Russia's Hidden War Debt (full report)
Moscow has been discreetly funding heavy war costs with risky, off-budget debt. But the scheme has caused major problems—with more likely to follow—offering useful leverage to Ukraine and its allies.
Working Draft
This report identifies a new dimension of Russia’s war-funding strategy: a heavy reliance on off-budget debt to supplement its defense budget allocations. Excessive reliance on this off-budget funding strategy has elevated Russia’s systemic credit risk to a point that it is constraining the Kremlin’s war finances and could weigh on it war calculus.
Summary
Moscow has been stealthily pursuing a dual-track strategy to fund its mounting war costs. One track consists of Russia’s highly scrutinized defense budget, which analysts have routinely deemed “surprisingly resilient.” The second track—largely overlooked until now—consists of a low-profile, off-budget financing scheme that appears to make up a major portion of Russia’s overall war expenditures. Under legislation enacted in February 2022, the state has taken control of war-related lending at Russia’s major banks. It is directing them to extend preferential loans—on terms set by the state—to a wide range of businesses providing goods and services for the war. Since mid-2022, this state-directed war-funding scheme has helped drive a large part of Russia’s anomalous ₽36.6 trn ($446 bln) surge in overall corporate borrowing.
Initially, this off-budget war-funding scheme proved advantageous to Moscow by helping limit defense spending in the budget to levels that are easily managed. That misled budget-watchers into concluding—incorrectly as it turns out—that Moscow faces no serious risks to its ability to sustain funding for its war on Ukraine. More recently, however, Moscow’s heavy reliance on state-directed preferential lending has begun to cause serious, adverse consequences at home. It has become the main driver of Russia’s 10% inflation and has sent the Central Bank’s key rate to a record 21%.
More broadly, Russia’s off-budget war debt is significantly elevating systemic credit risk, both for the near- and medium-term. High interest rates are driving up corporate distress levels in the “real” economy and raising fears of widespread bankruptcies. The Central Bank has voiced concern over “aggressive” lending and inadequate capital buffers in the banking industry. What’s more, the state has now saddled the banks with large amounts of problematic, corporate war loans. Many could turn toxic once the shooting stops and defense contracts get cancelled. Worse still, relaxed oversight rules on defense-related loans mean bank regulators might not see these problems arising until it’s too late.
By late 2024, the Kremlin had been briefed on these rising risks and warned that change is needed. This poses a dilemma for Putin: continue relying on off-budget debt, and you further increase the risk of cascading credit events that undermine Russia’s image of “surprising resilience” and weaken its negotiating leverage. The alternatives: a major increase in the budget deficit—with the bad optics that entails—or a sharp reduction in spending on the war. This may explain Putin’s recent complaint to his generals that they can’t “keep pumping up spending to infinity.”
These new developments are likely to affect Moscow’s war calculus in two ways:
Moscow will be less inclined to believe time is on its side—the longer it must fund elevated war costs, the greater the risk of escalating credit events;
Moscow will prioritize sanctions relief aimed at boosting cashflows to help with politically perilous post-war debt restructuring and rearmament. Concessions that would provide the greatest cashflow relief include (i) an easing of oil sanctions, (ii) the resumption of pipeline gas deliveries to Europe and (iii) the unfreezing of Russia’s wealth fund.
Given Russia’s financial challenges, maintaining these constraints on Russia’s cashflows insures Ukraine and its allies retain substantial leverage. If kept in place past a ceasefire, they could be instrumental in securing a final, comprehensive peace settlement—including reparations.
About the author
The author worked for many years as an investment banker at Morgan Stanley and Bank of America Merrill Lynch, where he was a vice chairman. During his banking career, he advised companies and governments around the world and led numerous financings, including Russia’s largest ever corporate transaction. He received an undergraduate degree in Russian studies and a doctorate in Russian and Middle Eastern history from Harvard and a masters in Middle Eastern languages from Oxford, where he was a Rhodes Scholar. Currently, he conducts research on Russia’s energy economy at Harvard’s Davis Center and is writing a history of the Russian oil industry and its impact on civil society. He also is the author of the Substack Navigating Russia.
Table of Contents
Introduction: In Search of Russia’s War Debt
Chapter 1: Russia’s Anomalous Corporate Credit Surge
Chapter 2: The Relentless Driver of the Credit Surge—State-Directed, Preferential Bank Loans
Chapter 3: How the Kremlin Seized Control of Defense-Related Bank Lending
Chapter 4: How Big is Russia’s Off-Budget War Debt? A Broad Estimate
Chapter 6: A New Threat on the Kremlin’s Radar—Credit Event Risk
Conclusion: Bonfire of the Cashflows
Appendix 1: Credit Surge Raw Data
Appendix 2: Russia’s Evolving Business of War. Identifying War-related OKVED2 Industrial Sectors
Introduction: In Search of Russia’s War Debt
“We have no limits whatsoever on financing. The country and the government will provide everything the army asks for, everything.”
—Vladimir Putin addressing the Ministry of Defense, December 21, 20221
“We cannot keep pumping up [defense] expenditures to infinity, increasing them without limit.”
—Vladimir Putin addressing the Ministry of Defense, December 16, 20242
Where is Russia’s war debt? Burdened by sanctions and showing only modest revenue growth, how is the Russian state paying for Europe’s largest war in 75 years while borrowing so little?
Where is Russia’s war debt? That is one of the puzzles of Russia’s full-scale invasion of Ukraine. Large wars normally go hand in glove with heavy state borrowing. Indeed, Western banking arose in part to help states pay for increasingly expensive wars.
And yet, Russia—despite waging Europe’s largest war in 75 years—appears to be paying nearly all its war costs out of pocket, from current tax revenues. At least that’s the impression one gets on initial inspection of the numbers. Federal budget deficits have been remarkably modest—under 2% of GDP in 2023 and 2024. So too has the state borrowing used to cover them. At the same time, Moscow’s budget revenues have grown very little in real terms since 2021. And sanctions have denied Russia access to most of its sovereign savings.
So, how, then, is Moscow covering the extraordinary costs of what looks to be a very expensive war? Where is the money coming from? Even the Soviet Union imposed war bonds on the public. Where are Russia’s “Special Military Operation” bonds?
Western analysis of Russia’s war finances often focuses too narrowly on the federal budget, overlooking a large “off-budget” component in Russia’s war-funding strategy.
Close observers of Russia’s budget will be quick to respond that the defense part of the budget has been growing much faster than the budget itself, thus boosting funding for the war. That observation is undeniably true. But it also illustrates a methodological problem in how we have been analyzing Russia’s war finances. We have been laboring under the assumption that the Kremlin runs all revenues and costs for the war through the federal budget. Consequently, all matters are viewed through the lens of the budget, and all questions are answered with reference to the budget. For example, when we ask “where is Russia’s war debt?” the answer comes back “there’s no substantial new debt in the budget, so it must not exist.”
But is it reasonable to limit ourselves to the budget when assessing Russia’s war finances? After all, any IMF official3 or scholar of state capitalism4 will tell you, the boundary between public finances and private markets is often blurred. Almost every state transgresses this boundary from time to time to direct private capital towards political priorities. Some, however, do it more frequently than others.
Examining relevant financial evidence outside the budget changes our picture of Russia’s war funding strategy and the risks around it.
Why should we think Russia—no stranger to transgressing boundaries—is any different? Why should we assume the Putin regime—facing its most costly and risk laden crisis ever—is scrupulously observing the boundary between Russia’s budget finances and the private capital markets? Perhaps it’s time to set aside these presuppositions and look at the relevant data with fresh eyes.
That is what this report aims to do: to take a fresh look at Russia’s war-funding strategy by broadening the scope of analysis beyond the budget. And once we do that, we begin find data and other evidence showing that Russia’s elusive war debt does, in fact, exist. Indeed, it appears to be quite substantial. It’s simply not sitting on the government’s balance sheet, where you’d normally look for it. Instead, it’s somewhere unexpected, lightly camouflaged, but otherwise hiding in plain sight.
The three key conclusions of this report
Based on analysis of this extra-budgetary data and evidence, this report draws three key conclusions:
1) the Russian state has been drawing discreetly but heavily on financial resources from outside the budget to fund its war effort; this “off-budget” funding strategy is a material part of its overall war-funding strategy;
2) Moscow’s off-budget strategy suffers from serious structural flaws; its overuse has elevated systemic risks in the economy, especially credit event risk;
3) By Q4 2024, senior figures in Moscow had begun recognizing the risks posed by their off-budget funding strategy; they now face a funding dilemma that could weigh on their war calculus.
The Kremlin’s strategy for dealing with the cash crisis at Gazprom offers insights into its off-budget strategy for funding its war costs: raise cash by borrowing in the corporate debt markets.
A confession. When I first stumbled across evidence of Russia’s missing war debt, it was quite by accident. I was investigating a different, but related, debt puzzle: how the Kremlin was dealing with the dual funding crises it had inflicted on Gazprom, its largest taxpayer.
After the Kremlin crippled Gazprom’s core business—exports to Europe—the company’s once mighty gas division was hemorrhaging cash. Those losses, in turn, threatened to trigger a debt service crisis. Gazprom is one of the world’s largest corporate borrowers. At the end of 2023, it was laboring under an estimated gross debt of some $80 billion, based on its IFRS accounts. With most of its European revenues gone and its domestic business apparently losing money, how would Gazprom manage its towering debt load?
As Russia’s most strategically important company, Gazprom’s cash problems were not only a challenge for management, but for the government as well, which owns a controlling stake in the business. My question was: how would the state respond to this funding crisis? Would it liberalize domestic gas prices? No—that’s way too inflationary and risked social unrest. Would it cut the gas giant’s taxes? No—the federal budget was already running a deficit.
Instead, the government’s solution was more radical: have Gazprom do something that’s rarely advisable for a debt-laden company with a structural cashflow deficit—borrow more money. And that’s exactly what the company did—and at record high interest rates. Since late 2022, the group has issued nearly 40 separate ruble bonds in Russia’s local markets raising ₽1.4 trillion ($15.8 bn). By late 2024, its borrowing costs had topped an eyewatering 22%. By comparison, as recently as November 2021, Gazprom had borrowed in the London markets with a razor thin coupon of just 1.85%.
The state is pragmatically, but recklessly, using Russia’s credit markets to channel money quickly where it’s needed, but with little apparent regard to how that debt gets repaid.
Gazprom’s slow-motion cashflow trainwreck is still playing out. But that’s a story for another day.
It does, however, bear on this report in two important ways. First, it reveals one of the strategies the Kremlin is using to address emergency funding needs in the teeth of a crisis. If a company needs funding quickly, as Gazprom did, the state has the company raise that cash in the corporate credit markets. For a sophisticated borrower like Gazprom, that can be done through the bond market. But it can also be done through Russia’s much larger corporate bank loan markets as well.
When you think about it, that’s a pragmatic funding strategy for the state: the corporate credit markets are Russia’s deepest, most liquid pools of readily investable capital. Money can be raised fast and at scale. And the government doesn’t have to mess around with adjustments to the federal budget or amendments to the tax code. If a strategically important company like Gazprom is short on cash, just find someone who will lend it to them.
But this can be a reckless strategy, too. Especially if it prioritizes political expedience over commercial concerns like the borrower’s credit quality and liquidity profile. Bank credit committees and regulators are there to reduce the risk of imprudent lending. Politically directed lending, however, often dispenses with these safeguards.
Russian markets keep lending heavily to a troubled Gazprom—₽1.4 trillion ($15.8 bn) and counting—because they see it as “too big to fail.” It’s just thinly veiled government debt.
Based solely on Gazprom’s deteriorating credit statistics, a sober credit committee might think twice before lending to the cash strapped company. But for special companies like Gazprom, creditworthiness isn’t just the sum of its cashflows—intangible factors also come into play. As Russia’s most strategically important company and a quasi-sovereign borrower, it’s the quintessence of “too big to fail.” And that’s pretty much what the Russian credit rating agencies have been saying in their reports when explaining their AAA rating for Gazprom’s ruble bond: ignore the company’s fundamentals—the state will never let this company go under.5 And this explains why the markets keep taking up new Gazprom issuances: in their eyes, it’s just thinly veiled government debt.
The state, in effect, is imposing losses at Gazprom by making it to supply the Russian market at deeply discounted prices, and then having the company cover those losses borrow heavily in the market. Meanwhile, the market is willing to lend because it believes the state will bail out Gazprom if it gets into trouble.
In the short term, that’s a nice outcome for the government. It spares the government the burden of having to raise debt or taxes to subsidize Russian gas prices. So, to all outward appearance, the state appears unfazed by the steep decline of its one-time national champion. In reality, there’s plenty of lending happening against the state’s credit; we just don’t see it, because it’s all on Gazprom’s balance sheet. But sooner or later there will be a reckoning—Gazprom can’t finance losses with debt forever. And when that happens, the state (and the taxpayers) will have to pay the bill—unless, of course, large-scale sales to Europe resume…
It’s not just Gazprom borrowing aggressively. There’s been an anomalous and large 71% surge in corporate debt since mid-2022, up ₽36.6 trn ($446 bn)…
So, the situation at Gazprom reveals how the state is using the corporate credit markets to address funding crises by having them lend money directly to the companies that need it. And for a sophisticated, too-big-to-fail company like Gazprom, that’s not a huge surprise; it’s a pragmatic stop-gap solution, especially if you think you can scare Europe into resuming Russian gas purchases with hollow threats of sending it all to China.
What did come as a surprise, however, was the second thing I came across in my Gazprom research. It turns out that Gazprom isn’t the only Russian company borrowing with abandon. When you dusted off the Central Bank’s much neglected data set on Russian corporate borrowing, something quite remarkable and unexpected appeared: a perfect hockey stick—a long flat trendline that suddenly inflects upward (see Figure 1).
Figure 1
…its scale is very large. It dwarfs key budget metrics, like oil and gas revenues, the defense budget or incremental government borrowing…
After years of low growth, in mid-2022, Russian companies suddenly began borrowing aggressively. The scale of incremental corporate borrowing was immense: ₽36.6 trn ($446 bn) from July 2022 through November 2024 (see Appendix 1).6
That’s 1.9 times the size of the defense budget for the same period, 7 times what the state had borrowed and 21.3% of 2023 GDP (see Figure 2). And it perfectly coincided with Russia’s partial shift to war footing.
Figure 2
…and the sectors taking on new debt the fastest are those providing goods and services for the war—2.7 times faster than non-war-related sectors
Moreover, closer examination of the data revealed the borrowing was highly concentrated in industry sectors providing the goods and services you would need to wage a large-scale land war. These war-related sectors consist of 4 core arms manufacturing sectors and 11 additional sectors providing essential goods and services required by the state for the war (see Appendix 2). Debt growth rates for these two war-related sectoral groups have tracked very closely with one another (see Figure 3). And since mid-2022, they have sharply outpaced debt growth in Russia’s 63 non-war-related industry sectors.
Figure 3
If this is Russia’s elusive war debt, why has the state chosen to impose it on companies providing war-related goods and services to the state, where credit quality has been notoriously poor?
So, was this it? Had I stumbled across Russia’s elusive war debt?
But it didn’t make sense. Why would you load up a lot of corporate balance sheets with war debt? Russia’s core arms manufacturers are nothing like the sophisticated, once-cash-rich Gazprom. They are notoriously bad credits, living hand-to-mouth off underpriced government contracts and perpetually on the brink of insolvency. As for the legion of new companies enlisted into war effort, they might be more efficient businesses, but their wartime contracts would dry up as soon as the shooting stopped. Why would banks take on so much risk? How are they going to get repaid? Not all these borrowers are too big to fail. How could bank credit committees sign off on such madness?
Since 2011, the state has orchestrated off-budget bank loans to defense contractors to discreetly supplement the politically sensitive defense budget—a funding strategy dubbed the “credit scheme”
It was then that I recalled the Russian defense sector’s quiet history of off-budget “credit scheme” financings. Back in 2007, Vladimir Putin launched a high-profile rearmament program. His promise to Russia: deliver Soviet-era military strength without Soviet-style economic mismanagement.
