Down But Not Out: The Russian Economy Under Western Sanctions

Introduction

No matter the outcome of ongoing ceasefire negotiations over the war in Ukraine, Russia will remain an acute security threat to Ukraine, Europe, and the United States. The sanctions tool kit will remain among the most potent weapons to contain Russian power, and specifically the ability of the Russian state to marshal its resources for conventional military confrontation. The Western sanctions regime imposed on Russia in the wake of its full-scale invasion of Ukraine in 2022 had clear successes, even if the threat of these sanctions failed to stop the invasion itself. However, its effectiveness has also had undeniable limits, and often unintended consequences. Through technocratic skill, its wealth of natural resources, and the slow-moving and inconsistent implementation of Western sanctions, Russia has had the time and capacity to adapt to the sanctions challenge over the last three years. This reality means that some of the sanctions imposed on Russia will offer diminishing returns over time.

This piece will provide an overview of Western sanctions policy toward Russia as it currently stands, outlining its largest successes and clearest shortcomings, as well as articulating new ways to apply acute pressure on Russia, should the Kremlin choose to open some sort of new front in its effort to undermine Western commitment to limiting Russian aggression.

Part I of the paper covers the initial impacts of the sanctions regime on the Russian economy. Next, Part II runs through the lessons Russia learned from the sanctions imposed in 2014, and how these lessons were applied in 2022. Part III of the paper addresses the question of how Vladimir Putin may have ultimately decided to move forward with his full-scale invasion of Ukraine, despite the economic risks. Part IV then turns to the ways the Kremlin has taken advantage of Russia’s wartime economy, the unique impacts of international sanctions, and its domestic political dominance to further strengthen its position at home. The paper concludes with recommendations for those tasked with implementing future sanctions policies.

Sanctions policy should not be framed as a suite of punitive measures that retroactively punish Russia for past bad behavior, but should instead be used as a coherent strategy of economic containment designed to weaken Russian power, and decisively and quickly bring Russia to the negotiating table in the event of future bad behavior. In this vein, sanctions practitioners should head back to the drawing board and try to think of new and creative ways to rapidly constrain Russia’s material ability to project power in a moment of crisis.

Part I: The Onset of the 2022 Sanctions Regime and Its Impact on the Russian Economy

Oil and Fiscal Engineering

The sanctions imposed on Russia at the start of its full-scale invasion of Ukraine targeted three main pillars of the country’s economy. Firstly, by disconnecting most Russian banks and companies from international finances and freezing Russian sovereign, corporate, and private foreign reserves, the United States and its allies hit the Central Bank of Russia’s ability to support the ruble, cross-border trade, and Russia’s capital account, thereby closing the doors for capital to easily enter or leave the country. Secondly, they targeted the import of goods and services, on which Russia continues to depend. Thirdly, the sanctions targeted Russian energy exports, the crucial source of government income.

Russia based its economic defense on massively stimulating fiscal spending and actively keeping capital from exiting the country. Sanctions gave the Kremlin political cover to keep capital from leaving Russia via the stick of capital controls and the carrot of an overnight spike in domestic interest rates. Western bans on Russians making European stock investments and deposits in European banks, as well as overcompliance on the part of Western financial institutions, helped stymie the kind of massive capital flight that could have put a heavier strain on the ruble and Russia’s balance of payments. In contrast, when the People’s Bank of China launched a surprise devaluation of the renminbi in 2015, concerns over the value of renminbi-denominated deposits and ensuing capital flight led to a $1 trillion drop in Chinese foreign exchange reserves as the central bank fought to defend the yuan. Nothing of the sort happened in Russia in early 2022.

One of the most effective capital controls put in place by the Russian government was the requirement that Western firms operating in Russia pay any dividends or proceeds from the sale of their assets into special “type-C” accounts domestically, thereby seizing these assets and keeping their value onshore. Effectively, the people who paid for the freezing of Russia’s sovereign reserves were foreigners who had invested in Russia.

The West and the Kremlin, albeit with opposite intentions, effectively combined their efforts to keep capital inside of Russia.

Russian oil and gas revenues, collected by the state through taxes, were the primary source of maintaining financial and social stability for years. They accounted for over half of federal budget revenue in 2011–2014, while dropping to as low as 28 percent in 2020 due to a sharp decline in prices amid the Covid-19 pandemic. Oil was more critical for the economy than gas. Russia’s energy export strategy was based on the principle that oil exports are more important for income, and gas exports are more important for political influence, especially in Europe.

The Russian finance ministry had developed a system called “the fiscal rule” to mitigate the volatility of the international energy market. In a nutshell, the rule worked as follows. The government sets a specific oil price derived from a long-term historical series on which it balances the budget. If the oil price or, rather, the revenue denominated in rubles exceeds the planned level, all of the extra income should be converted and directed to the rainy-day National Wealth Fund (NWF). The central bank, acting on behalf of the finance ministry, buys the dollars in the domestic market to sterilize extra revenue and prevent the ruble from over-strengthening. If the price of oil drops, a decline in fiscal revenue is partially mitigated by a weakening ruble and partially by the sales of the dollars from the abovementioned fund.

