The Russian economy is on the brink of collapse and Putin needs a deal more than ever (2025)

How close is Russia’s economy to collapse? As Donald Trump’s negotiators open direct talks with the Kremlin, Kyiv’s European allies hope that a final push on sanctions against Russia could be Ukraine’s last – and best – hope of victory. Mr Trump has warned that the US could impose a “devastating” financial blow on Russia if Putin refuses to accept the ceasefire agreement. “There are things you can do that wouldn’t be pleasant in a financial sense. I can do things financially,” he said in the Oval Office.

Putin intended his full-scale invasion of Ukraine to be a three-day operation that would force regime change in Kyiv. Neither Putin nor his military or economic planners anticipated a grinding war that now soaks up over 40 per cent of Kremlin spending.

Nor did they expect Europe to impose serious sanctions, and even less did they anticipate the destruction of three of the four Gazprom gas pipelines under the Baltic Sea that before the war supplied over 30 per cent of Europe’s gas.

The result in Russia has been rampant inflation, currently running at over 9 per cent, crippling interest rates of 21 per cent and runaway price hikes on staple goods that far outpace the headline inflation rate and have hit ordinary Russians hard.

Last summer the price of eggs jumped by 42 per cent, bananas by 48 per cent, tomatoes by 39.5 per cent and potatoes by 25 per cent. The Russian ruble has lost over half of its value since Putin first invaded Crimea in 2014, and over $600bn of the Kremlin’s foreign currency reserves have been frozen in Western banks.

More than 1,000 Western businesses – including Ikea and McDonald’s – pulled out, as did Western car manufacturers. Imports of Western goods – especially technology – are now expensively routed through sanctions-busting neighbours like Kazakhstan and Georgia. And last month Russian utility companies hiked prices for electricity by up to 250 per cent.

“Everyone drives Chinese cars these days, but there are no spare parts,” says Alexandra, 39, a former journalist who lives in Moscow and whose ex-husband is fighting in Ukraine. “The only foreign cars you buy are right-hand-drive [from Japan]. Anyone with a mortgage is paying crazy interest. People complain how expensive everything has become.”

Russia spent more on its military in 2024 than the rest of Europe combined, according to the International Institute for Strategic Studies’ latest Military Balance report – a staggering $462bn, if adjusted for purchasing power. The Kremlin’s spending splurge on its war effort has produced some winners, notably the 1.5 million troops currently serving in Putin’s army who are paid up to $2,500 a month to fight – four times the average salary in Russia’s most impoverished provinces.

Massive losses on the battlefield have worsened labour shortages, with a record-low unemployment rate of 2.4 per cent. Factories are running at capacity and beyond. Russia’s economy has “reached the limits of its productive capacity while demand continues to be stimulated,” Central Bank chief Elvira Nabiullina warned the Russian parliament in November, predicting a fatal combination of economic stagnation and inflation known as “stagflation”.

For the first three years of the war, the Kremlin’s war spending fuelled GDP growth which peaked at a staggering 5.4 per cent in early 2024. But 2025 will be the year that growth flatlines, experts predict.

The Kremlin has been able to afford its spending spree thanks, mostly, to India and China, which have continued to import Russian oil in record quantities. The EU has in theory capped the price that customers can pay for Russian Urals crude at $60 a barrel – somewhat below the current market price of $67. But so-called “attestation fraud” – such as making up the difference in fake transportation and other costs – makes the rules easy to bend.

Natural gas has never been sanctioned by the EU at all – and until 1 January of this year, 13 per cent of Europe’s piped gas was still being shipped from Russia through Ukrainian pipelines to Slovakia and Hungary.

Southern Europe continues to import millions of cubic meters of Russian gas via Turkey. And despite its posturing, Europe still sources more than 15 per cent of its liquefied natural gas or LNG from Russia – with some 17.8m tonnes of LNG docking in European ports in 2024, up by more than 2 million tonnes from the year before, according to analysts Rystad Energy.

In fact the only really effective “sanctions” on the Russian energy sector – which accounts for over two-thirds of government revenues – have been in the form of Ukrainian drone attacks on Russian oil refineries, pumping stations and storage facilities. Ukrainian fire and fury are currently doing damage to Russia’s war economy that European “sanctions” have failed to achieve.

International pressure has made it harder, but not impossible, for the Russian war machine to obtain important components such as semiconductors. And sanctions have certainly “achieved the crucial goal of leaving Russia’s economy highly unstable in the medium to long term”, according to Oliver Ruth of London’s Royal United Services Institute.

The current crazy levels of expenditure are unsustainable, so Putin has a strong economic incentive to bring his war to an end. Ukraine’s economy is also under attack.

But on the flip side, even as Russia’s economy slips into stagflation Ukraine’s economy is doing far worse. Concerted Russian assaults, damage to vital energy infrastructure and mass emigration have inflicted catastrophic damage of up to 40 per cent of the country’s pre-war GDP. Kyiv’s budget payments to millions of soldiers and state employees are currently being paid by the EU. Without those subsidies – the lion’s share of the €60bn in direct financial support so far sent by Brussels – Ukraine’s government finances would instantly collapse.

Ukraine’s European allies hoped that sanctions would force Putin into taking an early off ramp and bring his economy crashing down. That hasn’t yet happened yet – largely because Europe has been unable to kick its addiction to Russian gas, and the US did not want to risk a global oil price spike by cutting off Russian exports.

But while they have not brought Putin to his knees, they have made the war disastrous for Russia. As Moscow and Washington begin talks in Riyadh, and European leaders hold their own emergency meeting, keeping up economic pressure on Putin is the real weapon that they still have left in their arsenal.