But within 3 years, the program had gone off the rails. His initial rearmament budget—highly unrealistic and poorly managed—quickly disappeared into the blackhole of Russia’s military industrial complex with little to show in return.
It was an embarrassing scandal, and it posed a dilemma. To get the program back on track would require a major increase in spending. But a big hike in the defense budget risked undermining Putin’s carefully cultivated image as a responsible steward of the public purse.
As it would many years later with Gazprom, the Kremlin turned to Russia’s corporate credit markets for a funding solution. Dubbed the “credit scheme,” it involved banks making sizeable state-guaranteed “loans” directly to arms manufacturers. It was launched on New Years Eve 2010, with an edict issued by then Prime Minister Putin. As Julian Cooper, a veteran scholar of the Russian defense sector, observed not long after:
“[the] resort to sizeable state guaranteed credits is also a means of supplementing the defence budget: the real volume of military expenditure is now larger than shown by the budget alone.”7
In short, the “credit scheme” enabled the Kremlin to manage the politically sensitive problem of high defense costs by discreetly funding a portion of them “off-budget” with the help of the banks.
The credit scheme suffered from structural flaws—especially the need for frequent bail outs by the state—but it proved politically expedient in the decade up to 2022.
Over the short-term, this scheme worked quite well. But it suffered from two fundamental flaws. First, many of the borrowers couldn’t repay the debt—in fact, they probably struggled just to service the interest. Starting in 2016, the state had to step in almost annually with large bail outs that got discreetly booked in classified sections of the budget. The heavy debt burden impeded the performance of the contractors. And it created risk for the lending banks, which appear to have suffered losses despite credit support from the state.
Despite these problems, however, the state remained committed to this off-budget funding scheme and encouraged its expansion. Levering up the defense sector with debt helped reduce the headline number on the defense budget—and that it seems was deemed a good thing.
The Kremlin greatly expanded this off-budget defense funding scheme in 2022, even passing legislation obligating banks to lend on terms unilaterally imposed by the state
In the run up to 2022, as the Kremlin was planning how to pay for the extraordinary costs of a full-scale invasion of Ukraine and the large-scale occupation that could follow, it saw this off-budget credit scheme as an important part of its war-funding strategy.
But here it ran up against the second flaw in the credit scheme. To work, the banks needed to be on board, since it was their credit creating capacity that allowed the scheme to work. But the banks appear to have sustained losses in the 2019/2020 bailout had reportedly soured on lending to the problematic sector.
When it comes to getting the banks to cooperate, the Kremlin, of course, can always twist arms and call in favor. But doing that at scale is cumbersome and inefficient. So, to make sure the banks didn’t drag their feet about taking more exposure to bad credit risks, the Kremlin did something quite remarkable. In December 2021, it quietly introduced legislation legally obligating banks to extend preferential loans to defense-related companies on terms unilaterally set by the state—size, maturity, credit qualifications, everything. In short, on the eve of its full-scale invasion of Ukraine, the Kremlin was formally seizing control of defense-related lending at Russia’s leading banks. The law was passed and signed into effect on February 25th, 2022, as Russian armored columns continued to pour across the Ukrainian border.
Outline of the report
This report focuses primarily on what happened next: how Moscow has used the off-budget funding scheme as a stealthy component of its overall war funding scheme. It estimates the size of the scheme and shows it to be material relative to defense budget spending. It explores Moscow’s rationale for relying on this scheme—which appears to be similar to what it had been prior to 2022: to manipulate public perceptions around defense spending for political gain. And it identifies how the flaws inherent in the regime have elevated systemic risks—especially credit risks—in Russia, as the state has relied excessively on this flawed system of hidden state borrowing to cover its mounting war costs. It concludes with thoughts about how Moscow’s loosening grip over its key sources of cash is likely to weigh on its war calculus.
Chapter 1 reviews Russia’s anomalous and large-scale corporate credit surge and benchmarks it against the federal budget.
Chapter 2 examines a striking discovery the Central Bank of Russia (CBR) made during its ongoing struggle to tame high inflation by cooling corporate borrowing. As it has hiked the key rate from 7.5% to 21%, it observed a “highly heterogeneous” response by borrowers. Debt levels among companies borrowing at normal market terms stopped growing—as expected. But borrowing by a second group of companies enjoying state-backed “preferential loans” continued to surge upward, “insensitive” to rising rates.
Chapter 3 recounts the rise of systematic state-backed preferential lending to fund the defense sector. It tells the largely untold story of the “credit scheme” (кредитная схема), briefly described above, including a remarkable twist in the plot that occurred in late 2021, when the Kremlin was planning funding for its full-scale invasion of Ukraine. Intent on expanding the credit scheme to fund invasion and occupation but apparently concerned the banks might not be fully cooperative, the Kremlin quietly pushed through a new law imposing full state control over all war-related lending at Russia’s leading banks. It was a classic state-capitalist power move.
Chapter 4 analyzes Central Bank sectoral data on corporate lending to determine whether the scale of state-directed, off-budget lending for the war is a material part of Russia’s overall war funding strategy. It measures lending growth in 15 war-related sectors and estimates how much of that has gone to fund war-related goods and services. Even on conservative assumptions, off-budget lending appears to have been a material part of Russia’s war funding strategy. The quantitative and qualitative analysis used to identify the industrial sectors engaged in war-related activities is presented in Appendix 2.
Chapter 5 addresses the question of Russia’s motive for relying so heavily on off-budget funding for the war, rather than funding more of it through the state budget. It runs hypothetical analysis showing how consolidating all Russia’s war costs on the state budget could have substantially increased both the defense budget and state borrowing needs. It argues that the credit scheme continues to serve the same function as it did prior to 2022: to gain political advantage by manipulating public perceptions around the size of Russia’s defense spending. By limiting visible spending in the budget, the credit scheme helps Russia’s war finances appear “surprisingly resilient,” “sustainable,” and facing no significant risk. That image enhances Russia’s bargaining power in any eventual negotiations.
Chapter 6 observes how Moscow’s excessive reliance on its off-budget credit scheme has elevated systemic economic risk in Russia, especially credit event risk. The CBR has identified corporate credit growth as the primary driver of Russia’s high inflation and state-directed preferential lending as the main driver of corporate credit growth. That means Moscow’s off-budget credit scheme is helping fuel inflation.
Beyond inflation, the Kremlin’s off-budget credit scheme is elevating systemic credit risk—in 3 ways.
(i) by increasing financial distress in the “real” economy. The CBR says the rate insensitivity of preferential lending weakens the effectiveness of rate hikes; only “real” economy companies curb borrowing. Consequently, to achieve its inflation targets, the CBR must hike even more aggressively. That has driven rates to prohibitive levels (21%), increasing the risk of financial distress in the real economy—as reports of looming bankruptcies in the coal mining sector reflect.
(ii) by eroding credit quality and weakening regulatory oversight in the banking sector. The CBR has voiced concern over “aggressive” lending, and inadequate liquidity and capital buffers in the banking sector, brought on in part by a 2022 relaxation in macroprudential policies in response to sanctions. Worse still, prior to 2022, the CBR is reported to have greatly eased reporting and monitoring requirements around defense-related lending. Consequently, it’s possible financial sector loan statistics look healthier than they really are—and neither the regulator nor the banks themselves have an accurate read of the true levels of risk exposure;
(iii) by increasing the likelihood of large-scale restructuring needs among war-related borrowers. A ceasefire will likely deliver a double-blow to war-related borrowers: a reduction in contract revenues and access to soft loans. A large wave of defaults could ensue crystallizing credit risk at the banks and imposing an immense bailout burden on the state.
The Conclusion observes that wars are fought on cashflows, and that the Kremlin has gradually been losing control over its 3 key sources of cash: (i) its sovereign wealth fund, (ii) oil and gas revenues and (iii) domestic borrowing. It argues that this is likely to weigh on Russia’s war calculus in 2 ways: (i) Moscow will be less inclined to believe time is on its side—the longer it must fund elevated war costs, the greater the risk that credit-related events weaken its negotiating leverage; and (ii) Moscow will prioritize sanctions relief aimed at boosting cashflows to help with politically perilous post-war debt restructuring and rearmament.
The report Appendices include, among other things, a technical discussion laying out the quantitative and qualitative analysis used in screening the sectoral data used in the report.
This report differs from some other assessments of Russia’s war finances because it looks at Moscow’s overall war-funding strategy rather than focusing on the published defense budget.
Some readers may be aware of earlier Western assessments of Russia’s war-funding capacity that may appear to be at odds with the findings of this report. That’s mostly because we look at different data sets and ask different questions.
Many previous assessments of Russia’s war finances focus on Russian budget data—its revenues and expenditures. Based on those numbers, they conclude—not unreasonably—that Moscow’s war finances appear “surprisingly resilient.” And they often interpret elevated levels of defense allocations in the 2025 and 2026 budgets to mean that Russia is ready and able to fund a long-term war of attrition.
Some assessments conclude that the main risk to Russia’s war finances is oil price. Sophisticated analysis, such as that by Richard Connolly and Dara Massicot, also astutely point out that in the event of a major retreat in oil prices, the Russian government likely still has plenty of headroom to borrow (though it will now have to pay nearly triple the rates of late 2022).8
This report does not take a view on the sustainability of Russia’s published defense budget. It sees the published defense budget as part of a broader war-funding strategy, which includes the off-budget credit scheme—the main focus of this report. In some ways, it is complementary to those budget-focused assessments.
This report seeks fresh insight into Russia’s war finances by looking at underexamined evidence of large-scale, off-budget funding in the corporate credit markets. It’s hoped that other researchers will choose to train their skills on Russia’s extrabudgetary funding schemes. As they do, our understanding of Russia’s war finances is likely to evolve. We’ll be more likely to recall Aleksei Kudrin’s prophetic 2012 warnings of a profligate rearmament program that would impoverish Russia’s future. And our head-scratching over Russia’s “surprising resilience” will soon give way to talk about the Kremlin’s all-too-habitual imperial overreach.
For policymakers, this report identifies a new dimension of Russia’s war-funding strategy and flags risks arising from it—especially systemic credit risk—that could constrain Moscow’s war finances and weigh on its war calculus.
For policymakers, this report identifies a new dimension of Russia’s war-funding strategy: a heavy reliance on off-budget debt to supplement its defense budget allocations. It also shows how excessive reliance on this off-budget funding strategy has elevated systemic credit risk to a point that it could become a constraining factor on Moscow’s war finances and weigh on it war calculus.
Acknowledgements
I would like to acknowledge the generosity of many friends and colleagues who have taken the time to engage with analysis in this report and provide valuable feedback. This report has also benefited greatly from the insightful research of other analysts and scholars, some of which is cited in the notes to Chapter 4 and Appendix 2.
Chapter 1: Russia’s Anomalous Corporate Credit Surge
“War made the state, and the state made war.”
—Charles Tilly9
Russia’s wartime borrowing is immense—but it’s not where you’d expect to find it.
Wars are notoriously expensive. To soften the impact on taxpayers, states routinely finance wars with debt, spreading costs out over time.
Russia’s war on Ukraine should be no different. As the largest war in Europe for seventy-five years, waged under extensive sanctions, you’d expect to see large-scale borrowing to finance formidable costs. And, indeed, we do see a large, anomalous spike in Russian borrowing since mid-2022. It’s just not where you’d expect it to be. Instead of accumulating on the state’s balance sheet as it often does, Russia’s wartime debt surge has built up on company balance sheets across the corporate sector.
Since Russia shifted to a war footing in mid-2022, Russian companies have increased their outstanding debt by 71%, amounting to ₽36.6 trillion or $446 billion in incremental borrowing
For years prior to 2022, Russian corporate debt grew at a modest pace (see Figure 4). From July 2022, however, it abruptly began to surge—just as parts of the Russian economy were shifting to a war footing. Through November 2024, Russian companies added ₽36.6 trillion to their outstanding debt. That converts to $446 billion at historical rates (see Appendix 1). Corporate bank loans, which make up most borrowing, surged by 76%, with some sizeable corporate sectors doubling, even tripling their borrowing from banks.10
Figure 4
This corporate credit surge is large by comparison to budget metrics, significantly exceeding state borrowing, the defense budget, and total oil and gas revenues over the same period.
In the context of Russia’s economy, ₽36.6 trillion is a large number. It comes to 21.3% of 2023 GDP and equals total federal budget revenues for 2024.
The corporate credit surge is also significantly larger than certain key budget figures pro-rated across the same time period (see Figure 5). It is:
1.9 times larger than the Russian defense budget;
1.5 times larger than total oil and gas tax revenues; and
7 times greater than incremental government borrowing.
Figure 5
What explains Russia’s corporate credit surge? It has exhibited some unexpected behavior, including a lack of responsiveness to rate hikes.
What accounts for this curious, abrupt and relentless surge in corporate borrowing? No doubt a number of factors are behind it. For example, a short-lived boom in residential housing has likely driven some of the loan growth in building construction. And large borrowers like Gazprom that used to fund abroad are now largely reliant on the domestic credit markets. But the corporate surge is immense, and such factors appear to account for only a fraction of it.
What’s more, the corporate credit surge has also exhibited some unexpected behavior. It began in mid-2022, exactly at the time that Russia began shifting large parts of the economy to a war footing. Since, it has had 29 months of continual growth (see Figure 6). Even more notable, it continued its relentless surge despite two aggressive rounds of rate hikes by the central bank.
Figure 6
Fortunately, we aren’t the only ones trying to understand what’s driving the corporate credit surge. The Russian Central Bank (CBR), too, has been scrutinizing the credit surge. That’s because this relentless expansion in credit has been a major driver of Russia’s rising inflation, helping push official levels close to 10%—far above the CBR’s target levels of 4%.
In its analysis of what’s behind the corporate surge, the CBR has made some revealing observations. We examine these in Chapter 2.
Chapter 2: The Relentless Driver of the Credit Surge—State-Directed, Preferential Bank Loans
“Now let us look at where the high demand [driving inflation] has come from that I talk about so often. Household incomes are up, which one can only welcome. Budget spending has grown, which was unavoidable. But the main thing is that lending has grown very strongly, even at an unprecedented rate.”
—Head of the Russian Central Bank, Elvira Nabiullina, addressing to a joint session of the Russian parliament, November 19, 2024.11
“In our view, now is the most important time to give serious thought to a more flexible system of state-sponsored support. We’re actively discussing this with the Government. It should not be limited primarily to preferential lending. Of course, everyone has gotten used to preferential loans - both businesses and ministries.”
—Head of the Russian Central Bank, Elvira Nabiullina, addressing to the State Duma, October 31, 2024.12
Why, despite two rounds of aggressive rate hikes, has the Central Bank struggled to constrain the corporate credit surge?
“The situation is highly heterogeneous.” Those were the words the Russian Central Bank (CBR) governor used in November 2024 to describe an alarming development in the corporate credit markets. During the previous 15 months, the CBR had conducted two rounds of aggressive rate hikes in an effort to cool off the corporate credit surge. Unrelenting corporate borrowing had become the primary driver of rising inflation. Yet, despite raising the key rate from 7.5% starting in July 2023 to a record level of 21% by October 2024, the CBR was struggling to slow the unrelenting expansion of corporate credit.
After its tightening round, from July through December 2023, when rates had more than doubled to 16%, the CBR thought it had gotten borrowing under control (see Figure 7). But its victory was short-lived. By Q2 2024, borrowing was once against accelerating, which led to a second round starting in late July 2024.
Figure 7
Consumer borrowing fell sharply, helped by the termination of a popular program of state-subsidized home mortgages in July. But corporate borrowing continued to surge to record highs, much to the consternation of the bank. Indeed, the second round of tightening saw the largest increase in corporate debt of any three consecutive months of the corporate credit surge (see Figure 8).
Figure 8
The corporate debt market has split into groups of borrowers: (1) a rate-sensitive group that has curbed its borrowing and (2) a group that is largely “insensitive” to rate hikes and continues taking on new debt
What was driving the surge? Why was it so unresponsive to tightening? For months, the CBR had been gradually piecing together the puzzle. By November 2024, it had an answer.