This clever fiscal engineering prevented ruble swings, smoothed out inflation, and supported domestic industry by weakening the currency. On the whole, before 2023, the “base” oil price was consistently lower than the actual oil prices, thus creating a constant flow of savings to the fund. This conservative policy proved to be wise during the 2020 slump, as the fund’s usage helped mitigate the negative consequences of collapsing oil sales. Intentionally or not, the freeze of the central bank’s foreign reserves, which included part of the National Wealth Fund’s liquid assets by the West, reduced this Russian ability to moderate swings in the value of the ruble.

Another blow to the fiscal books came from the breakdown of oil sales. Facing sanctions, Europe’s gradual refusal to buy Russian oil, and an imposition of the so-called price cap, Russia started shifting sales to Asia—primarily India, China, and Turkey. The price cap mechanism provides a compromise between the European readiness to stop Russian oil and the U.S. eagerness to keep Russian oil flowing to prevent a rise in gasoline prices, of which crude represents a much higher share than in Europe due to lower taxes. The price cap allows Western insurers, brokers, shippers, and other relevant parties to sign contracts for Russian oil only if its price doesn’t exceed the cap. It also allows the nonparticipating buyers to haggle a discount on the market price.

These measures resulted in a discount at which Russia sold its oil, although this was offset by overall higher global prices in 2022 and 2023. Moreover, the reported discounts, as it turned out, were driven more by the tax regime, ill-fitted for the new reality, than by the actual Russian income from oil exports.

Responding to the issue within its tax structure, the Russian government acted swiftly. Today, the tax collected from oil no longer depends directly on the reported, easy-to-distort, realized price of exported oil. The fiscal oil revenues are defined by the global price of oil and the amount produced. Oil companies’ incomes still depend on their sales and costs, which affects the amount of corporate taxes they pay, but this revenue is incomparable to direct fiscal oil revenue.

Russia’s hardships increased as the West, notably the United States, launched a sanctions campaign targeting specific oil tankers transporting Russian oil outside the price-cap mechanism. Fear of U.S. secondary sanctions has prevented buyers from India or China from servicing black-listed vessels. In turn, Russia has shopped for more tankers, but the procurement and bureaucratic concealment of each additional tanker has become more expensive. This dents oil companies’ revenues and threatens the overall fiscal revenue from oil. However, these measures against the tankers came into force in 2024, which was too late to have a material effect on Russia’s state finances during its military transformation.

With oil revenue under control and stopgaps on draining the NWF removed, Russia started to spend. It suspended the “fiscal rule,” abandoning a self-imposed spending limit and allowing almost all of its oil revenue to be spent rather than keeping part of it in the NWF. It has also allowed itself a wider fund usage, particularly in terms of plugging the fiscal deficit.

The Kremlin has tightened its grip on the economy by distributing the newly available fiscal money on state (primarily military) procurement and subsidized loans.

In the past years, such a surge in spending would have resulted in a rise in capital outflow through higher imports, rubles conversion, and foreign asset purchases. This time, the Western sanctions on exports to Russia and on Russian investment, the Russians’ fear of unpredictable asset freezes in the West, and overscrupulous compliance practices of Western banks, on the one hand, and the decline in imports due to the sanctions and Russia’s capital control measures on the other, kept the money at home. Even if Russians want to move their funds to countries that do not participate, or only partially participate within the Western sanctions regime—such as Turkey, Armenia, or the United Arab Emirates—they still face difficulties. While, of course, leakage occurs, its scale remains limited, and by no means constitutes a panicked, systemic capital flight.

The lack of capital flight and the government’s unprecedented fiscal stimulus, designed to turbocharge the country’s wartime production, resulted in the unexpected growth of the Russian economy. According to the International Monetary Fund, in real GDP terms the Russian economy suffered a modest 1.2 percent decline in 2022, with 3.6 percent growth in 2023. The Russian government announced further growth of 4.1 percent in 2024. Russia has also seen an unprecedented boom in real wages and internal investment.

Military Keynesianism

Government spending has been transferred to the general public and businesses via state contracts, budget transfers, and social handouts. Salaries started to grow steadily in 2023 after a slump in 2022, and a little more than a year into the war, they registered double-digit inflation-adjusted growth. In 2024, salaries went up 17.8 percent in nominal terms and 8.7 percent in real terms compared to 2023. Despite the high borrowing rates and a steep rise in government-regulated tariffs, disposable incomes shot up 6.1 percent in 2023 and 7.3 percent in 2024, setting growth records not seen in almost two decades. This unprecedented rise in incomes started to slow down in the second half of 2024, but it remains well above Russia’s historic average. 

