in effect been running an austerity budget. Real incomes have stagnated since 2014 despite the massive accumulation of reserves thanks to booming oil exports. That all changed in 2022 when the Kremlin turned on the spending spigots and poured its accumulated cash into the economy in a reversal of Putinomics. Real incomes soared leading to a consumption boom that is only just starting to stall. But with unemployment at an all-time low of 2.2%, everyone has a job, is getting paid, and are largely insulated from the war in the south.

The pain of the war is finally starting to make itself felt on the streets of Russia’s millionkii as the central bank-induced-recession makes itself felt, but even this pain is mild.

"The more striking feature of the war economy has been the strength of Russian household spending. Since 2021, real GDP has risen by 8%, while private consumption has risen by 17% and households’ real disposable incomes are up by 30%. This ended the long period of stagnation in households’ real incomes that took hold from 2014,” says Peach.

Vulnerabilities

In addition to the kinetic war in Ukraine, there is an economic war raging between Russia, Ukraine and the West, but here Russia clearly has the advantage for now. But that is not to say Russia faces no risks.

The central bank itself has identified banking credit risk as the primary macroeconomic threat facing the economy. Russia’s banks have become the shock absorber of the war economy – funding corporates, absorbing sovereign issuance and intermediating state-directed capital – and are therefore key for macro stability.

As the economy slows, credits are starting to go bad and the sky high interest rates are bleeding companies of cash, as Vedomosti reported in an article on Russia’s 13 drowning men. Overall, non-performing loans (NPLs) remain at acceptable levels, but long-term bad debt could turn into a serious problem, undermining the stability of the banking sector. Nabiullina has already ordered the banks to recapitalise in preparation of problems.

The next vulnerability is fiscal. Energy tax revenues declined by 24% last year (taking them from 5.5% of GDP in 2024 to 4.0%). This reflects lower energy prices and a stronger (which reduces the local-currency value of receipts). Meanwhile, spending remained elevated due to the war effort.

As mentioned above, the government has sufficient revenues to pay for the war for now, but as it is relying heavily on domestic OFZ treasury bond issues to finance the war, the cost of the coupon payments is starting to become uncomfortably high.

“The biggest issue is financing cost and crowding out. If Russia continues to issue debt at this pace, it will become increasingly difficult for banks to absorb this supply without the government facing prohibitively high debt servicing costs,” says Peach.

By Capital Economics estimates, each 5% fall in energy tax revenues relative to 2025 will widen the budget deficit by 0.2-0.3% of GDP. A reasonable baseline is that energy tax revenues fall further by around 20% this year, taking energy revenues down to 3.2% of GDP and adding a percentage point to the deficit which will have to be covered by additional OFZ issues. Still, this is a slow moving train wreck and Russia still has sufficient buffers to soldier on for at least two years, according to the experts.

"Will economic pressure end the war? We don’t think so, largely because Russia’s economy is not yet at the pain thresholds that would likely force President Putin to change tack,” says Peach.

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