The market for corporate loans had split into two distinct groups—become “highly heterogeneous” in the CBR’s terminology. One group was borrowing at market (on normal market terms). This at-market group responded as expected to a sharp rise in rates: they curtailed their lending. The second group, by contrast, was borrowing off market, receiving “preferential” terms of credit (льготное финансирование). It was this group of “preferential” borrowers that was proving largely “insensitive” to rate hikes.
This rate-insensitive group has blunted the effectiveness of the CBR’s main inflation-fighting monetary tool: rate adjustments
For the CBR, the “insensitivity” to rates shown by these preferential borrowers posed a major challenge. The rate hike is its primary tool for fighting inflation. But if a large class of borrowers is immune to higher rates, the CBR is greatly disadvantaged in its fight against inflation. As the CBR observed:
“Preferential loans are weakly sensitive to changes in monetary policy. The larger their share, the more the key rate needs to be changed to influence credit activity, demand and inflation.”13
In other words, to cool down lending when preferential loans are prevalent, the CBR needs to hike even more aggressively than it would normally have to do.
This, however, has a perverse and undesirable effect: it squeezes out the most efficient users of capital, those borrowing “at market”—while the normally less efficient preferential borrowers continue to take on debt. So, rate hikes were doing significant damage to the “real” economy while having limited impact on the remaining driver of credit expansion—the preferential borrowers.
These rate-insensitive borrowers come from certain sectors, have revenues tied to state-contracts and receive state-directed “preferential” bank loans, often with low interest rates
Who, then, were these rate-insensitive, preferential borrowers? From CBR commentary on the problem, the following portrait emerges. They are associated with certain industrial sectors;14 their business is closely “tied to state orders”15 and “state contracts”;16 the state provides these borrowers with support in the form of “preferential” borrowing terms;17 credit support from the state can take a range of forms, including principal guarantees.18 But for these borrowers, support is often taking the form of interest rate subsidies, where the borrower pays a fixed rate well below the normal market rate and the state pays the lending bank the difference between the market rate and the “preferential” rate.19 In a high-rate market, the demand for such loans becomes very strong, and can even exceed the needs of the borrower.20 Quantifying preferential lending is a challenge21 because the CBR lacks comprehensive data.22
In short, Russia’s rate-insensitive corporate borrowers are companies that tend to do government contract work in certain unspecified sectors; in connection with those contracts they receive state-directed, preferential bank loans—routinely with subsidized interest rates; and their relentless demand for credit during the second tightening round (August – October 2024) was so strong that it pushed corporate borrowing to a new 3-monthly record, even as incremental demand from at-market borrowers dried up.
Conventional borrowing is driven by commercial calculations, while state-directed, preferential borrowing is driven by the state’s political agenda.
The essential difference between conventional, at-market borrowing and state-directed preferential borrowing boils down to the nature of the credit decision. With conventional borrowing, the decision is driven first and foremost by the commercial calculations of company management. With state-directed, preferential loans, however, it is the strategic priorities of the state that drive the borrowing decision. The state adjusts borrowing terms and conditions in pursuit of its political agenda.
What could be so important to the state that it would allow preferential borrowing to thwart the Central Bank’s battle against inflation?
By late October, the CBR seems to have understood its conventional monetary tools were inadequate to rein in the corporate credit surge. Higher rates were having little effect on borrowing. Insatiable credit demand from rate-insensitive, preferential borrowers was, in effect, stripping the gears on Russia’s monetary transmission mechanism.
How then to tackle the problem of unyielding preferential borrowing? Since this borrowing is driven by political, not commercial, objectives, the CBR recognized it would need a political solution. So, on the 28th of October, the CBR head met with Vladimir Putin and other senior officials to discuss what Putin described as “a sensitive and important topic—the dynamics and structure of [Russia’s] corporate debt portfolio.”23 Three days later, she would also present her case in a speech to the Russian Duma where she called for the curbing of state-directed preferential lending. We will return to these meetings in Chapter 6.
While the state uses soft financing to pursue various agendas, the scale and timing of the corporate credit surge strongly suggests much of this preferential lending is being used to fund the war.
Throughout its public commentary on preferential lending, the CBR remains vague about the specific nature of the state demand that is driving it. No doubt, it’s a mix of things. The state has been using various forms of soft financing for a range of projects, from agricultural subsidies to port and rail construction.
Those needs, however, have been around for years and have never fueled a major credit surge. And while they are priority areas of investment—especially agriculture—we can see from sectoral borrowing data these sectors account for only a small fraction of Russia’s incremental borrowing.
What, then could it be? Three clues points strongly to one answer:
the surge in borrowing coincided with the shift of much of the economy to a war footing in mid-2022;
since then, there have been major increase in budget funding for war-related state contracts; and
whatever these borrowers are doing for this state, it must be of immense importance, if the state is willing to sign off on record levels of new corporate borrowing at the same time the CBR is ratcheting rates to record highs in a desperate effort to cool off lending.
The obvious answer these clues point to is that this wave of preferential lending is being used to fund companies engaged by the state in the war.
In the next two chapters, we shall examine the data around this question. If, indeed, much of this state-directed preferential lending is going to fund the war, it wouldn’t be the first time the state relied on such off-budget credit funding to supplement the defense budget. As we shall see in Chapter 3, for over a decade prior to 2022, the state was regularly and discreetly funding a significant portion of its rearmament program using similar state-directed preferential bank loans.
Chapter 3: How the Kremlin Seized Control of Defense-Related Bank Lending
“an authorized bank shall be required…to provide defense contractors and subcontractors with preferential financing on terms set by the government of the Russian Federation for the purposes of fulfilling state contracts and state defense procurement contracts.”
—Amendment to the Law on State Defense Procurement, signed into effect on February 25, 202224
In February 2022, the Russian state quietly and formally seized control of defense-related lending at Russia’s leading banks when an amendment was passed to the Law on State Defense Procurement.
To understand what’s behind much of Russia’s corporate credit surge—and, indeed, much of what afflicts the Russian economy today—a good place to start is a largely overlooked amendment to the Law on State Defense Procurement. It states that all banks authorized to work in the defense sector:
“shall be required…to provide defense contractors and subcontractors with preferential financing on terms set by the government of the Russian Federation for the purposes of fulfilling state contracts and state defense procurement contracts.”25
This amendment was quietly submitted by the Kremlin to the Russian parliament in December 2021, approved on February 22, 2022 and signed into law by Putin on February 25, 2022—as Russian columns continued to stream across the border into Ukraine.
The “authorized banks” mentioned in the law refer to a list of banks approved for managing financial transactions for state defense contracts. These include a handful of Russia largest banks as well as several banks with close ties to Russia’s defense sector.
Banks would be obligated to extend preferential loans to defense-related businesses on terms unilaterally set by the state
In its brief commentary on the amendment, the official government newspaper, Rossiiskaia Gazeta, elaborated on the kinds of preferential financing terms the state might be setting:
“they include the size of loans being received, the conditions of their repayment, as well as any requirements concerning the financial condition of the borrowers and their creditworthiness.”26
While the amendment may be short, its implications are far reaching. It amounts to the state’s commandeering of the credit resources of Russia’s leading banks to fund its war needs. It deprives the banks of all discretion over the lending decisions to defense-related companies and cedes those authorities to the state. Exercised to its full extent, this law would be tantamount to state expropriation of the banks.
In the next chapter, we shall look at just how far the state has gone since 2022 in exploiting these powers to direct preferential bank loans to a wide range of companies now engaged in Russia’s war.
For a decade prior, the state had already been directing banks to make preferential loans to defense contractors to cover shortfalls in defense budget funding for rearmament.
In this chapter, however, we go back in time to gain insight into the roots of the February 2022 amendment. As it turns out, funding Russian defense contractors with state-directed preferential bank loans was hardly a new idea in 2022. For over a decade, the state had been systematically using preferential bank loans to cover substantial shortfalls in budget funding for Russia’s costly rearmament program. We shall look at why the state resorted to this as part of its defense funding strategy and the inherent flaws in this strategy—flaws that have gone unaddressed and pose a significant risk to Russia’s defense finances going forward.
In 2007, Putin launched a high-profile rearmament program, but by 2010 it was mired in embarrassing scandal and cost overruns.
As in 2022, in 2010 the Russian state faced a crisis in its defense industry, one it would end up addressing with help from its banks. Just 3 years earlier, In 2007—with coffers swelling from high oil prices and productivity gains from imported oilfield technology—Putin launched a major 8-year rearmament program. His promise to the Russian people: restore Russia’s Soviet-era military might while avoiding Soviet-style economic mismanagement.
By 2010, however, Putin’s grand rearmament program was in trouble. Cost budgets had been far too optimistic, while Russia’s production capacity had been greatly overestimated. Less than halfway into the program, funds were already running low with little to show in terms of new production. Putin was forced to abandon the old program and announce a new, ten-year program with a significantly higher price tag. A deputy minister was dispatched to explain that this time they had gotten the math right and wouldn’t make the same mistakes again.27
A major spending increase was needed to get back on track, but this risked tarnishing Putin’s carefully managed image as a prudent manager of the public purse.
The Kremlin was interested in avoiding a sudden and dramatic step up in defense spending, so it wanted to backload the plan, pushing some 70% of the expenditures out to the second five years. This presented a dilemma, however, because contractors needed more money straightaway if they were to get back on track. Putin faced a stark choice: scale back his rearmament ambitions or risk appearing soft on spending discipline.
A solution was found: the state would limit budget increases by discreetly arranging state-guaranteed bank loans to arms manufacturers to cover their funding shortfall.
A solution was soon found that would get more money to arms contractors without adding more costs in the budget...at least not straightaway. The state would arrange for several large Russian banks to provide 5-year loans to arms manufacturers to supplement the inadequate funding coming from the state budget.
There was only one hitch: the banks appear to have been unwilling to lend without a repayment guarantee from the state. That was not at all unreasonable. The sums involved were large, while many of the borrowers of record were likely to be very high credit risks. Many will have been heavily dependent on state contracts—which were still being negotiated—so their future revenue flows were uncertain. And many were largely unreconstructed legacy defense enterprises from the Soviet era with highly opaque cost-structures.
To address this problem of repayment, the state offered to the banks to guarantee the principal (but not the interest) of the loans. And on December 31, 2011, an edict was issued by then Prime Minister Vladimir Putin spelling out the terms.28 Judging by the subsequent amendments to this edict, new 4- or 5-year loans continued to be issued under this guarantee facility at least into 2016.29
This lending program wasn’t classified. There are odd references here and there, but there seemed an effort to play them down. When, for example, the Duma was rushed to approve enabling legislation, the head of the Defense Committee described them in a floor statement in nearly impenetrable bureaucratese:
“a new, important mechanism related to the formation and stimulation of the implementation of state defense orders, which consists of the provision of state guarantees.”30
By 2016, however, the cash-poor arms contractors predictably could not repay much of their debt. The state then paid off the banks under the guarantee agreement.
Over the next several years, little was said about these loans as they steadily accumulated on the balance sheets of Russia’s arms producers. By 2016, however, some ₽1.2 trillion in debt (an estimated $37 billion at historical rates) had built up, and some two thirds appears to have gone bad, with trouble on the way. That’s when the state had to step in and perform on its guarantees by repaying the loans. To fund this repayment, it needed money from the budget. And because it was a sizeable amount, some public explanation was required, which brought the loans back into the public eye.
In October 2016, addressing the Duma’s budget committee, Finance Minister Anton Siluanov offered the following brief explanation for what was behind the state’s supplementary funding need. Referring back to the late 2010 edict he explained:
“It was decided that arms manufacturers would take out loans with state guarantees so that they could more quickly implement the state armament program and fulfill the president's order to rearm our army within the allocations provided in the budget. These loans were used to manufacture products for military use.”31 [author’s emphasis]
Funds, of course, were duly allocated and tucked away into an expanded, classified part of the budget.32 A year later, in October 2017, Siluanov would be back asking for another ₽200 billion to repay debt borrowed under the state-guarantee.33
Despite the default, the “credit scheme” worked well for the state, by keeping a significant portion of defense costs off the budget for years. More loans were forthcoming.
In effect, then, through this state-directed “credit scheme” the state had managed to arrange five years of supplementary “off-budget” funding for defense procurement before it had to pay a single ruble from the budget. While there continued to be criticism from some quarters about excessive defense spending, this rollover of the “credit scheme” did not garner that much media attention. The Kremlin’s illusion of a financially disciplined rearmament program remained largely untainted.
Which perhaps made the rest of Siluanov’s statement to the committee easier to understand. By “repaying the so-called enterprise loans” the state would be “freeing these enterprises from their debt burden, so that they had the opportunity to borrow again”34 [author’s emphasis].
By 2019, debt distress in the sector had grown severe enough that Putin had to intervene and a difficult restructuring plan was negotiated with the banks.
And borrow they did. By the end of 2019, sector debt had grown still larger, to ₽2.7 trn and the sector was in distress again—an entirely predictable outcome. Banks and their borrowers were at loggerheads. But it’s not clear how much of this debt was fully backed by explicit state guarantees. The banks were demanding the state to step in and assume the bad debts, while defense contractors called for “non-productive” bankers to write off the debt.35 The debt load had become so onerous, it was impeding progress with rearmament.
Things had gotten bad enough that Putin had to publicly weigh in on the matter. He convened a meeting of senior officials to discuss the euphemistically named “program on the financial recovery of defence sector organizations.” He sanctimoniously harangued arms manufacturer for the “large debt burden” they had accumulated. It had become, he said, “the restraining factor” that was “seriously limiting the possibilities for diversifying production [and] introducing advanced technologies.”36
This, however, was the Kremlin passing the blame onto others for it own policies. It was Putin, after all, who had been Prime Minister in 2010 and whose name is at the top of governmental edict establishing the original “credit scheme.”
In due course, a compromise restructuring was agreed for part of the debt. The details were once again classified, but reports suggest the state assumed a portion of the bad debt, and forced lenders restructure the rest with long maturities and low interest.37
The state responded with a sector audit, but remained committed to state-directed preferential lending
How did the state respond to the second major sectoral debt crisis in less than five years? It did two things.
First, it launched a widespread financial audit of the defense sector. With debt continuing to accumulate in the sector, it appeared to be seeking a better understanding of how great the insolvency risk was. The audit came back in 2020 with reports of significant financial distress, with some companies crushed by debt-to-EBITDA ratios running into double digits. And these heavy debt loads were weighing on progress across the defense sector. As the head of the commission had once described the impact of the debt burden: “now the defense sector is an exercise bicycle: you crank the pedals, but you don’t go anywhere.”38 Following the audit, he went on to observe that the debt problem must be solved for the sector to make further progress.39
Second, the state advanced its plans to develop a special, state-owned bank, Promsviaz’ Bank (PSB), dedicated to the defense sector. After the painful experience of the 2019-2020 settlement, some of the banks authorized to service the defense sector had cooled on more lending to the sector. The plan was that PSB would, in time, consolidate much of the sector banking business. In theory, consolidating sector banking into a single institution would also give the state better control over sector finances. And PSB began issuing preferential, low-interest-rate loans aimed at reducing the risk of financial distress.40
The off-budget “credit scheme” shouldn’t be thought of as real corporate lending, since there seemed to be little reasonable expectation that much of it would get repaid.
What are we to make of this decade of chronic debt and default? One way to describe it is as a Kremlin conjuring trick: by levering up the defense sector with debt, the Kremlin appears to be making good on its promise to deliver soviet-era military strength while keeping the defense budget in check. As Julian Cooper, a veteran scholar of the Russian military, would astutely observe not long after:
“[the] resort to sizeable state guaranteed credits is also a means of supplementing the defence budget: the real volume of military expenditure is now larger than shown by the budget alone.”41
The fact the state was levering up the defense industry to get better returns on its budgetary investments is not in and of itself a conjuring trick, nor a betrayal of its public promise. For many businesses, having some debt in the capital structure is advisable, provided there’s a reasonable expectation they can manage the load.
And it’s exactly that “reasonable expectation” that seems to have been missing here from the very outset. There’s a reason the banks received state guarantees on their loans under Putin’s edict No. 1215 from 2010. It’s because all the key players—the borrowers, the lenders and the state—almost certainly knew Russia’s legacy defense sector was an unacceptably high credit risk. Many borrowers would struggle to repay the debt they were being forced to take; they might even struggle to service the interest payments. And scholarly research throughout the 2010s has repeatedly confirmed the weak financial state of much of the sector.42 And the cycle of borrowing and default briefly recounted above bears out the research.