This fiscal-fueled rise in living standards is expected to continue, albeit more slowly, in the coming years. In its budget projections, the government expects real salaries to rise 7 percent in 2025, 5.7 percent in 2026, and 4.1 percent in 2027—a far cry from the peaks in 2024, but still twice as high as they were in the decade before the invasion.

The growth in salaries and war-fueled demand resulted in growing corporate and private borrowing despite prohibitively high rates. Corporate borrowing has experienced significant growth since 2022. Developers were borrowing to fund housing construction projects, supported by state-subsidized mortgages, while transport, military production, and IT firms led the way thanks to government-subsidized loans.

A new kind of borrower now plays a prominent role on the Russian credit market. Given high rates, individuals with enough cash on hand are incentivized to place their funds into interest-bearing accounts, while using access to preferential loans—either through corporate channels or benefits from participation in the war effort—to cover expenditures. In the first quarter of 2024, lending to the population doubled, with a slight decrease only coming at the end of the year with the winding down of a national subsidized mortgage program.

In the years before the war, the Russian government tried but failed to convince businesses to stop stockpiling reserves that they used to fund large dividends. Businesses, however, complained that the investment climate was not ideal, tax policy lacked predictability, and the state was too overbearing. Now, everything has changed. Western sanctions and Russian efforts have made moving large amounts of capital outside the country next to impossible. On the other hand, there is a growing demand for capital amid limited production capacities. This has resulted in an investment boom not seen in years. Capital investment (expenditure on new construction, higher-tech equipment for enterprises, purchase of new kit, etc.) stood at 9.8 percent year-on-year in 2023, which exceeded inflation, and 7.4 percent in 2024, a quarter below the inflation rate.

A rise in incomes and lending has fueled a consumer boom. This, together with military procurement and investments, has resulted in higher economic growth rates, which has generated more taxes for the state coffers. However, one may call this economic growth a growth of the wrong kind.

A major factor behind the GDP growth is consumption, fueled by rising salaries. The Kremlin boasts record-low unemployment levels, but Russia is facing the most severe workforce crisis in its post-Soviet history. Prior to the war, Russia already had a declining number of workers due to natural demographic causes. The Labor Ministry predicts that, by 2030, Russia will be lacking 2.4 million workers. Mass emigration in 2022 has also deprived the labor market of about three-quarters of a million Russian and foreign workers, mainly in IT, finance, and management. Secondly, the Russian army is recruiting tens of thousands of working-age men per month. While the Kremlin remains reluctant to impose another round of mobilization, the army has to compete with all other employers.

Russia’s natural population decline was traditionally balanced by migrant labor. However, migration in 2023 was at its lowest level since pandemic-hit 2020. The number of migrants shot up almost fourfold in 2024, reaching the highest level seen in 25 years. However, there has not been a rise in the number of actual migrant workers, but instead a much stricter electronic registration system was introduced in 2024, enabling more accurate data. Following the March terrorist attack on Moscow’s Crocus City Hall, Russia imposed tighter checks on migrants entering the country, and there was aggressive anti-migrant rhetoric from officials. Given Russia’s long-term demographic challenges, combined with battlefield casualties and war-induced emigration, Russia’s demographic crisis only appears set to worsen.

However, there is a rising demand for workers in the military industry. Defense sector companies have hiked salaries to attract workers, and other companies have been compelled to follow suit. This fuels inflation, leading the Central Bank of Russia to raise interest rates in response. Those who enjoy state-subsidized borrowing rates are not impacted; for the rest, the future looks grim. This results in dislocated growth—production of everything defense-related is rising, while the rest of the economy is nearly stagnating.

Higher productivity could have partly resolved the workforce problem. However, that would have required a technological breakthrough, which has been thwarted by the continued and tightening restrictions on technological exports to Russia.

Further fiscal spending would contribute more to inflation than growth, slowing down the latter to below the pre-war average and aggravating the lack of synchronicity between monetary and fiscal policy inside the Russian economy today.

Russia has survived the first years of the economic war with the West by mortgaging its future and stockpiling its financial resources in advance.

Part II: The Lessons Russia Learned from the 2014 Sanctions Regime

The Kremlin started building its “Fortress Russia” foundations just after the global financial crisis of 2008. Back then, the Kremlin and Russia’s main industrialists reached an unwritten compact by which the former agreed to financially back the crisis-stricken industries in exchange for the latter’s refusal to fire workers. While political factors were the primary drivers of this interdependency, it has reduced Russian dependence on Western capital and tied corporations closely to the Kremlin, resembling a form of quasi-nationalization. This came in handy 15 years later.

Nevertheless, the role of international capital remained significant in Russia. Most large companies had international investors and lenders, and foreigners owned about a quarter of the country’s domestic debt at the time of the full-scale invasion.

Before the launch of the full-scale invasion, one of the main points of discussion in the United States regarding sanctions was a restriction on investing in Russian debt, such as through purchasing Russian sovereign or corporate bonds domestically and on international debt markets.

