On June 3, as Vladimir Putin prepared to open Russia's flagship annual economic forum in St. Petersburg - a gathering styled as a kind of Russian Davos, designed to attract foreign capital and project national confidence - Ukrainian drones flew more than 1,000 kilometers and set an oil terminal in the city's port on fire. Black smoke rose over the port. The airport briefly suspended flights. Authorities cut mobile internet services.

Putin opened his forum anyway.

The image could not have been designed more precisely: a war machine operating at full throttle, and the country behind it quietly falling apart. In the first three months of 2026 alone, more than 200,000 small and medium-sized businesses shut their doors across Russia. Shuttered shops line the main streets of St. Petersburg and Moscow. Sky News correspondent Ivor Bennett, reporting from St. Petersburg this week, described empty windows and "to let" signs multiplying down the main streets. Business owners told him the same things: higher costs, higher taxes, lower demand, and borrowing rates so punishing that credit has become almost unreachable.

None of this prevents Russia from launching thousands of drones at Ukraine every month. Both things are true at once. Understanding why requires following where the money actually goes.

The background

When Russia launched its full-scale invasion of Ukraine in February 2022, the Kremlin expected it to last days. It is now into its fifth year. What began as a blitzkrieg became something different - and, for the Russian economy, far more corrosive: a war of attrition, meaning a conflict where both sides grind each other down through sustained losses of people, equipment, and money rather than decisive battlefield maneuvers.

War economies behave strangely in the short run. Military spending functions like an economic stimulus: factories hire, wages rise in the defense sector, unemployment falls. The IMF - the International Monetary Fund, the global institution that monitors the health of national economies - estimated Russia grew at 3.5 to 4 percent in 2022 and 2023. Those figures surprised most Western economists who had predicted a quick collapse under sanctions. The growth was real. It just was not sustainable.

Here is the mechanism that eventually turns war spending against the economy that produces it. Governments direct banks to channel credit - the pool of borrowed money businesses use to invest and operate - toward military production. Arms factories expanding to meet wartime orders need cash. They get it. Everyone else does not. Meanwhile, taxes rise and non-military spending gets cut to help fund the campaign. Inflation - the rate at which prices across the economy rise over time - climbs because too much government money is chasing too few consumer goods. Central banks respond by raising interest rates - the cost of borrowing money - to cool the overheating. Those high rates crush civilian business activity further. The war economy and the civilian economy pull in opposite directions, and the civilian economy has no army behind it.

Germany in the Second World War is a clarifying example. Its war economy was at its most efficient and productive in 1944, even as Allied forces were already crossing into its borders. The armaments production surge looked, on paper, like a triumph. But the distortions required to produce it - every resource diverted to weapons, every credit line pointed at munitions - meant the civilian economy had been bent so far out of shape that it cracked in early 1945. Russia, according to Professor Michael Clarke, the British military analyst and former director of the Royal United Services Institute, is following a version of the same arc. Not sudden collapse, but a slow hollowing out that eventually makes the political cost of continuing unsustainable.

What is actually happening

The numbers coming out of Russia in 2026 are no longer deniable. More than 200,000 small and medium-sized businesses - the restaurants, cafes, repair shops, clothing stores, dental clinics, and retail outlets that employ most people in any modern civilian economy - closed in Q1 of this year alone.

The Moscow Times reported in May that Russia's small businesses are shutting down at an accelerating pace, squeezed simultaneously by higher taxes, collapsing consumer demand, and the country's first economic contraction since 2023. A change to Russia's VAT rules - value-added tax, a charge applied at each stage of production and sale and ultimately passed on to consumers and businesses - took effect on January 1. Businesses with annual revenue between 20 million and 60 million rubles, roughly $274,000 to $822,000, were brought into the VAT system for the first time. Russia's VAT rate itself was simultaneously raised to 22 percent. For many businesses sitting just above the new threshold, this was not a gradual tax increase. It was a sudden and severe change to their entire cost structure, arriving without additional customers or revenue to absorb it.

Russia's overall GDP contracted 0.3 percent year-on-year in Q1 2026, according to the country's own Economic Development Ministry, as analyzed by Meduza. The Kremlin attributed this to a calendar anomaly - two fewer working days in January than the year before. Economists were not persuaded. Out of 28 industrial sectors tracked by Russia's Rosstat statistics agency in January and February, 22 posted year-on-year declines. Metallurgical output fell 15 percent. Clothing and footwear dropped 11 percent. Even production of "finished metal products" - the Rosstat category that includes bombs and shells - slipped 1.9 percent. The Moscow Times had warned at the start of 2026 that the wartime spending sugar rush was fading and its costs were now being passed directly to Russian households and businesses through higher taxes.