The sector had chronically weak finances owing to underpriced state contracts, corruption and the assumption among managers that the state would bail out their bad debts.
Several reasons account for the chronically poor financial state of the sector.
First, there is what has been called the “pricing problem” (проблема ценообразования). Around 2008-2010, under then Defense Minister Serdiukov, the state reportedly became more aggressive and adversarial in its pricing of arms procurement contracts, pushing prices below what contractors claim they needed to cover costs and expenses. As an effective monopsonist, the state had superior bargaining leverage over the contractors and had begun to exercise it. Arms manufacturers had little choice but to sign contracts, even they could well result in losses.43 For many them, the Russian state was practically the only buyer for their products. This left them chronically short of cash.
The second reason was corruption. Part of the state’s rationale for low-balling contract prices was an effort to crack down on corruption, which was (and remained) rampant in Russia’s arms procurement. Price structures were highly opaque, cronyism rampant, and management often had little incentive to want cash to accumulate on the balance sheet.
Third, of course, was moral hazard. If the state had guaranteed this debt already, why should enterprise managers make provisions for debt repayment?
On top of it all, interest expense on these loans was only adding to the cashflow shortfalls at many of these companies. That was a finding of an Audit Chamber investigation into defense sector finances published in early 2013 It went on to add that a majority of defense sector enterprises were so technologically antiquated, that it would make more sense to build new factories from scratch than upgrade existing plant.44 The heavy burden of interest charges was also evident in the 2020 special audit.45
The “credit scheme” is better understood as hidden state borrowing, or “state-directed, off-balance-sheet debt funding” to be more technical.
Sector companies may be the borrowers of record, but the de facto borrower here is the state. These are cash injections that the state has “compelled” the companies to take—in lieu of fully priced contracts—so that they can cover their production costs. And it was the state whose credit the banks were counting on when they disbursed the funds. And it was the state that repaid the loans when they came due. Moreover, in many cases, there probably was never any reasonable expectation that the borrowers of record would be able to repay the debt themselves.
So, what in effect, we have is a case of “sham” borrowing, or “hidden” state borrowing, as the IMF might put it. The state is orchestrating these loans, providing the enabling credit and then paying them off.46 A more precise, though clunkier, label might be “state-directed, off-balance-sheet debt funding.” The state is using its credit to raise debt to fund the companies but directing the banks to structure the debt as company loan so that it stays off the state’s balance sheet until it’s time to repay.
And the state’s motive was clearly to provide supplementary defense funding above and beyond was was readily visible in the federal budget.
As to the state’s motive, two officials have provided similar explanations: it was to provide adequate funding for defense contractors while also limiting defense budget expenditures. We’ll recall Siluanov’s 2016 explanation to the Duma. He explained the purpose of the loans was to "implement the state armament program and fulfill the president's order to rearm our army within the allocations provided in the budget”47 (author’s emphasis). In 2011, a deputy defense Minister put it more bluntly: “Taking on state-guaranteed loans to carry out defense orders…is a compelled measure. The reason for it is that spending allocations in the armament budget are very unevenly planned: 31% for 2011-2015 and 69% for 2016-2020.”48
As often with “hidden” state borrowing, it’s riskier and costlier than normal state borrowing. In this case, it has worsened financial distress throughout the defense sector, led to disruptive debt restructurings, and created significant financial risk for Russia’s leading banks. It would have been far less risky, disruptive and costly had the state simply borrowed the money directly in the bond markets and used it to pay higher prices in its procurement contracts.
But state’s using “hidden” debt are often willing to put up with these costs and risks—to a point—as the price of achieving a desirable political outcome—often in the form of politically advantageous optics. In Moscow’s case, it appears to have found its off-budget “credit scheme” a useful—albeit somewhat unwieldy—tool for reducing the headline numbers on Russia’s defense budget and delivering on Putin’s promise to restore military strength without fiscal mismanagement.
More precisely, it was a form of hidden, supplementary revenues to compensate for underpriced contracts.
Pavel Luzin has characterized the peculiar function of these loans very well in his insightful 2020 essay, “Russia’s arms manufacturers are a financial black hole.” He observes that these loans “do almost nothing to increase [the] profitability” of these companies. Instead, preferential bank loans might:
“allow the state to compensate the military industrial complex for its losses through other budgetary streams — without publicly inflating its defence and security expenses.”49
In short, the state is using its hidden borrowing to pay what amounts to hidden revenues to the companies to help keep them afloat.
For the “credit scheme” to work, the state needs the credit-creating capacity of the banks. But banks had begun to sour on the high-risk defense sector.
Companies might have little say in whether they get compensated with more richly priced contracts or loans they don’t have to repay. They were “compelled” to take out the loans. But banks, in theory, did have a say—at least until February 2022, when the government passed the amendment commandeering them to fund the war. After banks apparently took some losses in the 2019/2020 bailout,50 it appears some banks were souring on the more lending to the sector. Promsviazbank was poised to consolidate sector debt.
To remove the risk of bank reluctance and make the credit scheme fit war-time use, the Kremlin put forward legislation giving the state full control over defense lending at the banks.
It appears, however, that the Kremlin had second thoughts as it laid plans for a full-scale invasion and subsequent occupation of Ukraine. Defense related costs were bound to soar. The off-budget “credit scheme” could prove a valuable tool both for directing cash quickly where it’s needed, “without publicly inflating” its defense budget, to paraphrase Luzin.
But why pass a law effectively expropriating the banks? If banks are reluctant to lend, they can find ways to drag their feet. Of course, a call from the right senior Kremlin official can often solve a problem. But where lending needs to happen at scale, such ad hoc solutions are impractical. To stop foot dragging and free up senior officials for other things, a law obliging the banks to lend to defense-related borrowers on terms unilaterally set by the state is simply a prudent measure.
As we shall see in the following chapters, however, the extent to which the state has come to rely on this carte blanche credit scheme since mid-2022 is anything but prudent.
Chapter 4: How Big is Russia’s Off-Budget War Debt? A Broad Estimate.
How material is Russia’s off-budget lending to its overall war-funding strategy? CBR sectoral data allows us to broadly estimate its scale.
In this Chapter we address the important question of materiality. How material has off-budget defense funding been relative to defense budget allocations since mid-2022? If it hadn’t existed, would it have been clearly missed?
To answer this question, we need to broadly estimate the amount of state-directed preferential lending that has been extended to war-related companies.
Fortunately, we are able to make such an estimate thanks to sectoral lending data published by the Central Bank. While the data is not sufficiently granular to allow precise, single-point estimates, it is suitable to support a broad estimate that provides a reasonable indication of scale. And for our purposes—establishing materiality—a reasonable indication of scale is all we need.
Even on our most conservative assumptions, off-budget funding appears material to Russia’s overall defense funding strategy
The analysis in this chapter concludes that off-budget defense-related lending makes up a material part of its overall war-funding strategy, even on our most conservative set of assumptions.
Central Bank data break corporate lending into 78 separate industrial sectors, allowing us to estimate borrowing trends of defense-related sectors
As we did when measuring Russia’s overall corporate debt surge (see Chapter 1), in this chapter we are making use of on Central Bank data sets on the Russian credit markets. The main difference is that this data provides ruble corporate bank debt broken out across 78 separate non-financial industrial sectors, covering everything from gambling to oil and gas extraction.51 These sectors follow standard Russian industry classification system known as OKVED2. This allows us to track monthly changes in bank borrowing levels across a wide range of industrial sectors. So, for example, we can see that the outstanding debt of companies involved in “production of motion pictures, video films and television programs, publication sound recordings and sheet music” (#59 in the OKVED2 system) has fallen by 34.3% or around ₽5 billion ($45 million) between mid-2022 and the end of November 2024.
By contrast, companies involved in the “production of chemical and chemical products” (OKVED2 #20) has increased by 127.2% or around ₽1.93 trillion ($23.5 billion) over this same time (see Figure 9). It’s not surprising that the chemicals sector should be taking on more debt during a war; it’s customarily seen by military analysts as one of the 4 OKVED sectors comprising the Russian arms manufacturing industry. Prior to 2022, it was tracked as a proxy for economic activity around Russia’s military industrial complex.
Figure 9
This ₽1.93 trillion in incremental borrowing is, in fact, a large number. It’s equal to 10% of Russia’s entire federal defense budget over this same period. Now, consider that—as a rule of thumb—around half the defense budget goes to arms procurement.52 That means that the amount of “debt” capital injected since mid-2022 just into this single war-related industry sector, chemicals, equals roughly 20% of Russia’s entire estimated arms procurement budget for the same period. That data point alone should alert us to the potential significance of Moscow’s off-budget credit scheme in the overall structure of its war-funding strategy.
15 sectors have been identified as likely to be (i) providing a significant level of war-related goods and services and (ii) receiving substantial amounts of state-directed preferential loans.
Of the 78 industrial sectors in the CBR data, we have identified 15 as directly relevant to estimating the scale of Russia’s off-budget war-funding scheme. The methodology and analysis involved in identifying these sectors is detailed in Appendix 2 and involves the application of qualitative and quantitative screening tests. The screening process has produced a group of 15 sectors that we can say with a reasonable degree of confidence (a) are likely to be providing the state with a significant level of war-related goods and services, and (b) appear to be receiving substantial amounts of state-directed preferential loans.
This list further breaks down into two subgroups:
4 core sectors customarily associated with legacy arms manufacturing (see above); and
11 “other war-related sectors.”
Borrowing behavior of these two subgroups tracks very closely to one another (see Figure 10). At the same time, they also sharply deviate from that of the remaining 63 sectors that did not clear our screening thresholds and are deemed to be “non-war-related.”
Figure 10
Estimating the scale of war-related debt: high- and low-case assumptions
In making our estimate, we will draw on incremental borrowing data from these 15 sectors. We begin by calculating the total increase among the war-related sectors in outstanding bank debt from July 2022 through November 2024. This provides us with a maximum estimate—our “high-case” estimate.
Next, we need to make a risking adjustment to account for the likelihood that not all borrowing in all sectors is state-directed, war-related preferential lending. In our 4 core arms manufacturing sectors, we assume 100% of borrowing is war-related. But in the 11 “other war-related sectors” we assume some incremental borrowing in our data may be unrelated to the war. Our screening process, however, suggests the non-war portion is not likely to be very large. This is evident in how these sectors scored in our screening tests (see Appendix 2). This is also reflected in how closely they track our benchmarks for fully dedicated war-related sectors—the 4 core arms production sectors (see Figure 10).
To be on the conservative side, however, we are running a “low-case” estimate that assumes only 50% of the incremental debt of these 11 sectors is war-related. The conservative quality of that assumption can be seen in the steady upward growth trend over the course of 2024, including August through November 2024, when debt levels among at-market borrowers stopped growing (see Chapter 2).
To summarize our input assumptions:
High case:
4 core manufacturing sectors = 100%
11 other war-related sectors = 100%
Low case:
4 core manufacturing sectors = 100%
11 other war-related sectors = 50%
Figure 11 shows the estimation analysis. Starting from the top down, the black vertical bar labeled 100% is our primary benchmark. It represents the headline defense budget figure, pro-rated for the 29 months running from July 2022 through November 2024.53
Figure 11
Beneath that is our estimated range of state-directed defense-related preferential lending. The dark red band represents our low-case estimate, which comes to 72% of our benchmark. The light-red band represents the range of values between our low-case and our high-case estimate, which totals 118% of our benchmark. The midpoint of the range is 95%.54
At the bottom are two additional benchmarks representing the annual defense budgets for 2023 (on the left) and 2024 (on the right).
Even at the low end of our range, off-budget funding appears material to Russia’s overall defense funding strategy
Even at the low end of our range, the estimated amount of off-budget, war-related lending comes to nearly three quarters of our pro-rated defense budget figure for the same period. As a percentage of total combined pro forma defense spending (budget + off-budget), our estimated range runs between 42% and 54%. That easily meets and exceeds any reasonable standard for materiality.
Chapter 5: Moscow’s Conjuring Trick. How Off-Budget War Debt Keeps the Defense Budget Looking “Surprisingly Resilient”
“everything necessary for the front, everything necessary for victory is in the budget.”
—Anton Siluanov, Russian Minister of Finance, September 28, 202355
“When [the Soviet leadership] wanted to conceal [defense spending levels], rather than invent an outright lie, they preferred either to mislead by giving out half or a quarter of the truth, or else to say nothing at all.”
—Mark Harrison, “Secrets, Lies and Half-truths”56
When announcing the big defense spending increase in Russia’s 2024 budget, the finance minister sent two important messages
In September 2023, Finance Minister Anton Siluanov sent shudders through Western capitals by unveiling a headline defense budget number that was some 68% higher than the 2023 figure. He described the increase with the following words:
“The priorities of the budget are set out in the structure of the budget expenditures. The structure of the budget shows that the main thrust is on ensuring our victory—the army, defense capability, armed forces, fighters - everything necessary for the front, everything necessary for victory is in the budget. This is a considerable strain for the budget, but it’s our unconditional priority.”57
As students of Russia’s Civil War will recognize, this is a bureaucrat’s lumbering riff on Lenin’s much pithier “Everything for the front! Everything for Victory!” (Все для фронта! Все для победы!). But through the verbiage, two messages come through—one pointed, the other more subtle.
Message #1: Russia is ready to spend what it takes to win and willing and able to bear the strain—a message validated by Western assessments.
The first, pointed message is that Russia is ready and able to spend what it takes to win. As Pavel Luzin astutely observed about the big increase in the 2024 defense budget, it appeared designed “to scare Kyiv and its supporters into accepting a ceasefire.”58 Moscow was telling us it was ready to spend what it takes to win. While it might be a strain, it was one Russia was prepared to bear.
Western analysts were soon running a ruler over these figures and confirming Siluanov’s basic claim: these figures might be a bit of a stretch, but they are achievable barring a steep and protracted drop in the oil price. What helped was that the overall increase in the budget was just 22%. The overall increase was all going to defense, plus some cannibalization of other non-defense spending.
Message #2: Everything Russia needs for the war is in the budget—a subtler message that goes largely unnoticed, but is patently untrue.
But there was a second, more subtle message in his statement that likely went unnoticed by many: everything Russia requires for the war is in the budget. That’s a statement Siluanov would like us to believe, but as we saw in Chapter 4, it’s simply not true. A material part of Russia’s war funding is structured off-budget.
And Siluanov, of course, knows it’s not true. After all, it was Siluanov who in 2016 went before the Duma budget committee to explain the rationale behind the credit scheme: to provide extrabudgetary funds to arms producers so they could “fulfill the president's order to rearm our army within the allocations provided in the budget” (see Chapter 3). And it is Siluanov who continues to allocate additional budget funds to cover subsidized interest charges on preferred loans. Indeed, Siluanov probably knows better than anyone just how much funding “for victory” is being arranged each month outside of the budget.
Why is Moscow keeping so much of its war-funding off-budget? As in the past, it seems intent on manipulating public perceptions around the size of its defense spending.
It should come as little surprise that a Russian finance minister might dissemble about Russia’s defense expenditures in time of war. The interesting question is: to what end?
As we saw in Chapter 3, prior to 2022, the “credit scheme” was largely an exercise in managing domestic perceptions around Russia’s billowing defense spending. The aim: promote an image of the Kremlin as a disciplined manager of the public purse, one that won’t allow military spending to spiral out of control as it did in Soviet times.
It’s worth noting that in Soviet times, manipulating public perceptions around defense was a well-used tool of statecraft. As the historian, Mark Harrison, has shown, throughout the Soviet period, Moscow tailored defense spending disclosures to manipulate Western perceptions for political advantage.59
Shifting costs off-budget allows Moscow to artfully craft a Goldilocks defense budget: large enough to menace, but small enough to be sustainable.
Here we arrive at the crux of the matter. Our analysis through Chapter 4 shows that Russia’s war costs are substantially higher than the budget numbers would suggest, and that much is being discreetly funded off-budget using state-directed bank loans. As before 2022, this off-budget funding gives Moscow flexibility in managing how much overall defense spending to channel through the highly scrutinized federal budget.