The earlier sanctions only barely touched the public debt—before the full-scale war, international companies could not buy the Russian government’s domestic and foreign debt on the primary market (i.e., directly from the issuer), although nothing prevented them from doing so through an intermediary. Over time, however, corporate Russia came to gradually reduce its reliance on foreign capital.

On several occasions, the U.S. Congress unsuccessfully considered a complete ban on holding, trading, and investing in Russian debt. The Russian finance ministry considered an eventual ban on buying new debt highly probable, but a blanket ban on all debt less so. Nevertheless, the crawling rate of sanctions before the onset of the full-scale invasion contributed to lower capital outflow, and the ministry saw enough cash in the country to borrow domestically for its conservative fiscal needs if the worst came to pass.

Unlike in the 1990s, Russia’s need for foreign capital over the last quarter century was limited thanks to its status as a surplus country. But international investors were still drawn to the Russian market by prudent monetary and fiscal policies in line with the “Washington consensus,” which outweighed the potential political risks. Foreign investors continued to invest in Russia despite the state’s growing authoritarianism, drawn by what they perceived to be a stable and balanced economic climate. Between 2014 and 2022, roughly one quarter to one third of all Russian domestic debt, both corporate and sovereign, was owned by foreign investors.

Another dependence Russia has managed to reduce is that of imported food. As food constitutes the lion’s share of the Russian consumer basket, any sharp rise in the exchange rate caused by an oil price slump translates into high consumer price inflation. Russian protectionism of its agricultural sector in response to the West’s 2014 sanctions aided in this effort to insulate Russian consumers from a Western food cutoff. By closing the market for almost all Western foods and subsidizing local production, the government reduced the share of imported food in retail by half—down to 18 percent—in 15 years.

Russia also developed a national payment system and decreased the dollar share in its sovereign reserves.

Furthermore, following the onset of the 2014 sanctions, Russia continued to expand the role of the state in the economy and maintained an increasing appetite for dirigisme, combined with conservative fiscal policy, an open capital account, and a fully convertible ruble.

The earlier batch of sanctions was imposed by the United States and its allies in 2014 in response to Russia’s annexation of Crimea. Limited in scale, the sanctions were primarily intended as a warning of more brutal consequences if Moscow did not change its policy. This was also the purpose of the public warnings the United States sent to Russia before the full-scale invasion in 2022. Another purpose of the threat of personal sanctions was to pull the oligarchs and top managers away from the Kremlin, which on the whole has failed.

The eight years of sanctions between the annexation of Crimea and the full-scale invasion reduced the inflow of Western money into the country; the sanctions also created financing problems for some banks and oil companies. However, similar to weak antibiotics, which over time allow for the growth of more resilient bacteria, the limited sanctions aided Russia in preparing for the larger confrontation of 2022.

On the other hand, the meekness of the 2014–2021 sanctions policy and the Kremlin’s belief that the West would not risk its economic well-being created a lackadaisical attitude toward economic warfare at the top echelons of much of the Russian political class. However, as Russian tanks started rolling into Ukraine and the West dramatically expanded its suite of sanctions, the Russian business and political elite had no choice but to rally around Putin.

Russia’s economic strategy had been based on keeping the economy’s commanding heights under the Kremlin’s control while keeping the rest of the economy relatively open for foreigners. This created a potent lobbying force against any bold moves against Russian assets abroad, which could have resulted in reciprocal seizure of the foreign assets by the Kremlin.

In the years leading up to the full-scale invasion, the Kremlin remained skeptical about potential Western moves against its commodities exports if geopolitical tensions increased. Botched U.S. sanctions in 2018 against Russian aluminum giant Rusal, which caused a dislocation on the global market and were revoked, must have strengthened this belief.

Russia saw its energy export as a win-win game vis-à-vis potential sanctions. The United States had no appetite for removing about 10 percent of oil from the global market, which would have caused a spike in domestic gasoline prices. On the other hand, any attack on pipeline gas exports would have been met with opposition from the European Union. Consequently, Russia didn’t prepare its logistics, taxation, and financial infrastructure for the loss of the Western market and for the “pivot to the East.” Almost three years into the war, Russia has not replaced European gas market demand with either expanded liquified natural gas (LNG) shipments or increased gas exports to China. Today, Russia’s state-owned gas giant, Gazprom, once one of the world’s most profitable corporations, is a loss-making company.

Equally, conversations with high-ranking figures within the Russian state have confirmed that the Kremlin did not believe in a joint Western move to attack its sovereign assets and banking system. More than half of Russia’s reserves had been parked in Western countries, demonstrating the Kremlin’s belief that even if it moved on Kyiv, its back-up financial firepower would not actually be a target of Western governments. On this front, however, the Kremlin grossly miscalculated.