Russia's central bank raised its key interest rate to 21 percent in October 2024 - a two-decade high - as an emergency measure to control inflation that wartime spending had stoked. The rate has since been cut in stages to 14.5 percent, but that figure is still high enough to make credit nearly inaccessible for businesses that lack a state contract or defense-sector connection. Meanwhile, according to Ukraine's Foreign Intelligence Service, which issued a detailed assessment in late March, 95 percent of Russian entrepreneurs surveyed described worsening business conditions at the start of 2026, 75 percent cited serious difficulties, and more than two-thirds reported falling revenues since January. The service projected that up to a third of Russia's small and medium-sized enterprises could close entirely.

The money trail

The collapse of Russia's civilian sector is not a side effect of the war. It is the direct result of a policy decision made at the highest level of government.

Russia's banks were instructed to direct all available credit toward the arms industries. As defense factories geared up to expand production of tanks, artillery shells, and drones, they needed capital, and the entire Russian financial system was pointed at them. What remained for civilian businesses, startups, and entrepreneurs was, in Clarke's assessment, essentially nothing. The credit had already been conscripted.

Jacobin reported in May that workers laid off from civilian sectors are migrating into defense plants financed directly by the state - the one corner of the economy where wages remain stable. Russia's official unemployment rate sits at around 2 percent, the lowest since the Soviet era. But that headline number conceals a structural shift: people are employed, increasingly in an economy that has been reorganized around weapons production rather than goods and services that ordinary people can buy.

Approximately 40 percent of all Russian government spending now goes directly to funding the war, according to the Sky News analysis. To put that in context: imagine a government that has decided nearly half its entire budget will serve a single military campaign, and that everything else - health services, infrastructure, business support, regional development - must compete for the rest, which is itself shrinking as energy revenues fall. Russia's National Wealth Fund - the sovereign savings reserve built up during oil boom years to provide a buffer in a crisis - has been drawn down from the equivalent of 6.5 percent of GDP before the 2022 invasion to just 1.8 percent at the end of 2025, according to BOFIT, the Bank of Finland's Institute for Emerging Economies.

The businesses absorbing the worst of this are the ones without political connections or state contracts. When VkusVill, a mainstream Russian grocery chain, closed 286 outlets in 2025, and Magnit - Russia's largest retailer by store count - ended the year with a net loss, the signals were impossible to ignore. These are not niche or marginal businesses. They are the commercial backbone of Russian urban life.

The group that benefits from the present arrangement is narrow but powerful: the defense-industrial complex, the executives and oligarchs tied to it, and the banks that lend to it with implicit state backing. The strong ruble - sustained by high interest rates designed partly to maintain the purchasing power needed to import Chinese components for weapons systems - is essential to the war effort. It is also, simultaneously, the mechanism that makes Russian civilian exporters uncompetitive and keeps ordinary borrowing costs so high that most civilian investment is frozen.

What people are doing about it

Russia's small business owners have not simply accepted their situation. Lacking access to formal political channels - organizing against government tax policy is not an option in Putin's Russia - they have turned to digital campaigns instead. The Christian Science Monitor reported in April that entrepreneurs are using online "flash mobs" on VKontakte, Telegram, and Instagram to share stories and coordinate pressure, reaching audiences in the hundreds of thousands. One campaign focused on a single business symbolizing the fate of thousands, built an Instagram following of 360,000. "We never had any idea it would be so big," one organizer said. It is a notable development in a country where the government tightly controls most formal civic expression.

Ukraine, for its part, has made the Russian economic rear a deliberate strategic target. Al Jazeera reported in April that Ukrainian long-range drones - domestically manufactured and capable of flying up to 1,500 kilometers with up to 120 kilograms of explosives - had already struck two major Baltic oil terminals handling roughly two-fifths of Russia's seaborne oil exports. The June 3 strike on St. Petersburg's port terminal, carried out on the opening day of Putin's economic forum, was the latest operation in a sustained campaign to raise the cost of the war for Russia's energy sector. Fuel is being rationed in some Russian regions. Petrol exports have been suspended. Prices for Russian consumers and businesses have risen.

