Windfall from Iran War in Line with Expectations; Lasting Peace Deal Would Exacerbate Russia’s Structural Challenges

KSE Institute has published the June edition of its Russia Chartbook, “Windfall from Iran War in Line with Expectations; Lasting Peace Deal Would Exacerbate Structural Challenges.” The latest data show that higher oil prices have supported Russia’s export earnings and budget revenues. However, this effect is already weakening, while Russia’s fiscal and economic challenges remain firmly in place.

The Iran war’s impact on Russia has become increasingly visible. Oil export earnings increased from $10.4 billion per month on average in January-February to $20.5 billion in March-May. Oil and gas budget revenues reacted with a one-month lag, rising from $6.2 billion per month on average in Q1 to $13.6 billion in April-May.

In May, however, Russia’s export earnings weakened moderately compared to April. This happened as Russian export prices declined from $95.2/bbl in April to $88.7/bbl in May. Ukrainian drone strikes on Russian refineries also shifted part of exports from petroleum products to crude oil.

Higher oil prices do not fully translate into additional budget revenues. Part of the effect is weakened by increasing subsidies used to keep domestic fuel prices under control. Another factor is the stronger ruble, which weighs on the local currency value of extraction taxes. At the same time, Russia has benefited from lower discounts on its oil compared to global prices, partially driven by OFAC sanctions waivers that have reduced the risk of purchasing Russian oil.

If the US-Iran agreement holds and the Strait of Hormuz is fully reopened, energy prices are expected to normalize. For Russia, this would mean lower global oil prices and the risk of a potential reinstatement of US sanctions. In this scenario, a lasting peace deal in the Middle East would not help Russia — it would exacerbate its structural challenges.

Russia’s budget deficit is growing only marginally, but the underlying problems remain. The cumulative federal budget deficit reached 6.0 trillion rubles in January-May, up from a revised 5.8 trillion rubles in January-April. The smaller May shortfall was mainly the result of expenditure restraint: spending in May was 30% lower than in April and 25% lower than the January-April 2026 average.

This level of spending is unlikely to hold going forward. In January-May, expenditures were still 17% higher than in the same period of 2025. At the same time, oil and gas revenues fell by 30%, while non-oil and gas revenues grew only 12% year-over-year. Oil and gas revenues are also heavily dragged down by the damper mechanism used to keep domestic fuel prices low. In May, these subsidies surged to 204 billion rubles.

Under these conditions, Russia’s budget problems are likely to grow. The economy is stalling, energy prices may normalize, and expenditures are unlikely to remain at their May level. To finance the deficit, Russia has been relying on its Treasury accounts. Domestic borrowing has remained moderate, albeit markedly higher than last year, while NWF liquid assets have not been used to a significant degree. This will likely not be a sustainable model.

Another problem is the growing divergence between the government’s fiscal policy and the central bank’s position. A recent law passed by the State Duma allows the government to increase expenditures and state debt beyond the limits established by the budget law. The expanding deficit is expected to be covered by increased domestic borrowing.

The CBR has repeatedly warned that this kind of unconstrained fiscal expansion is a severe pro-inflationary factor. As a result, the CBR’s recent decision to narrow its rate cut step to a mere 25 bps provides no meaningful relief to the civilian economy, where businesses continue to struggle with high borrowing costs. For the government, this also creates a vicious cycle: elevated interest rates make financing the soaring state debt increasingly expensive.