Part III: Putin Thought His Full-Scale Invasion Was Worth the Risks

On the one hand, given the important but limited impacts of the post-2014 sanctions on the Russian economy writ large, it is not surprising that Putin concluded that he could launch his full-scale invasion of Ukraine in 2022 with the possibility of not actually facing serious economic consequences. The West’s previous measures had been narrow in scope, and were often haphazard and inconsistent in their implementation. Fundamentally, trade between Russia and Europe remained robust, and the Kremlin’s continuing cultivation of Western “fellow-travelers,” not only at the edges of the European political spectrum but amongst some of its foremost industrial and business leaders, meant that Russia maintained an outspoken cohort of supporters who could be relied upon to advocate against a cutting of economic ties with Moscow from within the European Union’s own market and capitals, particularly when it came to Russia’s cheap energy supplies.¹

Putin had reason to feel confident that any large-scale drive into Ukraine, coupled with a well-timed wave of concurrent disinformation, could prevent Western leaders from taking the harshest steps against Moscow. Additionally, if the reported intelligence Putin was receiving from his spymasters was correct and the Ukrainian state would collapse in just a few days following a serious Russian effort at regime change, then the Kremlin could present the West with a fait accompli in Ukraine, further disincentivizing the leveling of sanctions as a means of reversing Russia’s advances.

On the other hand, reporting has made clear that Putin was consistently warned by some of his closest economic advisors that the war, and the ensuing sanctions and economic fallout that would follow, would be devastating for the Russian economy. A number of the regime’s prominent technocrats, central bankers, and more liberally inclined magnates apparently cautioned against the 2022 invasion, even personally briefing the Russian president on their dire concerns in the weeks running up to the full-scale invasion.

Ultimately, it would appear that unlike Putin and his closest associates, the technocratic wing of the regime found the threat of a more widespread application of sanctions promised by the Western leadership to be credible, and concluded that this time around, the Western coalition would not allow Moscow to get away with its land grab as easily as it had in 2014 (when the earlier round of Russia sanctions did not seriously kick off until July 2014, following the downing of the MH17 passenger jet over eastern Ukraine). Their warnings to Putin—the only decisionmaker whose opinion mattered—fell on deaf ears.

Putin appears to have concluded that the risk of sanctions and economic fallout, even if they were to be as devastating as the technocrats feared, were worth the geopolitical gains that victory in Ukraine would provide. Like beauty, state interests are in the eye of the beholder. Leaders who weigh the varying definitions of successful statecraft differently will choose different paths for their polities to pursue. Whereas the technocrats and systemic liberals within the Russian regime may have seen the pathway to greatness through Russia’s acceptance and inclusion within the Western-led international community, participation in the international financial system, and a security policy predicated on diplomatic engagement, Putin may have concluded that the state’s interests were best pursued through decisive military power and trade with fellow nations who bristled at the perceived constraints of the Western-dominated international system.

Those who believed the threat of massive economic sanctions alone could deter Putin’s invasion did not properly understand how the Russian leader perceived his state’s interests, underestimated the importance of ideology in his decisionmaking, and overestimated the analytical competence of the Russian intelligence agencies informing the president on the state of affairs inside Ukraine.

Historian Stephen Kotkin has argued that the greatest surprise discovered within the Soviet archives when they were opened after the Soviet Union’s collapse was that the early Soviet leaders spoke in private in the exact same ways they spoke in public—that is, their ideological convictions were sincere, and impacted the way they viewed the world. Relatedly, historian James Harris persuasively argued that throughout much of his time in power, Stalin—the cloistered dictator—formed his perception of global affairs and foreign relations in large part through the constant stream of intelligence reports he received. The agents and analysts writing these reports and responding to the political incentives within the Soviet system often fed their higher-ups the information they wanted to hear, which in turn only reinforced preexisting formulations and ideological predispositions.

While any direct comparisons between Putin and his predecessors in the Kremlin risk analytical imprecision, it would appear that in his belief that war in Ukraine would be met with quick victory, Putin fell into the same trap of ideologically inflected miscalculation reinforced by bad intelligence that had previously bedeviled Stalin. While some of the information Putin was receiving—for example, that his troops in Ukraine would be greeted across the east and south of the country as liberators—was clearly false, that does not mean it did not sincerely impact his cost-benefit analysis of an invasion, or his understanding of Russian state interests.

Beyond the limited deterrent effect of the 2014 sanctions, the faulty intelligence fed to Putin, and the clouding effect of his regime’s ideology upon his own decisionmaking process, Putin could have been influenced by an additional factor—the idea that the costs of Russia’s isolation after a full-scale invasion would be outweighed by the domestic political benefits the regime stood to inherit from an ensuing rally-around-the-flag effect, an increased opportunity to justify further crackdowns on domestic dissent, and the cultivation of economic interest groups directly profiting from the war’s prosecution. While this final claim is purely speculative, its arguments have been borne out by ongoing domestic developments in Russia, particularly within the economic sphere.

Part IV: The Power of the Purse, or How the Kremlin Has So Far Managed to Strengthen Its Wartime Domestic Position

It would be a gross understatement to say that the Russian economy of today faces long-term challenges. With its access to key technologies and components either restricted or constrained by inflated prices connected to the costs of importing under sanctions, Russian companies in many cases lack the materials needed to build the competitive industries of the future. Additionally, with the Russian economy essentially cut off from the U.S.-dominated international financial system, Russia’s capacity to raise capital on international markets remains curtailed.

