Russia's real war costs are twice as high as the defense budget: a financier explains the consequences for the Kremlin

Russia's expenditures on the war against Ukraine are twice as high as its defense budget due to shadow financing. This creates huge risks for the aggressor country's economy and potentially weakens its position in negotiations, if any.

This opinion was expressed by former Bank of America and Morgan Stanley financier Craig Kennedy in his Navigating Russia newsletter. He clarified that this is a draft summary of a forthcoming report titled "Russia's Hidden War Debt," which will be released in the coming days.

The analyst described the scheme of how the Kremlin created a parallel shadow system of financing the war through preferential lending. According to him, immediately after the invasion of Ukraine by Russian troops, on February 25, 2022, dictator Vladimir Putin signed amendments to the law on preferential lending to defense companies.

This allowed for a sharp increase in corporate borrowing by 71% to $415 billion, or 19.4% of GDP, starting in mid-2022. Kennedy calculated that this is more than Russia's total oil and gas revenues and defense budget expenditures for the period from the fall of 2022 to the fall of 2024. In particular, about $250 billion of this amount was used to finance often insolvent and war-related enterprises.

The financier says that the surge in borrowing has helped the Kremlin create a misleading impression that the Russian authorities are coping with the defense budget. However, in his opinion, it is this parallel scheme that has been the main factor in inflation and the rise in interest rates above 21% since the second half of 2024.

The Russian Central Bank recognized such preferential lending as a "threat to the country's economic stability." Its officials pointed out that high borrowing costs create risks of overindebtedness for large companies like Gazprom, which borrowed money at 22% and higher to cover losses from the suspension of European exports.

"The government will probably soon have to commit to rescuing the over-indebted companies, which in total can eat up to half of the entire budget. After that, the Kremlin will not be able to finance the rearmament of the army unless the West eases sanctions," Craig Kennedy concluded.

He notes that today Russia, like the USSR, is hiding the real state of affairs with the financing of the military-industrial complex to look better in the upcoming negotiations. However, now the longer Moscow "postpones the truce," the more likely it is that a credit crisis will occur in the aggressor country. The only way out of the situation for Putin to continue the war is to seek the lifting of sanctions during the negotiations.

In his summary of Russia's financial losses, Kennedy recommended that the Ukrainian authorities not agree to sanctions relief as a condition for a possible truce and insist that Western resources can outweigh Russian forces on the battlefield. In particular, Kyiv may ask for a new package of weapons and tougher sanctions. The financier believes that lifting some of the sanctions against Russia will be acceptable to Ukraine only if it becomes a condition for a complete end to the war and payment of reparations.

"Moscow's problems with financing will only get worse, especially if the coalition countries make fuller use of the powerful energy sanctions instruments at their disposal. With continued determination and a clear understanding of Moscow's vulnerabilities, Ukraine and its allies will be able to realize the full potential of their negotiating leverage, avoid unnecessary concessions, and reduce the long-term risks associated with Russian revanchism," the author emphasized.

As reported by OBOZ.UA, analysts have calculated how the war in Ukraine has emptied the pockets of Russians. Thus, the number of Russian citizens experiencing financial difficulties has increased by a third over the past four years: in 2020, there were 35% of them, and by the end of 2024, their share increased to 48%.

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