This flexibility has allowed Siluanov to artfully craft what might be called a “Goldilocks” defense budget: it’s big enough to be menacing, but small enough to appear sustainable. What’s more, it gives the impression of Moscow being “surprisingly resilient”—as some Western assessments have phrased it. Despite waging the largest European war in 75 years, having lost access to most of its sovereign savings and laboring under an extensive sanctions regime, Moscow’s publicly visible war finances appear unfazed: budget deficits are well below 2% of GDP, sovereign debt up only modestly and there seem to be no risks looming on the horizon.
This conjured image of risk-free resilience greatly enhances Moscow’s bargaining leverage
This image of risk-free resilience confers tangible advantages to Moscow since it greatly enhances Russia’s bargaining leverage in any prospective negotiations. Moscow appears able and willing to fight on indefinitely without jeopardizing the prosperity of its people. So, to persuade Moscow to stop fighting will require grievous concessions on the part of Ukraine and its allies.
We know now, however, that not everything is in the budget. To see the full picture of Moscow’s war finances, we must look at its off-budget funding as well. And when we do, this picture of risk-free resilience begins to change—in two ways.
First, the overall cost of fighting the war looks much bigger and not nearly so sustainable. Based on our estimate in Chapter 4, Moscow’s off-budget war debt is roughly the size of its on-budget headline defense allocation. If all that had been funded through the budget, the defense figure would have roughly doubled. The resulting budget deficits would have ballooned up 5.5% and 6.2% in 2023 and 2024 (using the mid-point of our estimate). Deficits would have accounted for a full quarter of the 2023 and 2024 budgets.
Could Moscow have managed? Probably. It’s likely it could have covered the deficits with debt. But the additional issuance needed would have been sizeable: 4.5 times more than it has so far issued since mid-2022 (see Figure 12). And total government debt today would be 137% above mid-2022 levels.
Figure 12
With numbers like that, efforts by Moscow to promote an image of risk-free resilience and sustainability would have gotten much less traction in the analytical community. And that would have translated into a weaker position at the bargaining table.
When we look beyond the budget at the totality of Russia’s war funding strategy, it’s not just more war costs we see. We also begin to see a new kind of risk—systemic credit event risk—emerging as a consequence of Russia’s heavy reliance on its off-budget credit scheme. It’s a significant risk and has the potential to weigh on Russia’s war calculus. We examine it in Chapter 6.
Chapter 6: A New Threat on the Kremlin’s Radar—Credit Event Risk
“The key rate’s record level is a serious brake on further industrial growth. It’s simply unprofitable for companies to borrow … If we continue to work like this, the majority of our enterprises will practically go bankrupt. I don’t know a single business with 20% plus profitability… Maybe there are some—drug trafficking or something. But even trading arms you can’t make that kind of profit.”
—Sergey Chemezov, Vladimir Putin’s former KGB colleague in Dresden and head of Russia’s largest arms exporter, Rostekh, addressing the upper house of Russia’s parliament, October 23, 202460
“Regulatory easing measures made it possible for banks to expand lending aggressively neglecting the need to maintain a more liquid asset structure and to additionally accumulate capital buffers.”
—Chair of the Central Bank of Russia, statement on raising the key rate to 21%, October 25, 2024.61
In late October, 2024, a high-profile industrialist very publicly raised the alarm over the threat of widespread corporate bankruptcies posed by interest rates.
“If we continue to work like this, the majority of our enterprises will practically go bankrupt.”62 That was the soundbite that made headlines across Russia on October 23, 2024. They were uttered by Sergey Chemezov, one of the lions of the Moscow elite, during a speech to the upper house of the Russian parliament. Chemezov is long-time associate of Vladimir Putin, having served together with him in Dresden in the 1980s.63 Now Chemezov holds the important position of CEO of Rostec (Rostekh), Russia’s sprawling state-owned arms conglomerate. Along with being Russia’s leading supplier of arms to the state, Rostekh is also Russia’s largest arms dealer. As such, Chemezov is both a beneficiary and victim of the state’s heavy reliance on off-budget debt funding for the war. Many of his innumerable subsidiaries have likely received preferential loans.64
But Chemezov was specifically complaining about how the high cost of debt is pushing his arms export into the red. Customers, he explained, pay advances of 30 – 40% on weaponry that can take more than a year to produce. A working capital loan would normally be used to fund the balance of production costs. But with debt capital costs above 20%, borrowing would wipe out his profits.
By late 2024, borrowing costs for companies had become prohibitively high, with yields on AA-rated corporate bonds at 27%, while BBB bonds topped 37%.
Chemezov was drawing attention to a growing problem. Since the start of 2024, the cost of corporate borrowing had been rising dramatically in Russia (see Figure 13). For blue-chip, AA-rated corporate borrowers, yields had risen from 14% to 27%. For BBB-rated borrowers, the increase was even steeper, surging from 16% to 37% by year end. With capital priced that high, few companies can borrow and make a profit.
Figure 13
These soaring rates are driven by several things. First, there’s the rising key rate. Then there’s competition for capital from state-backed preferential borrowers. And, finally, there are growing investor concerns over default risk. Bond buyers are concerned that such expensive debt can tip previously healthy borrowers into distress. And, so, they demand a premium to take credit risk on corporate borrowers.
To show a concerned public he was tackling the problem, Putin convened a top-level meeting on “the dynamics and structure of [Russia’s] corporate debt portfolio.”
Two days after Chemezov’s speech, on Friday October 25, the CBR hiked the key rate a record high 21%. The following Monday, October 28th, Putin convened a meeting of top officials dedicated to what he called “a sensitive and important topic for our business people… the dynamics and structure of [Russia’s] corporate debt portfolio” and corporate credit grew at (see Chapter 2).65 Chemezov’s concerns over corporate insolvency had clearly been heard. And with bankruptcy now in the headlines, Putin needed to reassure the public that he was on the case and would sort things out.
The CBR chair, Elvira Nabiullina, was the first to speak after Putin. We don’t, unfortunately, have a transcript of what she said, but judging by her numerous public statements at the time, we know some of what was on her mind.
The head of the CBR likely urged Putin to back her call to curtail state-directed preferential lending by arguing it was elevating two systemic risks in the economy: (i) inflation…
She would almost certainly have been seeking Putin’s support in pressuring the government to curtail its heavy reliance on preferential lending to fund the war. Later that week, she would say publicly that she was in active discussions with the government to find alternative ways to provide “state support” to companies.66
To persuade Putin of the need to find another way to fund his war, she would likely have cited two systemic risks that the state’s off-budget strategy was acting to elevate. One was inflation risk, which we noted in Chapter 2. Unchecked growth in corporate borrowing had, in the CBR’s view, become the primary driver of Russian inflation. And state-backed preferential lending had become, by the second half of 2024, the main driver of corporate borrowing. Preferential loans were “insensitive” to interest rate hikes and continued to grow despite tightening, thus fueling inflation. (see Chapter 2). On the continued use of rate hikes to battle inflation, Nabiullina and Chemezov were at odds.
… and (ii) credit event risk. High borrowing costs and deteriorating credit quality could lead to illiquidity and insolvency in companies and banks.
The second systemic risk was one that the CBR had been increasingly voicing alarm over. That was credit risk—the risk that high borrowing costs and the deteriorating credit quality of corporate borrowers and bank balance sheets could lead to problems with illiquidity, insolvency and bankruptcy.
The CBR head was worried about “the risk of over indebtedness of major companies”…
Here, again, Nabiullina would have drawn a direct line from Moscow’s excessive use of preferential lending to elevated levels of credit risk. In her November Duma address and elsewhere, she voiced “concerns” around the “consequences” of preferential lending. “Preferential borrowing is paid for… by ‘non-preferential’ borrowers (through borrowing at elevated market interest rates).”67 With so much preferential lending, she warned, “the risk of over indebtedness of major companies can start to grow.”68 And here Nabiullina and Chemezov shared the same concerns.
…but also that the easing of bank regulations in response sanctions had led banks to “lend aggressively” while “neglecting to maintain” adequate liquidity and capital buffers.
Nabiullina’s publicly voiced credit concerns didn’t stop with corporate default risk. She was also concerned about the state of the banks. On the surface, some of Russia’s banks appear to be doing very well. When interest rates are high, they can make good money by paying depositors several percentage points below what they charge borrowers. This boosts bank revenues.
But Nabiullina appears concerned that banks are managing their businesses imprudently and not recognizing losses when they should. The reason has to do with “regulatory easing.” This refers to a complex set of rules that the CBR sets to insure banks don’t lend too much, keep a close eye on the credit quality of their loan book, and maintain adequate capital and liquidity to withstand market shocks.
During the initial sanction of 2022, the CBR greatly relaxed regulatory policy, to help banks manage. Since then, however, the CBR had not managed to reimpose its standard policy. Now she was worried that the banks had taken advantage of lax oversight and taken on too much risk: “Regulatory easing measures made it possible for banks to expand lending aggressively neglecting the need to maintain a more liquid asset structure and to additionally accumulate capital buffers.”69
It wouldn’t be that surprising if banks took advantage of lax oversight to take excessive risks. But in fairness to the banks, some didn’t have full control over their loan book. With the February 2022 amendment to the Law on State Defense Procurement, the state had effectively taken over control of all credit decisions around defense-related lending. They were obligated by law to issue any defense-related loan on any terms the state might dictate. That could well have contributed to what the CBR deemed “aggressive” lending by the banks and the CBR’s concern over the legacy of 2022 regulatory relaxation. And Nabiullina probably raised this concern with Putin.
Worse still, a special regulatory waiver for problematic defense sector loans could make banks look healthier than they really are and prevent regulators from spotting trouble early
But there’s a deeper and potentially much more problematic issue with the banks arising from defense-related lending. One wonders whether Nabiullina dared to bring it up with Putin.
In the years prior to 2022, when the state was encouraging banks to participate in its preferential lending schemes to the defense sector (see Chapter 3), the Central Bank waived certain reporting and monitoring requirements for loans to defense-related borrowers.70 Lending to chronically distressed arms manufacturers posed a problem to banks, because many of these loans were likely to go bad. Even if banks were confident the state would eventually step in with a bailout, having problematic loans on the books is costly. Banks are supposed to monitor the financial health of their borrowers; if a loan starts to look “doubtful,” banks must make expensive adjustments to their reserves to offset the risk.71
Waivers, however, reduced the need to monitor the financial fitness of their defense-related borrowers and flag problematic loans as doubtful. For the banks, that’s a double-edged sword. On the one hand, if they don’t have to mark problematic loans as “doubtful” they are spared the very real costs. On the other hand, by not adjusting their reserves, they are exposing the themselves to greater risk of failure.
What’s more, not having to flag these problematic loans risks making the banks look healthier than it really is, misleading regulators (and the public). Indeed, the banks themselves may have a less accurate picture of their true risks, if they have reduced their monitoring of the financial health of defense-related borrowers.
That’s not such a big thing if defense-related lending is a small part of your loan book and the state will soon be stepping in with a bailout. That might have been the case prior to 2022, but that no longer seems to be the case. Banks appear to have been loaded up with a large amount of state-directed, defense-related loans (see Chapters 3 and 4). That means there could be a significant amount of credit risk in bank loan books that is not being accurately reported. That’s especially problematic for the Central Bank, since it can prevent it from spotting trouble at banks early on. That increases the risk that trouble at a bank could cascade into the market before the Central Bank has a chance to step in with a bailout.
As for the preferential borrowers themselves, they may struggle to repay their loans once the shooting stops, their contracts are cut and they have no more access to cheap credit.
Elevated credit risk arising from the state’s off-budget defense debt not only affects “real” economy companies and the banks. There are the preferential borrowers themselves—the companies providing war-related services to the state. They face major insolvency risk from the state’s off-budget policy—though it is likely to materialize only further down the road.
Under the state’s off-budget credit scheme, they remain the borrowers of record of a large amount of debt. Some may be doing well for the moment, thanks to a combination of state contracts and abundant credit at below-market rates. Others may be struggling to service their interest payments, despite the discounts.
The big question is: what happens when the fighting stops, war-related contracts get cut and it’s time to repay the principal on all this debt?
From this big question many others follow:
Will we see a wave of sector defaults start to occur as we did prior to 2022—only on a far larger and broader scale and encompassing not only core defense manufacturers, but a range of civilian companies enlisted into the war effort?
How long will it take the state to audit the true extent of the problem?
How quickly will the state move—or be able to move—to prevent contagion and protect the banks?
How great will the cost of a bailout be?
How will Moscow structure the bailout? Will it bail out the companies from the budget—as it did before? Or will it go down the bank recapitalization route?
If Moscow uses the budget, how will it fund the bailout? Through a big tax hike? Or heavy government borrowing?
The Kremlin now has a sense of the systems risks unleashed by its heavy reliance on off-budget war debt, and understands there are no quick fixes.
Thanks to Chemezov and Nabiullina, by November of 2024 Putin had begun to recognize the systemic credit risks Russia’s excessive reliance on off-budget war debt had unleashed. On more than one occasion, he would admonish Siluanov to exercise good judgement in how preferential lending was used. And he appears to be supporting Nabiullina in her crusade to replace preferential debt with equity funding—which would ease inflationary pressure.
But admonishments to Siluanov and encouraging more IPOs won’t fix the problem Moscow has created. With each passing week it seems, there are new signs of credit risk materializing. Company debt servicing costs are rising, consuming cashflows and pushing companies towards distress.72 Problems with arrears are on the rise.73 There is news of debt distress afflicting vulnerable sectors, such construction74 and retail shopping complexes,75 while the government is preparing rescue measures for the coal industry.76 And Russian economists forecast a wave of bankruptcies starting in the 2nd quarter.77
The insidious nature of credit risk makes it a more pressing problem than inflation or slowing GDP. That poses a financing dilemma that could weigh on Moscow’s war calculus
The scary thing about credit risk is its insidious nature. It is different from the slow-burn risks of declining GDP or even inflation. It’s more akin to seismic risk. You can sense when it’s building up, but you can’t predict when and where it will strike and with what intensity. All you know is that it has the potential to spin out of control quickly and be very disruptive.
And this poses a dilemma for Moscow. If it keeps relying heavily on off-budget debt funding, it increases the risk that a series of credit events erode its artfully crafted image of resilience and weaken its hand at the negotiation table.
So, what are the alternatives? The Kremlin can cut back on off-budget funding and shift more of its war costs onto the budget. That may be what’s behind the anomalous 14-fold increase in the January 2025 budget deficit.78 Shifting costs may ease inflationary pressure and credit risk a bit, but it can make Russia look weaker at the negotiating table.
Putin appears to understand that any solution starts with a big cut in defense spending—which can ease near-term risks.
The only real way to address these risks is to stop spending so much on the war. And it appears Putin now understands this—at least that’s the impression one gets from an apparently unguarded comment in his annual Ministry of Defense speech back in December. In his 2022 speech, a munificent Putin promised “no limits whatsoever on financing. The country, the government will provide everything the army asks for, everything.”79 Two years on, Putin was in a much more miserly mood as he scolded his generals: “we cannot keep pumping up [defense] expenditures to infinity.”80
In the medium-term, Russia’s large pool of hidden war debt is at risk of going bad, causing on-going problems for the state and risks to the banks.
If Russia slashes spending on the war, it will somewhat ease pressure on real-economy companies and the banks. But a large pool of hidden war debt will still remain on company balance sheets across Russia. Once the shooting stops, much of that debt will be at risk of turning toxic. We may see a repeat of the serial defense sector defaults of the decade before 2022—only on a far larger scale. If and when this debt does go bad, there will be many questions about how to deal with it and many risks—especially to the banks—the arise along the way.
Conclusion: Bonfire of the Cashflows
“Tick, tick, tick”
—Andrei Belyi, Petersburg
Wars are fought on cashflows—and Moscow has been steadily losing control over its three main sources of cash
Wars are fought on cashflows, not GDP. And the risks overhanging Moscow’s wartime cashflows have never been greater than they are today.