However, at least in the short to medium term, in many ways the Russian economy has weathered the storm dramatically better than expected. Despite predictions that the economy could collapse when faced with the onslaught of sanctions, it has not only endured, but adapted to the challenge. Growth rates remain impressive, and while inflation remains a serious concern, the technocrats running the Russian central bank and ministry of finance have remained determined enough in their efforts to keep the problem controllable, at least for now. Continued Russian profits from hydrocarbon exports allowed the Russian state to postpone and limit the kinds of spending trade-offs the sanctions regime was designed to cause.

Furthermore, the Kremlin has effectively used the context of economic war to write a new domestic social contract for Russia’s political economy—one that economically strengthens the regime’s internal allies and weakens its opponents. In sum, the Kremlin has used the unique wartime economic climate to enrich existing loyalists and build a coalition within society that directly benefits from the war’s different revenue streams.

At the lower end of the economic spectrum, the Kremlin has made enlistment economically attractive through large signing bonuses and competitive salaries, along with survivors’ benefits paid to the families of soldiers killed in battle. As money pours into the country’s industrial base, domestic defense companies are able to offer high salaries, particularly in Russia’s depressed regions, which draws workers into the state’s military procurement effort. Due to Russia’s aforementioned labor shortages, workers find themselves in a uniquely advantageous position, leading to the real wage growth described above. Russia’s working classes are now an interest group directly benefiting from the war’s continuation.

A parallel process of enrichment has played out within the upper echelons of Russian society. First, the turbocharging of investment into defense and national security has provided elements of the Russian elite with lucrative defense opportunities as defense contractors. Additionally, wealthy Russians who support the state’s war effort have found themselves in pole position to receive the spoils of Western asset seizures. As part of its response to Western sanctions, in particular the seizure of Russian state and private assets by governments backing Ukraine, the Russian government has effectively frozen Western assets stranded in Russia, as well as engineered forced sales at massive discount to well-connected Russians willing to toe the party line.

Just like with Russia’s lower classes, the Kremlin has used the dramatic changes forced on the Russian economy by the war and sanctions to strengthen its power base within the Russian elite—by rewarding loyalty and seizing assets from anti-war business leaders driven from the country by their refusal to kowtow politically. One prominent example is the case of Oleg Tinkov, former owner of Tinkoff Bank, who claims he only received 3 percent of the market value of his bank shares after he was forced to sell off his assets after speaking out against the full-scale invasion. With sanctions limiting the opportunities for Russian wealth to move abroad, the Kremlin has functionally achieved a long-held goal dating back to the 1990s—the reshoring of Russian oligarchic wealth. Combined with an effective purge of Russian society’s system-liberals, the war has provided the Putin regime with the opportunity to build a new class of stakeholders invested in the system’s durability and success.

Since the start of the war, Russia has witnessed the most significant redistribution of property since the massive privatization of the 1990s. While many of the assets involved belonged to foreign companies leaving Russia, this redistribution was not limited to those assets alone.

According to the Kyiv School of Economics and Yale’s Chief Executive Leadership Institute, more than 1,000 transnational companies, or about two-thirds of all the foreign companies monitored by these researchers, either left Russia or suspended operations following the full-scale invasion of Ukraine.

After the invasion of Ukraine, Russia installed capital controls for foreigners to keep capital from leaving the country. In April 2023, Putin signed a decree that enabled the state to take over the management of any asset owned by a company from an “unfriendly” nation. Later, the government installed draconian conditions to prevent foreigners from departing the Russian market. Foreign companies that want to sell their assets must receive permission from the Kremlin and then must sell at a 60 percent discount before paying a 35 percent tax, leaving them with 5 percent of the market price after the latest installment of the exit law. Additionally, others have left due to pressure from shareholders and politicians at home.

The fire sale of Western assets left behind inside Russia has allowed Russian businessmen with the right political connections to seize the moment and make a major profit. For instance, The Bell, an independent Russian news outlet, found 41 different businessmen benefiting from the Western asset bonanza who had each acquired assets with a pre-war valuation of at least $1 billion. In 2021, the combined revenues of the previously Western-owned companies came in at $32 billion. Many of the prominent figures cashing in on this asset reshuffle are not the most prominent oligarchs, but rather middle-tier operators who make up a new pillar of support for the regime and its aggressive foreign policy. These include partners Alexander Varshavsky and Kamo Avagumyan, who have taken advantage of the exodus of Western firms from Russia to purchase the major Russian car plants previously owned by both Volkswagen and Hyundai. Describing the opportunity at hand in 2022, Russian oligarch Vladimir Potanin emphasized, “Foreign investors have left us so much that you just have to pick it up.” Potanin directly benefited from the French bank Societe Generale’s exit from the Russian market.

