Russia's struggling war economy might be what finally drives Moscow to the negotiating table

CNBC

22-05-2025

Russia has shown little appetite for peace negotiations with Ukraine, despite Moscow making a show of what war experts described as "performative ceasefires," and a number of attempts by U.S. President Donald Trump to persuade Russian leader Vladimir Putin to talk to Kyiv.
In fact, Moscow is widely believed to be planning a new summer offensive in Ukraine to consolidate territorial gains in the southern and eastern parts of the country, that its forces partially occupy. If successful, the offensive could give Russia more leverage in any future talks.
While Russia seems reluctant to pursue peace now, increasing economic and military pressures at home — ranging from supplies of military hardware and recruitment of soldiers, to sanctions on revenue-generating exports like oil — could be the factors that eventually drive Moscow to the negotiating table.
"Russia will seek to intensify offensive operations to build pressure during negotiations, but the pressure cannot be sustained indefinitely," Jack Watling, senior research fellow for Land Warfare at the Royal United Services Institute (RUSI) in London, said in analysis Tuesday.
Russian stockpiles of military equipment left over from the Soviet era, including tanks, artillery and infantry fighting vehicles, will be running out between now and mid-fall, Watling said, meaning that Russia's ability to replace losses will be entirely dependent on what it can produce from scratch.
"At the same time, while Russia can fight another two campaign seasons with its current approach to recruitment, further offensive operations into 2026 will likely require further forced mobilisation, which is both politically and economically challenging," Watling surmised.
CNBC has contacted the Kremlin for a response to the comments and is awaiting a reply.
In the meantime, dark clouds are gathering on the horizon when it comes to Russia's war-focused economy, which has labored under the weight of international sanctions as well as homegrown pressures, also largely resulting from war, such as rampant inflation and high food and production costs that even Putin described as "alarming."
Russia's central bank (CBR) has stood the course of keeping interest rates high (at 21%) in a bid to lower the rate of inflation, which stood at 10.2% in April. The CBR said in May that a disinflationary process is underway but that "a prolonged period of tight monetary policy" is still required for inflation to return to its target of 4% in 2026. In the meantime, a marked slowdown in the Russian economy has surprised some economists.
"The sharp slowdown in Russian gross domestic product growth from 4.5% year-on-year in the fourth quarter, to 1.4% in the first quarter is consistent with a sharp fall in output and suggests that the economy may be heading for a much harder landing than we had expected," Liam Peach, senior emerging markets economist at Capital Economics commented last week.
"Such a sharp drop in GDP growth has surprised us, although we had expected a slowdown to take hold this year," he noted, adding that "a technical recession is possible over the first half of the year and GDP growth over 2025 as a whole could come in significantly below our current forecast of 2.5%."
The growth that remains in the Russian economy is concentrated in manufacturing, specifically the defense sector and related industries, and is being fueled by state spending, according to Alexander Kolyandr, senior fellow at the Center for European Policy Analysis.
"After three years of militarizing the country, Russia's economy is cooling," he said in online analysis for CEPA, noting that the slowdown in inflation, less borrowing by companies and consumers, declining imports, industrial output and consumer spending all pointed to the slowdown continuing.
That's not disputed by Russian officials, with the Economic Development Ministry predicting that economic growth will slow from 4.3% in 2024 to 2.5% this year.
"The economy is not demobilizing; it is just running out of steam. That said, a drop can easily become a dive. Bad decisions by policymakers, a further dip in oil prices, or carelessness with inflation, and Russia could find itself in trouble," Kolyandr said.
What's particularly starting to hurt Russia are factors beyond its control, including tighter sanctions on Russia's "shadow fleet" (vessels illicitly transporting oil in a bid to evade sanctions enacted following the 2022 invasion of Ukraine) and a decline in oil prices as a result of Trump's global tariffs policy that is hitting demand.
On Thursday, benchmark Brent futures with a July expiry stood at $64.94 a barrel while frontmonth July U.S. West Texas Intermediate (WTI) crude was at $61.65. The last spot price of a barrel of Urals crude oil, Russia's benchmark, was at $59.97, according to LSEG data.
At the start of 2025, Brent was trading at $74.64 per barrel, while WTI and Urals crude were trading at $75.13 and $70.04, respectively.
Russia's finance ministry said in April that it expects 24% lower revenues from oil and gas this year, compared to earlier estimates, and lowered its oil price forecast from $69.7 to $56 per barrel. The ministry also raised the 2025 budget deficit estimate to 1.7% of GDP, from a previous forecast of 0.5%.
A lower oil price will "severely limit Russian revenue while its reserves are becoming depleted," RUSI's analyst Watling remarked.
"More aggressive enforcement against Russia's shadow fleet and the continuation of Ukraine's deep strike campaign could reduce the liquid capital that has so far allowed Russia to steadily increase defence production and offer massive bonuses for volunteers joining the military," he said.
If Western allies can maintain and strengthen efforts to degrade Russia's economy, and Ukraine's forces "deny Russia from reaching the borders of Donetsk [in eastern Ukraine] between now and Christmas," then "Moscow will face hard choices about the costs it is prepared to incur for continuing the war."
"Under such conditions the Russians may move from Potemkin negotiations to actually negotiating," Watling said.