Going into the 2022 full-scale invasion, the Kremlin had three major sources to draw on for ready cash: (1) its sovereign wealth fund measuring in the hundreds of billions of dollars, (2) its all-important oil and gas export revenues and (3) the government’s domestic borrowing capacity.
One by one, however, each has become more fraught with risk or lost altogether, through a combination of Kremlin mismanagement and eroding effect of sanctions. And with those losses, the landscape of risk around Russia’s war finances has changed for the worse.
(1) in a remarkable blunder, the Kremlin lost control over most of its sovereign wealth savings early in 2022
The first cash source the Russian state lost control of—in a remarkable blunder—was its sovereign wealth savings. For years following its 2014 invasion of Ukraine, the Kremlin’s vaunted financial team developed its much heralded “fortress Russia” strategy, designed to render Russia invulnerable to future financial sanctions. Inexplicably, however, they left the vast majority of liquid wealth fund—some $300 billion in value—sitting on Western accounts, where they were promptly frozen in 2022. In an earlier day, such financial malpractice would have triggered accusations of “wrecking.”
(2) Its gradual loss of control over its all-important hydrocarbon revenues began with its self-inflicted and crippling blow to Gazprom that plunged the company into losses.
Moscow’s grip over its second source of cash—oil and gas export receipts—has also been significantly loosened, though the story with each is quite different. The more surprising story was gas, since this loss was self-inflicted. The Kremlin’s immensely ill-judged gambit to weaponize European exports in 2022 backfired spectacularly. Moscow enjoyed a short-lived revenue windfall, but at the expense of plunging its most important company into a cashflow crisis from 2023 on. European sales are simply irreplaceable; Russian sales are loss-making, while China offers no alternative on a meaningful scale. The once mighty Gazprom is now reduced to issuing ruble bonds now yielding 22% and higher to cover its shortfalls.
Oil sanctions have taken longer to bite, but are now effectively shrinking Russia’s shadow fleet and putting its oil revenues under greater pressure
Oil has been a more involved story of cat and mouse, though Moscow now looks poised to bow to the inevitable. Early on, Russia’s heavy reliance on tanker transport was identified as its critical vulnerability, its “Achilles heel.”81 The challenge was how to exploit that vulnerability to reduce oil revenues without triggering a destabilizing supply shock. Two years of moves and countermoves ensued, as Russia skirted price-cap sanctions by assembling a parallel “shadow” fleet at an estimated cost of over $10 billion. By early 2024, however, Western authorities had zeroed in on direct tanker sanctions as the most effective way to sideline Russia’s shadow fleet. By early 2025, they scaled up tanker sanctions, precipitating a Russian tanker crisis and deepening discounts on Russian crude.82
Moscow now faces a tanker dilemma. Buying more used tankers risks throwing bad money after good, given their vulnerability to targeted sanctions. But the alternative means relying more heavily on mainstream tankers, leaving oil revenues more exposed to sanctions. And it’s doubtful Moscow attempts to engineer a supply shock by withdrawing barrels from the market for any extended period. Higher prices would only invite OPEC and U.S. producers to step up production and steal Russia’s market share. What’s more, the Kremlin’s impotence in Syria has diminished its political clout in the region—along with Moscow’s ability to pressure regional producers to show OPEC+ solidarity, should Moscow decide to unilaterally cut exports.
(3) Moscow’s heavy reliance on its flawed scheme of off-budget borrowing has needlessly elevated insidious systemic credit risk, further limiting Russia’s war funding options.
The third troubled source of cash, of course, has been wartime borrowing—the focus of this report. The problem was not so much the borrowing itself—a more orthodox strategy of transparent, AAA state bonds issuances, supplemented with additional tax hikes, would have left Russia’s war finances in far better shape than they are today.
But Putin, a dissembler schooled in the dark arts of reflexive control, simply couldn’t resist the temptation to seek political advantage in financial deception. So, he took his already flawed credit scheme from 2010 and rendered it even more dangerous by imposing full state control over war-related bank lending and eliminating prudent reporting requirements on this debt. Then, as the war dragged on, he overused the scheme, fueling inflation and forcing interest rates to distress-inducing levels.
Now Russia is awash in insidious, systemic credit risk. Corporate distress levels are rising in the “real” economy. This will erode the credit quality loan books at Russian banks—made even riskier by poor visibility around problematic corporate war debt. And once the shooting stops, the time will come for a large-scale, politically perilous restructuring of toxic war-time debt.
Putin is now aware of the elevated credit risk and the dilemma it imposes, causing him frustration over the high costs of the war.
Thanks to Chemezov and Nabiullina, Putin is now aware of his credit risk problem and the funding dilemma it imposes. His frustration can be seen in the stark shift in his war-funding rhetoric seen in his annual speech to the Ministry of Defense. In 2022 he was promising his generals “no limits whatsoever on financing. The country, the government will provide everything the army asks for, everything.”83 By 2024, he admonished them saying: “we cannot keep pumping up [defense] expenditures to infinity.”84
The risk environment around the Kremlin’s war finances is deteriorating—especially because of rising credit risk. And this is likely to weigh on its war calculus in 2 ways.
The main finding of this report is that the risk environment around the Kremlin’s war finances is deteriorating—with insidious, systemic credit risk becoming a significant factor during the second half of 2024. And the Kremlin has become aware and concerned by this. This report doesn’t predict a coming crisis or a collapse in Russia’s ability to fund the war. But it does show how the risks of such a crisis have gone up significantly and will likely rise still higher if Moscow continues to rely heavily on its off-budget war-funding scheme.
The changing risk landscape around Moscow’s war finances will likely weigh on Moscow’s war calculus in a couple of ways.
(1) Moscow will be less inclined to believe time is on its side—the longer it must fund elevated war costs, the greater the risk that credit-related events weaken its negotiating leverage.
First, Moscow will be more inclined to believe time is not on its side. The longer it takes to achieve a ceasefire and the longer it must fund heavy war costs, the higher the risk of credit problems accumulating that dispel its image of “surprising resilience” and weaken its negotiating leverage.
Moscow will, no doubt, redouble its efforts to suppress bad news and project resilience. But serious credit risk can’t be fully suppressed—its telltales are all about. Like with Ableukhov’s timebomb in Petersburg, we don’t know how destructive it will be, but we know the timer has been set, and there’s no escaping its relentless ticking.
Ukraine and its allies will no doubt recognize that it’s not in their interest to appear in a hurry to get a deal. Moscow is painfully aware that it cannot match the combined resources of a resolute West in an extended test of wills.
(2) Moscow will prioritize sanctions relief aimed at boosting cashflows to help with politically perilous post-war debt restructuring and rearmament.
The state will no doubt try to hide from taxpayers just how much wartime borrowing there is to repay. To mitigate domestic political risks and speed rearmament, Moscow will no doubt prioritize Western concessions that deliver large boosts to its cashflows. These include an easing of oil sanctions, the return of Gazprom pipeline deliveries to Europe and—the Kremlin’s holy grail—the unfreezing of its wealth fund. In view of Russia’s financial challenges, Ukraine and its allies will, no doubt, recognize the immense leverage these cashflow constraints provide. And they will see the advantage of keeping these constraints fully in place until a final, comprehensive settlement—including reparations—has been secured.
Appendix 1: Credit Surge Raw Data
Appendix 2: Russia’s Evolving Business of War. Identifying War-related OKVED2 Industrial Sectors
CBR sectoral data allows us to broadly estimate the scale of state-directed preferential lending in support of the war effort.
To determine how material Russia’s off-budget credit scheme is to its overall war-funding strategy, we need a rough estimate of its size. We can make this estimate using sectoral lending data published by the CBR. It provides monthly corporate borrowing data for 78 distinct industrial sectors, based on Russia’s widely used OKVED2 classification system. These data reflect borrowing trends across a range of sectors from gambling to oil and gas extraction. They also provide us with a reasonable basis for making the broad estimate we need for determining the materiality of Russia’s off-budget war funding (see Chapter 4).
To use of these data in a methodologically rigorous manner, they are subjected to a multi-step process of qualitative and quantitative screening and risking.
To use these data in a methodologically rigorous manner, we need to screen out from the list of 78 industrial sectors those which are not relevant for our analysis. Additionally, where there is reasonable uncertainty, we need to apply a range of risking factors. To accomplish that, we follow a four-step process:
1. determine the scope of goods and services the state requires for prosecuting its war in Ukraine. That determination involves analyzing and adjusting for the transformational effect this war is having on the scale and scope of the state’s defense-related resource requirements as well as the evolving profile of the companies providing those resources;
2. apply a qualitative test to screen out sectors unlikely to be providing war-related resources in significant measure based on their functional profile;
3. apply quantitative tests to screen out companies unlikely to be receiving state-directed preferential loans on a meaningful scale; and
4. apply risking factors to sectors where we suspect there may be a mixture of war-related and non-war-related incremental borrowing.
This appendix details the first three steps of this process. It results in a list of 15 sectors which—based on both qualitative and quantitative screening tests—we can say with a reasonable degree of confidence (a) are likely to be providing the state with a significant level of war-related goods and services, and (b) appear to be receiving substantial amounts of state-directed preferential loans. The fourth step—the application of risking factors—is carried out in the estimation process detailed in Chapter 4.
An ancillary observation arising from the research for this appendix is the significant transformational effect this war is having on Russia’s defense-related economy. Not only has it significantly broadened the scope of goods and services required by the state for defense and substantially increased their scale, it has also changed the profile of companies providing these resources. In particular, it appears to have greatly expanded the role of civilian, private sector companies across all aspects of the war effort, from supply chain management to arms manufacturing, to operations services and even to the recruitment and fielding of fighting units.
In one of the ironies of this war, Vladimir Putin may have finally achieved—after a fashion—his long-sought goal of defense-sector “diversification” (диверсификация). Rather, however, than taking the form of defense enterprises diversifying into civilian lines of business, as Putin has long exhorted them to do, it has been civilian private sector actors diversifying into the defense business.
The creation of a Coordinating Council for resourcing the war in October 2022, with the Prime Minister in charge, was aimed at galvanizing this transformation
To determine the state’s scope of resource requirements for its war effort, we begin by examining how these resources are being organized. In October 2022, 8 months into the full-scale invasion, Russia significantly altered the administrative regime for provisioning resource requirements for the war. In that month, Vladimir Putin established an ad hoc interministerial body called the “Governmental Coordinating Council for suppling the requirements of the Russian Federation Armed Forces, other troops, military formations and bodies.” In includes top officials from a range of ministries and bodies, including the “power ministries” (силовые структуры), but is chaired by the Prime Minister and appears to be firmly under civilian control. According to its founding decree, it has full broad powers, with control over all aspects of resourcing the war, from contracts to resource allocation.85
It was set up after 8 months of disastrous performance by the Russian army, including retreats from Kyiv in the spring and the collapse of Russian lines around Kharkiv in September. Judging from his public comments on the rationale for establishing the Coordinating Council, Putin appears to have lost confidence in the military’s ability to oversee the coordination of resources for the war. As he explained at the November 2022 meeting of the Council:
“Let me remind you that we launched this [council] to radically improve the quality of coordination and the pace of work of ministries, departments, regions and enterprises - both in general, but also in the implementation of state defense procurement and in supplying the special military operation.”86
It is clear from much of Putin’s early commentary on the Council’s objectives that the early performance of Russian arms and equipment did not meet expectations, despite 15 years of rearmament funded by many trillions of rubles of investment. Consequently, there needed to be a root-and-branch change in how the war effort was being resourced.87
The civilian-led Coordinating Council has been invested with broad powers, including over contracts, contractors and funding.
For the purposes of this analysis—determining the scope of goods and services being resourced by the state—the establishment of the Coordinating Council reveals three things. First, a significant shift in the administrative coordination of defense-related resources. Prior to this full-scale war, much of the coordination of defense-related resources had been centered in and around the Defense Ministry. With the advent of a full-scale war, however, a far broader scope of resources would be needed. The Kremlin took the view that this coordination effort would be better managed at the senior-most levels of the government and led civilian ministers.
Moreover, it role would not be a purely passive one of monitoring. The presidential decree gave the Council broad powers over resourcing all aspects of the war effort and, most importantly, the power of the purse. It was given discretion over contracts, contractors, pricing and “the amounts and sources of financing” needed to pay for it all.88
The scope of resourcing overseen by the Coordination Council extended well beyond arms manufacturing to include a range of goods and services for operations, from construction services to transport and logistics.
Second, the scope their mandate is broad, reflecting the needs of a full-scale war. It ranges far beyond arms procurement and compensating personnel, which for years had been a primary focus of the Ministry of Defense. It includes supplying the full range of operational needs of a major land war, one in which Russia is occupying Ukrainian territories the size of Bulgaria and managing a 1,000-kilometer front line. The range of operations goods and services would be broad, and the presidential decree establishing the Council spells them out: among other things, medical and sanitary services, repair and restoration works, construction and installation works, provision of logistics, transport, etc.89
The Coordination Council has transformed the resourcing of the war by enlisting “countless” businesses from the private sector to provide everything from arms manufacturing to construction services to supply chain support.
The third thing of note about the Council is its explicit mandate to address the many shortcomings of the military industrial complex. Importantly, the Council has been explicitly instructed to engage companies from outside of the legacy defense sector to participate in arms production. Putin stated this clearly and emphatically in Councils inaugural meeting. In explaining the rationale behind establishing a new, ad hoc body to coordinate resourcing of the war effort, he says following “standard bureaucratic procedures” and “previously established standards,” would not yield results:
“To achieve a qualitatively new outcome, it is not enough to follow the beaten path - I have already said this several times - interacting only with a narrow circle of familiar actors... new manufacturers must appear - efficient, modernly equipped and ready to work in the required new format and produce the required quality of this or that product” [author’s emphasis].90
And these “new manufacturers” wouldn’t be limited just to arms production, itself. Putin says they should be sought out for a range of war-related production and services from “medicine production to the construction sector in the widest sense of the word.”91
In November 2022, Prime Minister Mishustin, who heads the Coordination Council, elaborated on Putin’s call to broaden the scope of companies engaged in the war effort. As the TASS headline read, “Mishustin calls for small and medium sized businesses to be engaged for supplying the Special Military Operation.”
"It is necessary to more actively involve a larger number of enterprises, including representatives of small and medium businesses, in the processes of supplying material and technical resources. Only a part of the production we need is of a closed nature, carried out by specialized enterprises. The rest can be mastered by private companies as well. For this, we need to provide them with technical specifications and design documentation” [author’s emphasis].92
Over the coming months, top officials from Putin on down comment on the novel and significant contribution of the private sector across an entire range of goods and services, from supply chain support to construction and civil engineering services to weapons innovation, design and construction.
During an address to the Ministry of Defense collegium in December 2023, Putin underscored the unexpected extent to which civilian technology and engineering businesses have been effectively drafted into the war effort:
“It’s important to further increase the delivery of the weapons most in demand, as I have said. This includes creating a production line of unmanned aerial vehicles from heavy attack vehicles to ultra-small vehicles. [It’s important] to attract high-tech businesses and engineering design companies into development and production. By the way, I want to thank them for this. Many private enterprises, which were previously far removed from the defense industry, have taken on various projects and are carrying them out – quickly, efficiently and with good quality. It’s simply terrific. Many, probably, didn’t even expect it” [author’s emphasis].93
Later in the same session, the then defense minister, Sergei Shoigu details the “colossal” effort involved in building out defensive fortifications along what he described as a 2,000 kilometer line of engagement in occupied areas of Ukraine. Even assuming Shoigu was padding the numbers, the engineering, construction and installation works he cites are substantial:
“Seven thousand kilometres of minefields, 1.5 million anti-tank Piramida-type barriers, 2,000 kilometres of anti-tank ditches, 12,000 prefabricated reinforced concrete structures, 3,000 platoon strongholds, 45,000 bunkers, and over 150,000 equipment hideouts.”94
While he praises the work of military engineers, he also acknowledges that civilian sector engineering firms had also been engaged in the effort “by decision of the Supreme Commander-in-chief” (i.e., Putin).95 That was probably a begrudging acknowledgement, since it was the machinations of another civilian sector contractor, the late Evgenii Prigozhin of Wagner Group notoriety, that had done so much to expose the limitations and inadequacies of the legacy defense establishment. Five months later, Shoigu would be replaced as Minister of Defense.