However, and more importantly, the scramble for assets didn’t stop at foreign-owned property. The extreme political conditions of wartime have allowed the state to break the taboo of not radically reconsidering the results of the 1990s privatization, except in cases of perceived political disobedience, such as that of Mikhail Khodorkovsky’s energy firm, Yukos. In September 2023, the state seized methane producer Metafrax Chemicals after a Russian court ruled that the 1992 privatization of the firm was actually illegal. At the same time, in the occupied territories of Ukraine, the Russian administration started to nationalize the property of those who had left. In 2024, the Duma was considering seizing the property of disloyal émigrés. In terms of redistributing private assets inside Russia, the war opened up Pandora’s box.

According to research by a Russian law firm, NSP, at least 85 companies have been nationalized by the courts since 2022. In many cases, it took the courts just a day to decide in favor of nationalization. Not a single such decision has been overturned. The Kremlin is not redistributing these assets to buy loyalty, given that the beneficiaries are chosen for their record of loyalty to the regime. Rather, the Russian leadership wants to concentrate property in the hands of proven loyalists to send a warning to Russian business figures who might consider breaking ranks.

In sum, all of these domestic economic changes have institutionalized an outright rejection of the path to Westernization offered by a development model rooted in the new consensus that emerged in Russia following the collapse of the Soviet Union. This rejection of economic collaboration with the West is coupled with a symmetrical economic pivot to the East—to trade with China, often denominated in renminbi—proving a critical lifeline to Russia’s war effort, and broader macroeconomy. Today, we see the formulation of an alternative political economy of Putinism that empowers certain sections of society, and certain segments of the ruling elite, over others, and generates a new narrative of legitimacy for the Putin regime.

Policy Recommendations

No matter the ultimate conclusion of the Trump administration’s ongoing efforts to negotiate a quick settlement to the end of the conflict in Ukraine, the topic of sanctions relief will likely continue to be brought up by the Russian side as a precondition for any sort of peace deal. Heading into negotiations on potential sanctions relief, the Trump team will need to be strategic in its approach. Sanctions still play a critical role in stunting Russia’s economic power, and therefore should not be removed without tangible concessions from the Russian side. No matter the ceasefire agreement signed between Ukraine and Russia, the Putin regime’s words and actions make clear that it remains committed to long-term, strategic, and direct confrontation not just with Ukraine, but also the United States and its Western allies.

Trump-backed negotiators should zoom out, head to the drawing board, and weigh each element of the current sanctions strategy without prejudice before making any concessions to Moscow. Individual sanctions policies that have proven less impactful could be traded, but sanctions that directly impede Russian efforts to develop and expand its war machine, along with sanctions that apply pressure to Russia’s current account, the country’s main economic weakness at this point in time, should not be relaxed.

The following are specific policy recommendations for shaping a targeted and effective sanctions policy toward Russia within the current context of ongoing negotiations to end the war in Ukraine:

