Russian finance ministry proposes raising VAT to help fund Ukraine war

Russia's finance ministry has proposed raising the value-added tax (VAT) rate from 20% to 22% in 2026, aiming to fund military spending and curb a swelling budget deficit projected to reach 2.6% of national output in 2025, the highest since the Ukraine war began. This measure, part of a new "wartime budget" and expected to generate 1.2 trillion roubles ($14.33 billion) in additional revenue, is forecast to boost inflation by 1.5 percentage points, complicating the central bank's monetary policy and further slowing economic growth to an anticipated 1%.

Analysis

Russia is implementing significant fiscal consolidation measures to sustain its war economy, as evidenced by the finance ministry's proposal to raise the Value-Added Tax (VAT) to 22% from 20% in 2026. This move is explicitly designed to fund military spending and curb a budget deficit projected to hit a post-war high of 2.6% of GDP in 2025, exceeding prior targets by 53%. The tax hike is expected to generate 1.2 trillion roubles but will be enacted amid a sharply deteriorating economic outlook, with growth forecast to decelerate to just 1% in 2026 from 4.3% in the prior year. This policy creates a direct conflict for the central bank, as the VAT increase is estimated to add 1.5 percentage points to inflation, complicating the path back to its 4% target and making it difficult to lower interest rates to support the slowing economy. The fiscal strain is further highlighted by plans to increase government borrowing by 46% in 2025 and eliminate other tax breaks, indicating a broad-based effort to marshal resources that will likely weigh on private consumption and investment. While the rouble has been stable, supported by the prospect of tighter monetary policy, the government's own forecast of 92.2 RUB/USD for 2026 signals an expectation of significant currency depreciation from current levels.

Key Decisions for Investors

• Investors should price in heightened Russian sovereign risk, as the combination of a swelling budget deficit, a 46% planned increase in borrowing, and a sharp economic slowdown points to deteriorating credit fundamentals.
• Expect continued rouble volatility and a restrictive monetary policy, as the central bank navigates the stagflationary pressures of slowing growth and tax-induced inflation, creating a headwind for domestic equities.
• The VAT hike and elimination of business tax breaks reinforce a bearish long-term outlook for the Russian consumer and private sector, warranting caution on any exposure to the country's domestic-facing economy.
• Monitor geopolitical developments closely, as the announced fiscal measures confirm that the economic costs of the war are escalating, making the economy more vulnerable to prolonged conflict or further sanctions.