Finally, consider this statement by Anton Alikhanov, Russia’s Minister for Economy and Trade from August 2024. He is discussing the unprecedented expansion of resources now dedicated to military production. He starts by noting a sharp increase in the workforce at Russia’s traditional arms factories. But then he adds:
"And this does not take into account the civilian branches [of industry], which are also actively helping in terms of raw materials, components and other materials. Based on the most modest estimates, we have about 900 civilian enterprises engaged in the production of military and dual-use products. But in fact, the companies providing supplies to the defense complex are far greater in number. It’s simply impossible to count them all” [author’s emphasis].96
RIA Novosti, a state-owned news agency, went on to report that
“Alikhanov also emphasized that this synergy between the two branches of the manufacturing industries [i.e., civilian and military branches—author] is one of the factors behind the efficient implementation of the tasks set forth by the President to increase the production of weapons along with military and specialized equipment [author’s emphasis].”97
Western analytical literature also observes Russia’s increased reliance on both (i) civilian companies and (ii) foreign imports to resource the war, as supply-chains are fundamentally reconfigured.
The limitations of Russia’s military industrial complex and the outsourcing trends that ensued—both to domestic civilian companies and to foreign suppliers—are widely observed in recent Western specialist literature. As the team at CNA has shown, Russia’s traditional defense industry is facing significant constraints during the war, owing to years of underinvestment in modernization, a dysfunctional industry consolidation process, and a largely failed import substitution program.98 As Massicot and Connolly have argued, the lack of investment in productivity makes the traditional defense sector more vulnerable to the labor shortages we see today in Russia.99
And the team at CSIS has astutely noted “shifts in the military supply chains” towards more companies with “a principally civilian footprint.” They observe: “[Russia] has moved away from tailored high-end military components toward dual-use or even purely civilian technologies.”100
Western analysis has made similar observations about Russia’s growing dependence on imported machine tools, components and munitions—as important substitution has largely gone into reverse. The team at KSE exposed large scale patterns of parallel imports, as Russia sourced banned Western dual-use components through third countries.101 CNA has described how Russia has turned to cooperative foreign countries to address everything from shell hunger (North Korea) to custom machine tools (China), to advanced drone weapons systems (Iran).102 And the CSIS team has observed that with the evolution of Russia’s foreign supply-chain dependency, more Russian companies “with a principally civilian footprint [are] finding themselves on sanctions lists.”103 And many of the companies now being used to facilitate imports are not well-established import firms but likely shell companies.104
In short, since 2022 the business of war in Russia has been fundamentally transformed. Accordingly, we should think afresh about how to adjust our methods and practices for analyzing it.
Russia’s full-scale invasion of Ukraine marks the first protracted, full-scale foreign war Russia has fought in the post-Soviet period. Authority over resourcing the war has been placed in a newly formed body headed by civilians and sitting outside of the traditional power ministries. It has an explicit mandate to transform how things are done and, specifically, to integrate civilian private sector capabilities across the board. The scale and scope of resource requirements has been vastly expanded. The supply chains have been fundamentally reconfigured. The profile of companies engaged in defense activities has been transformed.
In short, the business of war has been fundamentally transformed in Russia from what it was just a few short years ago. As analysts, we should be alert to this and prepared to think afresh about how we adjust our practices, methods and perspectives. Here, it is worth recalling the recommendations offered by Eliot Cohen and Phillips O’Brien on how to enhance the quality of assessing a system as complex as Russia. We should broaden the range of skills, experience and analytical perspectives contributed to the discussion.105
That includes re-examining the scope of OKVED2 sectoral categories we consider when examining Russia’s war finances and not limiting ourselves just to legacy arms manufacturing.
Having surveyed the evolving resourcing needs for Russia’s war effort, we now turn to the second step in our evaluation process: screening OKVED sectors based on qualitative considerations. This involves examining the range of goods and services provided under each OKVED sector and identifying those that match the state’s war-related resourcing requirements discussed above.
We begin with four OKVED sectors that military analysts have used, by convention, as proxies for conducting longitudinal analysis of arms manufacturing economic activity during times of relative peace. They are:
#20 Production of chemicals and chemicals products;
#25 Production of finished metal products, except machinery and equipment;
#26 Production of computers, electronic and optical products; and
#30 Production of other transport vehicles and equipment.
These four categories represent the core of Russia’s legacy military industrial complex. Investment in and output from these sectors has risen significantly during the war. As we shall see, borrowing has likewise increased substantially. We can say with a high degree of confidence that these sectors are being heavily drawn on to resource the war effort. As such, they also provide us with a useful benchmark for some of our quantitative screening of other sectors.
Based, however, on the war-time defense-related resourcing needs of the state discussed above, these 4 categories alone do not begin to cover the full scope of goods and services being sought by the state. A few example suffice to illustrate. As we saw, civilian, private sector engineering and construction groups have been engaged by the state to help constructive the extensive fortification systems built in occupied Ukraine. One would not expect any state-directed preferential loans provided for those activities to be reflected in the figures for the 4 core legacy arms manufacturing sectors. They would likely be booked in one of several other sectors relating to construction and engineering.
And what of the extensive trade finance required for Russia’s rapidly proliferating cross-border supply chains? For example, intermediary companies facilitating the import of North Korean shells and missile, Chinese CNC machines and Iranian Shahed drone technologies will all need large amounts of trade finance and working capital. And as noted above, “countless” civilian companies have been newly engaged in facilitating these supply chains, including arranging the expensive business of parallel imports of sanctioned dual-use components through third countries. Under which OKVED category will loans to these import agents and facilitators be booked? Again, it is unlikely to be reflected in borrowing data for our 4 core legacy arms manufacturing sectors. Some of this trade finance lending, however, might be booked under OKVED2 code #46, which includes companies engaged in wholesale import trade activities for a broad range of goods other than motor vehicles and motorcycles.106
Based on analysis of the OKVED2 classification system and the stated resource requirements of the Coordination Council, we have identified 12 additional sectors that appear likely to be contributing a significant amount of goods and services to the war. They constitute our long-list of “other war-related” OKVED sectors. They are:
19-Production of coke and refining of oil products
41-Construction of buildings
42-Construction of civil engineering structures
43-Specialized construction work
49-Land and pipeline transport activities
24-Metallurgical production
46-Wholesale trade, except wholesale trade in motor vehicles and motorcycles
52-Warehousing and auxiliary transport activities
62-Computer software development, consulting services in this field and other related services
63-Information technology activities
71-Architectural and engineering design activities; technical testing, research and analysis
72-Scientific research and development.107
As noted above, it is almost certain that some of the incremental debt taken on by these sectors since mid-2022 is not war related. We correct for that in three ways: through the application of the two quantitative screening tests further below and by applying risking factors to our final list of “other war-related sectors” when carrying out estimation analysis detailed in Chapter 4.
Test #2: the time window test. Did the sector significantly grow its debt load both in absolute and relative terms during second tightening round, when state-directed, “insensitive” borrowers dominated?
The second test we apply is a quantitative one designed to confirm whether a given sector has been taking on substantial amounts of state-directed preferential debt. It takes advantage of what we learned from the Central Bank about the bifurcation of the corporate borrowing market during the second round of rate hikes, from August through October 2024 (see Chapter 2). As the CBR explained, incremental debt levels of sectors borrowing “at market” stopped growing; by contrast, incremental borrowing by sectors receiving state-directed preferential loans kept growing at high rates and in large amounts.
This market bifurcation allows us to conduct a “time-window” test that shows whether a sector has been receiving substantial amounts of state-directed, “rate-insensitive” debt. If it has been borrowing heavily between August and October and showing signs of steep growth in its overall outstanding debt levels during this period, it is likely to have been receiving state-directed preferential loans. This strengthens our conviction that these sectors have been providing goods and services for the war.
Figure 14 shows a distribution of all 78 sectors based on both absolute amounts borrowed and the relative change in the sector’s total debt during these three months. Our provisional list of “other war-related sectors” is represented by the red dots on the scatter plot. From this distribution, it is evident that all but 1 of our 16 provisionally short-listed sectors both (a) borrowed significant amounts during this period (>$300 million) and (b) saw significant 90-day growth in their outstanding debt (>3.5%) during this time window. By contrast, only 8 of the remaining 62 sectors cleared both these screening thresholds. As a result, 93.75% of our provisional short-list cleared the screening threshold demonstrating the likely presence of state-directed preferential lending, whereas only 12.9% of the remaining 62 sectors cleared the threshold.
Figure 14
Figure 15 shows this same data in tabular form for the top 25 sectors by size of incremental debt added. All sixteen of our provisional candidates make the top 25. One of these, “warehousing and auxiliary transport activities,” is the outlier. It has both borrowed a relatively small amount this period and shown only modest levels of overall growth in outstanding debt. For this reason, we are excluding it from our provisional list of other war-related sectors going forward.
Figure 15
The non-war-related sectors on this list make for informative reading. Seven of the 7 pass both our threshold tests. Nonetheless, they are excluded from our list for qualitative reasons. A few observations:
The list includes food related sectors—food production and fisheries—that would be expected to attract state-backed lending. While food is a core provisioning requirement for the war, these industries will be primarily serving the broader civilian population. Consequently, they are not included in our list.
This list also includes systemically important extractive industries, such as oil and gas and mining. There appears to be some state-directed lending to these sectors, especially for the construction of infrastructure. It is also possible that recent lending to the coal industry may be a state-directed effort to inject liquidity into a sector that is in financial distress according to recent reports.108 Again, however, these sectors are unlikely to be receiving state-directed loans to facilitate the provision of goods and services directly to the war effort. Hence, they are not included in our list.
Finally, there is the curious case of “head office activities; management consulting” which added an extraordinary $3.1 billion notching up 13.7% growth for the quarter. This may simply show that consulting is profitable in all markets. But there is another potential explanation. The Coordinating Committee may be enlisting consultants to help coordinate the highly complex supply-chain trade logistics around parallel imports and import diversification. And this borrowing number could reflect the large amount of trade finance and working capital that would be required to maintain these supply chains. To err on the conservative side, however, we are leaving them out of our list.
Based on the time-window test, then, we will not be adding sectors to our provisional list, but we will be cutting one: warehousing and auxiliary transport activities.
Test #3: back-testing borrowing growth trends for our newly included and excluded sectors against benchmark sectors.
Our data also reveal useful trends in longer-term growth in outstanding debt levels. Figure 16 shows long-term growth in outstanding debt for the 78 sectors broken into three groups:
First, there are the 4 core sectors associated with legacy arms manufacturing. They serve as a benchmark for borrowing trends by sectors heavily engaged in the war process and known to receive state-directed preferential loans.
Next, there are the “other war-related-sectors”—the 11 sectors that passed both our function and time-window tests.
Finally, there are the “non-war-related sectors” made up of the remaining 63 sectors.
Prior to mid-2022, the total debt in all three groups rose at roughly the same modest rate. But after mid-2022, growth in our 15 war-related groups surged, growing 2.7 times faster than the remaining 63 groups.
Moreover, our two war-related groups grew in remarkably close tandem with one another over this period. Outstanding debt levels for the 4 core arms manufacturers and the 11 other war-related sectors rose by 136% and 116% respectively. This sharply distinguishes the borrowing patterns of our 11 other war-related sectors from the 63 non-war-related sectors while closely associating them with our 4 benchmark sectors.
Figure 16
Applying our three screening tests, we have reduced our original 78 sectors to a list of 15 sectors that we can say with reasonable confidence (i) are likely to be providing a significant portion of goods and services to the war effort and (ii) appear to have been receiving substantial amounts of state-directed preferential loans (see Figure 17). These consist of the 4 core arms manufacturing sectors plus the newly tested 11 “other war-related” sectors.109
Figure 17
Endnotes
Kremlin.ru, December 21, 2022.
Kommersant, December 16, 2024.
Sebastian Horn, David Mihalyi, Philipp Nickol & César Sosa-Padilla, “Hidden Debt Revelations,” NBER Working Paper 32947, September 2024, http://www.nber.org/papers/w32947
Sebastien Canderle, “State Capitalism in Private Markets: Mission Creep,”CFA Institute, 2024;
Alami, I., Babic, M., Dixon, A. D., & Liu, I. T. (2022). Special issue introduction: what is the new state capitalism? Contemporary Politics, 28(3), 245–263. https://doi.org/10.1080/13569775.2021.2022336
See, for example, the June 2023 Gazprom ratings report by Ekspert RA.
Unless otherwise noted, the data sets on Russian debt are sourced from the Central Bank of Russia. Throughout this report, “corporate” borrowing data excludes borrowing by financial sector companies (eg., banks and insurance companies), which is reported separately by the Central Bank. Most of the data sets used in this report run through October or November of 2024. All numbers are nominal unless otherwise noted. Conversions to U.S. dollars, where provided, have been done at historical average monthly exchange rates. Budget numbers are sourced from the Russian Ministry of Finance. Where reference is made to GDP, it refers to Russia’s reported GDP for 2023, unless otherwise noted.
Julian Cooper, “Russian Military Expenditure: Data, Analysis and Issues,” FOI, September 2013.
Dara Massicot and Richard Connolly, Russian Military Reconstitution: 2030, Pathways and Prospects, Carnegie, 2024.
Tilly C (1975) Reflections on the history of European state-making. In: Tilly C (ed.) The Formation of National States in Western Europe. Princeton, NJ: Princeton University Press, pp. 3–89.
Unless otherwise noted, the data sets on Russian debt are sourced from the Central Bank of Russia. Throughout this report, “corporate” borrowing data excludes borrowing by financial sector companies (eg., banks and insurance companies), which is reported separately by the Central Bank. Most of the data sets used in this report run through October or November of 2024. All numbers are nominal unless otherwise noted. Conversions to U.S. dollars, where provided, have been done at historical average monthly exchange rates. Budget numbers are sourced from the Russian Ministry of Finance. Where reference is made to GDP, it refers to Russia’s reported GDP for 2023, unless otherwise noted.
CBR, November 19, 2024.
CBR, October 31, 2024.
Central Bank of Russia, Osnovnye napravleniia edinoi gosudarstvennoi denezhno-kreditnoi politiki na 2025 god i period 2026 i 2027 godov, October 2024, p. 97.
CBR, November 19, 2024.
CBR, September 13, 2024.
CBR, July 26, 2024 (Q&A).
CBR, October 31, 2024.
Central Bank of Russia, Osnovnye napravleniia edinoi gosudarstvennoi denezhno-kreditnoi politiki na 2025 god i period 2026 i 2027 godov, October 2024, p. 99-100.
Central Bank of Russia, Osnovnye napravleniia edinoi gosudarstvennoi denezhno-kreditnoi politiki na 2025 god i period 2026 i 2027 godov, October 2024, pp. 86, 97.
CBR, July 26, 2024 (Q&A).
CBR, July 26, 2024 (Q&A).
Central Bank of Russia, Osnovnye napravleniia edinoi gosudarstvennoi denezhno-kreditnoi politiki na 2025 god i period 2026 i 2027 godov, October 2024, p. 98, footnote 2.
Kremlin.ru, October 28, 2024.
Федеральный закон от 25 февраля 2022 г. N 29-ФЗ "О внесении изменений в Федеральный закон "О государственном оборонном заказе"" (Federal Law dated February, 25 2022, No. 29-F3 “On the introduction of amendments to the Federal Law “On State Defense Procurement””) in Rossiiskaia Gazeta, March 1, 2022, point 91. For the amended passage in the current version of the law, see article 8.2, section 2, point 9.1 at legalacts.ru.
Федеральный закон от 25 февраля 2022 г. N 29-ФЗ "О внесении изменений в Федеральный закон "О государственном оборонном заказе"" (Federal Law dated February, 25 2022, No. 29-F3 “On the introduction of amendments to the Federal Law “On State Defense Procurement””) in Rossiiskaia Gazeta, March 1, 2022, point 91. For the amended passage in the current version of the law, see article 8.2, section 2, point 9.1 at legalacts.ru.
Rossiiskaia Gazeta, March 1, 2022. For the text of this commentary, see: https://sozd.duma.gov.ru/bill/44740-8?ysclid=m6r3yfipp8219727820 .