• Sanctions and export controls on key technologies, components, and dual-use goods should remain in place. These are the items that Russia desperately needs to reconstitute its military in the wake of any sort of ceasefire. Given the direct danger that reconstitution will pose to both Ukraine and its European allies, any weakening of these sanctions must be a nonstarter. As recent history has shown, these banned goods will still find their way into Russia, but at a much higher cost, extending pressure on the Russian economy and current account.
• Any sanctions removed from the Central Bank of Russia must be regularly reviewed, perhaps every six months, with the threat of “snap-back” sanctions on the central bank remaining in place. In the event of a Russian violation of the ceasefire with Ukraine, or a parallel thrust to undermine Western security, the return of these sanctions must be immediate.
• Sanctions on certain noncritical industries, like Russia’s civil aviation sector, could be traded over the course of negotiations, but technologies that help Russia make critical industrial investments for the future, like in its nascent LNG industry, should remain in place.
• Few Western firms with effective compliance teams should want to make significant investments into the Russian economy while the current leadership remains in power. The risk of geopolitical instability impacting profits, in addition to the threat of outright nationalization, should be a powerful deterrent. Therefore, nominally removing existing penalties on Western firms investing in permitted Russian sectors could be allowed without too much worry of a return to the kinds of robust EU-Russian trade that took place before 2022. While it could have some positive effect on lowering inflation inside the country, the trade in consumer goods will face stiff domestic resistance from those who benefit from the closed market, and also will aid in capital outflow from Russia to the West while not directly benefiting the military-industrial complex.
• It seems unlikely that Russia will agree to any sort of settlement that does not remove Western sanctions that are impeding Russian hydrocarbon sales. However, given the critical role these revenues play in the broader Russian macroeconomy, Western negotiators should bargain hard on this front. A full removal of sanctions would be a mistake. But a concession on raising the oil price cap, and removing certain recently sanctioned Russian banks that process these transactions, could be a compromise. It is key that U.S. policymakers keep in place some sort of easily expandable mechanism to limit Russian hydrocarbon revenues in the future, even if its effectiveness will be limited. As recent discussions on returning certain Russian banks to the SWIFT financial messaging system have demonstrated, the European Union will have the potential to limit the removal of certain penalties placed on Russian financial institutions. Brussels should use its influence to ensure that any concessions offered to Russia are met with worthy concessions from Moscow.
• Russia’s frozen central bank reserves remain a valuable carrot the West could use to force Russia to fund at least part of Ukraine’s reconstruction. Western negotiators should stick to the European Union’s political declaration that those funds will remain frozen until Ukraine is satisfied with a future damages settlement with Russia. Western negotiators should tie the future of Russia’s frozen central bank reserves to a post-war Ukrainian reconstruction settlement, in addition to the release of Western assets frozen and nationalized within Russia. The European Union is unlikely to seize the funds outright given concerns for the potential repercussions, but there remain persuasive and creative mechanisms to leverage the assets’ total value as a means to financially support Ukraine’s defense and reconstruction.
• Western policymakers should work to increase the labor strain on the Russian economy. This could be done by easing the process of professional emigration from Russia—with a focus on engineers, technical experts, and postgraduate students—while removing unusual restrictions against Russians already settled in the West. While this does raise the risk of hostile Russian actors infiltrating Western societies, all policies require trade-offs. Western officials should try to balance the need to limit the inflow of potential Russian intelligence assets with the desire to heighten the contradiction between Russia’s strained labor supply and Russia’s raging labor demand.
• Additionally, when it comes to increasing the strain on the Russian labor market, Western policymakers should work with Central Asian governments and financial institutions to limit the flow of migrant workers to Russia by directly attacking the flow of remittances from Russia into Central Asian financial systems. Central Asian laborers could be encouraged to work in other countries that are allies of Ukraine and its coalition partners.
• The West’s strategy to economically contain a revanchist Russia should try to prevent Russia from waging future wars by kneecapping Russia’s efforts to restock its financial war chest and reconstitute its military forces. If a return to hostilities were to break out after a previously agreed-upon ceasefire and sanctions relief, the West should learn from the limitations of its expanded sanctions regime launched in 2022, and instead launch a rapid, full-on attack on Moscow’s ability to process financial transactions associated with commodity exports, with a focus on speed and severity.
• In the above scenario, coordinated overnight sanctions on the Russian energy and banking sectors could trigger massive capital flight out of the Russian economy. Rather than stopping that money from flowing out of the country, Western financial institutions should keep avenues open to accept it. Western governments should encourage financial institutions to accept these funds into their coffers and avoid overcompliance that could hamper this process. The Central Bank of Russia will most likely have to respond with rapid capital controls, stemming the flight—but then they will have to bear the political cost of doing so domestically, such as promoting black market activity, the stockpiling of cash, and pressure from business elites. This situation would differ from that of 2022, where Western banks’ refusals to receive Russian outflows allowed the central bank to relatively quickly and quietly remove most of the limited capital controls they had put in place at the outset of the war by the summer. Sanctions on Russian export sectors must be maximalist, coordinated, and launched simultaneously. This risks a spike in the global price of oil, but any gradualist approach would allow Russia to adapt as it has from 2022 to 2025. For maximum effectiveness, energy sanctions should be paired with attacks on other key components of Russia’s suite of key export products—minerals, metals, agricultural goods, and fertilizers, many of which face the risk of long-term price declines on the international market as the commodity price boom of the 2020s fades and market conditions begin to look more like the period of commodity price drops of the 2010s. Furthermore, with the ongoing threat of extended trade wars putting downward pressure on the price of oil, Russia’s revenues from hydrocarbon sales may be entering a period of acute stress.
• Western policymakers would need to develop contingency plans to avoid a sharp rise in food prices in the Global South and for key mineral inputs for European industries. Given the Russian economy’s dependence on importing expensive sanctioned goods, any direct attack on Russia’s hard currency-earning exports combined with massive capital flight, if severe enough, could lead to a balance-of-payments crisis in the following months. This kind of acute financial breakdown, more so than the more slow-gathering burst of a credit bubble, would more likely force Russia to back down from whatever aggressive maneuver had triggered the snap back of the sanctions regime in the first place.

The goal of any smart sanctions strategy toward Russia should not be to cause economic disruption as an end in itself. Rather, the goal should be to create economic problems so severe that they generate enough social tension to force the Kremlin to back down or face serious domestic unrest. It should be noted, however, that without proper sanctions buy-in from key countries such as China, India, Turkey, and the United Arab Emirates, this kind of scenario will remain difficult to bring to fruition.

Nicholas Fenton is an associate director and associate fellow with the Europe, Russia, and Eurasia Program at the Center for Strategic and International Studies in Washington, D.C. Alexander Kolyandr is a non-resident senior fellow with the Democratic Resilience Program at the Center for European Policy Analysis (CEPA) and the co-author of the weekly newsletter “Inside the Russian Economy” from The Bell.

This report is made possible by a grant from Carnegie Corporation of New York.

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