Clarke identifies three distinct objectives in Ukraine's long-range drone strategy. The first is material: disrupting oil production and processing hurts government revenues and raises domestic costs. The second is psychological: striking deep inside Russia - hitting Moscow-area airports repeatedly, forcing the scaled-back Victory Day parade in May over fears of drone attacks - erodes the sense among the Moscow and St. Petersburg elite that the war is happening somewhere else. The third is logistical: targeting supply lines up to 50 kilometers behind the front lines to slow the movement of weapons and personnel to where they are needed most.

On manpower, Russia is currently recruiting fewer than 1,000 soldiers per day while losing more than 1,000 to death and serious injury daily, according to the Sky News analysis. Ukraine is attempting to push Russian casualty rates to 50,000 per month, calculating that this pace would eventually prevent sufficient reinforcement of the front lines.

The bottom line

Russia's economy is not collapsing. Big economies - 140 million people, vast natural resources, a nuclear arsenal - do not disintegrate like houses of cards. What they do, under sustained military pressure and fiscal distortion, is hollow out. The Russia of mid-2026 is operating two parallel economies: a war economy that is functioning precisely as its architects intended, and a civilian economy being systematically starved of credit, crushed by tax hikes, and drained of the businesses that employ most ordinary people. The question is not whether Russia implodes this quarter. It is whether a government can keep fighting a war by dismantling the country it claims to be defending - and whether the people in Moscow and St. Petersburg, who can now see the smoke from their windows, are still willing to look away.

Timeline

  • February 2022: Russia launches its full-scale invasion of Ukraine, framing it as a "special military operation" and anticipating a rapid conclusion.
  • 2022-2023: Russia's economy grows 3.5 to 4 percent, boosted by military spending stimulus. IMF growth figures outperform Western expectations.
  • October 2024: Russia's central bank raises its key interest rate to 21 percent - a two-decade high - to fight inflation driven by wartime spending.
  • December 2025: Russia's defence minister confirms Ministry of Defence spending rose to 7.3 percent of GDP in 2025. The National Wealth Fund has fallen to 1.8 percent of GDP, down from 6.5 percent before the invasion.
  • January 1, 2026: Russia raises VAT to 22 percent and lowers the revenue threshold at which businesses must pay it, sharply increasing the tax burden on small and medium-sized enterprises.
  • Q1 2026: More than 200,000 small and medium-sized businesses close across Russia. GDP contracts 0.3 percent year-on-year per Russia's own Economic Development Ministry.
  • March 2026: Ukraine's Foreign Intelligence Service warns that up to a third of Russia's SMEs could shut down entirely.
  • April 2026: Ukrainian drones strike two major Baltic oil terminals handling two-fifths of Russia's seaborne oil exports. Russia's central bank cuts its key rate to 14.5 percent.
  • April 20, 2026: The Christian Science Monitor reports on Russian small business owners using online flash mobs to protest tax hikes and business closures.
  • May 2026: The Moscow Times reports that SME closures are accelerating. Victory Day parade in Moscow is scaled back amid fears of Ukrainian drone attacks.
  • June 3, 2026: Ukrainian drones strike an oil terminal in St. Petersburg as Putin's International Economic Forum opens. The airport briefly suspends flights. Black smoke rises over the port while Putin addresses attendees.
  • June 4, 2026: Professor Michael Clarke tells Sky News that the strains in the Russian war economy are "coming through" and the Russian war machine is "stuttering."

Summary

Who: Vladimir Putin's government; Russia's small and medium-sized businesses; Ukraine's military; Russia's civilian population, particularly in major cities.

What: Russia's war economy is systematically starving its own civilian sector of credit, crushing businesses with tax hikes, and depleting the national savings buffer - while still launching record drone attacks on Ukraine and hosting economic forums designed to project stability.

When: The pressures have been building since 2022, but Q1 2026 produced the first visible economic contraction and the most acute wave of business closures, as wartime fiscal policies collided with a civilian economy no longer able to absorb them.

Where: Across Russia, most visibly in Moscow and St. Petersburg, where empty storefronts and to-let signs have become a visible feature of urban landscapes previously associated with economic growth.

Why: Financing a multi-year industrial war requires directing the entire financial system toward weapons production. Credit, tax revenue, and government spending all flow toward the war economy by design. The civilian economy has no political leverage and no choice but to absorb whatever is left.