Voennoe obozrenie, March 14, 2011. For background on the period, see Susanne Oxenstierna and Bengt-Göran Bergstrand, “Defense Economics” in Carolina Vendil Pallin (ed.) Russian Military Capability in a Ten-Year Perspective – 2011, FOI, 2012.
Postanovlenie Pravitel’stvo RF ot 31.12.2011 No. 1215, https://www.law.ru/npd/doc/docid/499069927/modid/99
See revisions to the Postanovlenie Pravitel’stvo RF ot 31.12.2011 No. 1215, https://base.garant.ru/12181810/
Statement by the chairman of the Duma Defense Committee, December 23, 2010. See also https://sozd.duma.gov.ru/bill/473287-5?ysclid=m6shc3e4h81876152
RIA Novosti, October 17, 2016.
RIA Novosti, October 17, 2016. See also Aleksei Zatsepin’s commentary in Kommersant, October 17, 2016, and RBC, October 17, 2016.
RBC, Oct 16, 2017.
RIA Novosti, October 17, 2016.
RBC, Dec. 21, 2020.
Совещание по финансовому оздоровлению организаций ОПК [Meeting on the financial recovery of the Military Industrial Complex enterprises], Kremlin.ru, October 16, 2019.
Vedomosti, January 20, 2020; RBC, Dec. 21, 2020; RBC, January 23, 2020.
RBC, December 6, 2018.
RBC, Dec. 21, 2020. See also RBC, August 16, 2021.
RBC, Dec. 21, 2020.
Julian Cooper, “Russian Military Expenditure: Data, Analysis and Issues,” FOI, September 2013.
See VPK, February 20, 2013; Aleksi Päiväläinen & Karoliina Rajala, “Competitiveness of Russia’s Defence Industry: Weak but Steady. Analysis of Economic Indicators,”National Defense University, Department of Warfare, Series 3, Working papers No. 16, Helsinki, 2020; Lugacheva, L. I. and Solomennikova, E. A. “Finansovo-khoziaistvennye disbalansy kompanii oboronno-promyshlennogo kompleksa I funktsional’naia podderzhka gosudarstva” in Ekonomika, predprinimatel’stvo I pravo, vol. 10, no. 12, 2020, pp. 3249-3268; RBC, Dec. 21, 2020; and Pavel Luzin, “Russia’s arms manufacturers are a financial black hole,” Riddle Russia, January 30, 2020.
The literature speaks of the lack of “an adequate mechanism for price formation and the existence of extremely low prices for defense industry products.” See Lugacheva, L. I. and Solomennikova, E. A. “Finansovo-khoziaistvennye disbalansy kompanii oboronno-promyshlennogo kompleksa I funktsional’naia podderzhka gosudarstva” in Ekonomika, predprinimatel’stvo I pravo, vol. 10, no. 12, 2020, pp. 3249-3268. For more anecdotal discussions of the issue, see also: Novaia Gazeta, July 21, 2019, and Nasha Versiia, no. 28, July 29, 2019. Former finance minister, Alexei Kudrin, who reportedly left his job because of his opposition to the expanded rearmament program, alludes to the pricing problem in comments made in 2012, see Republic.ru, May 28, 2012.
VPK, February 20, 2013.
RBC, Dec. 21, 2020. RBC, August 16, 2021.
Sebastian Horn, David Mihalyi, Philipp Nickol & César Sosa-Padilla, “Hidden Debt Revelations,” NBER Working Paper 32947, September 2024, http://www.nber.org/papers/w32947.
RIA Novosti, October 17, 2016.
Tass, October 11, 2011.
Pavel Luzin, “Russia’s arms manufacturers are a financial black hole,” Riddle Russia, January 30, 2020.
RBC, January 23, 2020.
Pavel Luzin, “Russia’s Military Industry Forecast 2023-2025,” Foreign Policy Research Institute, April 30, 2023.
There is a decades-old debate among analysts and scholars over how to measure Russia’s military expenditures. This report does not aim to engage in that debate beyond observing that a substantial portion of those expenditures are structured as off-budget loans and, therefore, not visible in the state budget.
For the purposes of benchmarking the materiality of off-budget, defense-related lending, we are prorating headline annual defense budget figures. Military analysts frequently use the headline number for the budget chapter on defense as a benchmark from which to build a higher, adjusted defense estimate. Since, however, there is no conventional formula for these adjustments, estimates vary significantly from analyst to analyst. For that reason, we are adhering to the published headline figures.
It's important to note that not all defense spending is going towards prosecution of the war; it’s war-related spending, however, that is our primary concern. So, there are both upward and downward adjustments that we could make to our benchmark “defense budget allocation” item. It seems unlikely, however, than any reasonable adjustments to this benchmark would fundamentally change materiality analysis in this chapter.
The following are some of the report consulted while preparing this report. They contain many valuable insights into the defense budget and related matters: Julian Cooper, “Russia’s Military Expenditure During its War Against Ukraine,” SIPRI, June 2023; Julian Cooper, “Another Budget for a Country at War: Military Expenditures in Russia’s Federal Budget for 2024 and Beyond,” Stockholm International Peace Research Institute, 2023, Richard Connelly’s section in Dara Massicot, “Russian Military Reconstitution: 2030 Pathways and Prospects,” Carnegie Endowment for International Peace, September 12, 2024; Michael Kofman and Richard Connolly, “Why Russian Military Expenditure Is Much Higher Than Commonly Understood (As Is China’s),” War on the Rocks, December 6, 2019; Pavel Luzin, The Russian Military’s Inflation Paradox, December 7, 2023; Pavel Luzin’s various publications in the Eurasia Daily Monitor, such as “Russia Releases Proposed Military Budget for 2025,” Eurasia Daily Monitor, vol. 21, issue 143, October 3, 2024, as well as his collaboration with Alexandra Prokopenko in “Pushki vazhnee vsego. Chto proekt biudzheta—2024 govorit o prioritetakh Kremlia,” Carnegie Berlin Center, September 29, 2023 (which appears to be far more detailed than its companion English language piece published at that time); Erik Andermo and Martin Kragh, “Defence Expenditures, Secrecy and State Programmes in the Russian Federal Budget: A Closer Look at the Data,” Stockholm Center for East European Studies, June 11, 2024; Janis Kluge, “Update on Russian Military Spending,” Russianomics, December 6, 2024; Dmitry Gorenburg, Samuel Bendett et al., “Crafting the Russian War Economy. The Effects of Export Controls on Russia's Defense Industrial Production,” CNA, 2024; Olena Bilousova et al., “Challenges of Export Controls Enforcement,” KSE Institute, January, 2024; and Boris Grozovski, “Russia’s Unprecedented War Budget Explained,” in The Russia File (Kennan Institute), September 7, 2023.Additional valuable insights into the sanctions and the Russian economy can be found, among other works, in: Oleg Itskhoki and Elina Ribakova, “The Economics of Sanction: From Theory in to Practice,” Brookings, September 2024; Ben Hilgenstock, Yuliia Pavytska, Vira Ivanchuk et al, “Russia’s Economy at the End of 2024: Weak Ruble, Growing Macro Imbalances, Economic Management Increasingly Challenging,” KSE Institute, December 2024; and a range of valuable, on-going research on the Russian economy by the team at the Bank of Finland.
The CBR sectoral data do not cover the bond markets, which make up around 14% of total corporate debt outstanding. Consequently, our off-budget debt estimate does not account for any state-directed preferential borrowing in the bond market. The sole exception are the Rostekh 1.5% bonds which amount to ₽358.4 bln. These are included since they constitute a clear case of state-supported, preferential lending through the bond market. The entire issue has been purchased by the state using money from the Nation Wealth Fund (see note below). The CBR sectoral data cover ruble bank loans (which make up 88% of total corporate bank lending) but not loans in foreign currencies. Because it is very likely that businesses involved in war-related import operations are making extensive use of state-directed foreign currency bank loans, our estimate is grossed up slightly to account for these. It is assumed that the share of our two war-related sectoral groups in the foreign currency bank loan markets is the same as what we have observed in the ruble bank loan market. If anything, that is likely to be a conservative estimate.
Harrison, Mark. (2008). “Secrets, Lies, and Half Truths: The Decision to Disclose Soviet Defense Outlays,” PERSA Working Paper No. 55.
Pavel Luzin, The Russian Military’s Inflation Paradox, December 7, 2023.
Harrison, Mark. (2008). “Secrets, Lies, and Half Truths: The Decision to Disclose Soviet Defense Outlays,” PERSA Working Paper No. 55.
Sovet Federatsii, October 23, 2024.
CRB, October 25, 2025.
Sovet Federatsii, October 23, 2024.
Belton, Catherine. Putin's People: How the KGB Took Back Russia and Then Took On the West. United Kingdom, Farrar, Straus and Giroux, 2020.
In 2023, Russia’s largest arms conglomerate, Rostekh, was given permission to issue ruble bonds on the local market to fund a ₽42 billion shortfall in a “civilian” airline development program (around $460 million at the time). See Vedomosti, December 26, 2023. In December 2023, 15-year bonds were offered—but with a suspiciously low, fixed coupon of 1.5%, at a time when the key rate was at 16%. Curiously, all the bonds were taken up. Then something even more curious happened. Over the next 12 months, another 7 issues were placed, on the same terms, for a total of $3.97 billion in proceeds (see the Moscow Exchange). Who was buying? The mystery was solved when the Ministry of finance published data about the holdings of the National Wealth Fund. They revealed that the state had used money from the wealth fund to buy up all of the Rostekh bonds. See Ministry of Finance, January 16, 2025.
Kremlin.ru, October 28, 2024.
CBR, October 31, 2024.
Central Bank of Russia, Osnovnye napravleniia edinoi gosudarstvennoi denezhno-kreditnoi politiki na 2025 god i period 2026 i 2027 godov, October 2024, p. 98.
CBR, November 19, 2024.
CBR, October 25, 2024.
RBC, December 6, 2018; Garant.ru, “Regulation of the Bank of Russia dated June 28, 2017 No. 590-P ‘On the procedure for the formation by credit institutions of reserves for possible losses on loans, loan and equivalent debt’" (Положение Банка России от 28 июня 2017 г. № 590-П "О порядке формирования кредитными организациями резервов на возможные потери по ссудам, ссудной и приравненной к ней задолженности").
Regulatory rules require banks to keep track of the quality of the loans on their books by watching out for early signs that a loan might be getting into trouble. This often includes measures such as monitoring key cashflow indicators at the borrowing company and keeping tabs on the status of its other outstanding loans. If too many warning bells go off, the bank must reclassify the loan as “doubtful.” Banks don’t like doing that, because regulations require them to take the costly measure of adjusting their liquidity and capital to compensate for the additional risk.
Forbes Russia, January 27, 2025.
Vedomosti, November 2, 2024.
RBC, January 16, 2025.
Kommersant, November 1, 2024.
RBC, January 17, 2025.
Lenta.ru, January 27, 2025.
Reuters, February 11, 2025.
Kremlin.ru, December 21, 2022.
Kommersant, December 16, 2024.
See several related essays and reports at Navigating Russia.
Julian Lee and Alex Longley, “Russian Oil Tanker Fleet Severely Hobbled by Last Month’s US Sanctions,” Bloomberg, February 13, 2025; Julian Lee, “Russia Faces an Impending Oil Tanker Crisis as Sanctions Pile Up: Oil Strategy,” Bloomberg, February 7, 2025.
Kremlin.ru, December 21, 2022.
Kommersant, December 16, 2024.
Decree of the President of the Russian Federation dated October 21, 2022, No. 763.
Kremlin.ru, November 24, 2022.
Kremlin.ru, October 25, 2022, and November 24, 2022.
Decree of the President of the Russian Federation dated October 21, 2022, No. 763.
Decree of the President of the Russian Federation dated October 21, 2022, No. 763; RBS, October 19, 2022.
Kremlin.ru, October 25, 2022.
Kremlin.ru, October 25, 2022.
TASS, November 22, 2022; NTV, November 22, 2022.
Kremlin.ru, December 19, 2023.
Kremlin.ru, December 19, 2023.
Kremlin.ru, December 19, 2023.
TsAMPTO, August 12, 2024.
RIA Novosti, August 12, 2024.
Dmitry Gorenburg, Samuel Bendett et al., “Crafting the Russian War Economy. The Effects of Export Controls on Russia's Defense Industrial Production,” CNA, 2024.
Richard Connolly, in Dara Massicot, Russian Military Reconstitution: 2030, Pathways and Prospects, Carnegie, 2024, pp. 53-54.
Maria Snegovaya, Max Bergmann et al., ‘Back in Stock? The State of Russia’s Defense Industry After Two Years of the War’, CSIS, April 2024, pp. 14, 39.
Olena Bilousova et al., “Challenges of Export Controls Enforcement,” KSE Institute, January, 2024.
Dmitry Gorenburg, Samuel Bendett et al., “Crafting the Russian War Economy. The Effects of Export Controls on Russia's Defense Industrial Production,” CNA, 2024.
Maria Snegovaya, Max Bergmann et al., ‘Back in Stock? The State of Russia’s Defense Industry After Two Years of the War’, CSIS, April 2024, p. 40.
Maria Snegovaya, Max Bergmann et al., ‘Back in Stock? The State of Russia’s Defense Industry After Two Years of the War’, CSIS, April 2024, p. 21.
Eliot A. Cohen, Phillips O’Brien, “The Russian Ukraine War: A Study in Analytical Failure,” CSIS, September, 2024.
As one further explores the range of businesses that have been mobilized into the war effort, a number of curious classification questions arise. Which OKVED2 classification code, for example, is being used for economic activity around the various private military battalions and mercenary groups engaged for this war? For example, how are Gazprom’s two corporate battalions being coded? Under #6 “Oil and natural gas extraction?” Or what about the Wagner Group? Was it perhaps coded under #56, which covers catering services?
Most of the items on this list will be self-explanatory. One bears commentary: refining of oil products. Russia’s refining plant plays a dual military and civilian role, providing critical fuels for both sectors. It has been subject to extensive aerial attack by Ukrainian drones and appears to have suffered significant levels of attrition in a range of distillation units. In the second half of 2024, the sector showed a distinct insensitivity to rate hikes, taking on $3.9 billion in new debt during the course of the second rate-hike round from August 2024 through October 2024. This amounted to 11.8% quarterly growth in debt outstanding, suggesting that the sector may now be receiving substantial amounts of state-directed preferential lending for vital repairs. Given that the refineries are deemed military targets and are providing fuel for the military sector, we are including it in this list.
Kommersant, January 20, 2025; The Bell, January 23, 2025.
One additional observation. We should also be alive to the possibility that the CBR and Rosstat may recognize loan data differently. For example, the CBR is likely to recognize a loan to a transportation company as a transportation sector loan whether that loan is provided to the group holding company for general corporate purposes or to a project-related company for project finance.
When, however, Rosstat provides the source of capital used in additions to fixed capital, if may classify that debt differently from the CBR. Where debt is provided by a bank directly to a project company where the capital investments are being made, the source of those funds appears to be recognized as “bank debt.” By contrast, if acompany borrows cash for general corporate purposes through a holding company or special purpose financing vehicle and then downstreams that cash to a project company where capital expenditures are made and booked, Rosstat may be recognizing those funds as “company funds” rather than “bank debt.”Consequently, we must be cautious in any conclusions we draw from Rosstat data pertaining to sources of funding. It may misleadingly classify debt capital as company funds.
Disclaimer: No Advice
The author of this substack does not provide tax, legal, investment or accounting advice. This report has been prepared for general informational purposes only, and is not intended to provide, and should not be relied on for tax, legal, investment or accounting advice. The author shall not be held liable for any damages arising from information contained in the report.
© Copyright 2025, by Craig Kennedy. All rights reserved.
As someone living in Moldova, I'd LOVE to believe Russia is approaching economic collapse.
What happens next?
I've been reading reports that the war was economically unsustainable since just after it started, but still it continues. So what are the signs that the breaking point has been reached, what should we look for to see that the final stage has been reached? And what would that collapse look like?
Loved the in depth analysis, but I'd love to see "what happens next" even more.