The Military Economy Has Contracted Dutch Disease: Rising oil prices and economic revenues are leading to ‘reverse import substitution’
The windfall revenues that have fallen into the Kremlin’s lap as a result of the sharp rise in oil prices and the easing of sanctions have failed to revive the Russian economy. On the contrary, the inflow of foreign currency has contributed to a further strengthening of the rouble, whose exchange rate has returned to pre-war levels. As a result, the recovery in domestic demand is being met through expanding imports. Russia’s war economy has encountered a classic case of Dutch disease. The economy is experiencing what might be termed ‘reverse import substitution’, while the additional revenues generated by Russian energy exports are being transformed into gains for Chinese manufacturers. The largest increase in imports during the first quarter of 2026 was concentrated in vehicles, machinery and equipment imported from China.
Industrial output data for April, as well as figures for the first quarter as a whole, indicate that growth continues to be concentrated almost exclusively in sectors directly or indirectly linked to the war effort, whether drone production, electronics or pharmaceuticals. By contrast, civilian industries have reduced output in recent months. Measures of overall industrial production and civilian-sector output calculated by independent research centres are diverging ever further.
At present, however, Rosstat’s data obscure rather than clarify the picture because the agency has shifted to a new base year for calculating industrial production indices. In this case, the change is far from a purely technical adjustment. The new base year, 2023, was a period of profound structural change in the economy and a surge of investment into the military sector. As a result, the militarised structure of the economy will now be treated as the norm, and the weight of military-related sectors in the statistics will increase. This will help the Russian authorities camouflage contraction in the civilian industrial sector and generate more favourable aggregate indicators for industry and the economy as a whole, even as underlying production imbalances continue to deepen. As long as commodity revenues remain elevated, these imbalances will be offset by rising imports. Should those revenues decline, however, the result is likely to be stronger inflationary pressures stemming from supply shortages.
Reverse import substitution
Whilst oil rain quite literally fell in Tuapse following Ukrainian strikes on a local refinery, a metaphorical rain of oil has been showering the Russian economy for the third consecutive month thanks to the ongoing crisis in the Strait of Hormuz. Russia has emerged as one of the principal beneficiaries of the US-Israeli war against Iran. However, a substantial share of the gains generated by crisis-driven increases in oil prices will accrue not to Russian producers but to Chinese manufacturers. This phenomenon is known in economics as Dutch disease.
According to the Ministry of Economic Development, the price of Russian Urals crude used for tax calculations reached $94.9 per barrel in April, following $77 in March, $44.6 in February and $41 in January. According to estimates from the International Energy Agency’s (IEA) May oil market report, Russia’s revenues from oil and petroleum product exports in March-April jumped by 85% compared with January-February, reaching $38.3 billion versus $20.6 billion. Moreover, compared with March-April 2025, these revenues were up by 40%, and were still 7% higher than during the same period in 2024. This increase occurred despite export volumes remaining broadly unchanged relative to the beginning of the year and falling below the levels recorded in 2025 and 2024 by 5% and 9% respectively.
Figure 1. Russian exports of crude oil and petroleum products in physical and monetary terms, 2024–2026
A side effect of the growth in export revenues, however, has been a further strengthening of the rouble. Over the past year, it had already appreciated by almost 25%, from 102 to 79 roubles per dollar (→ Re:Russia: Victim of Disinflation, Sanctions and the ‘Chinafication’ of Trade). By the end of May this year, the exchange rate set by the Central Bank had strengthened further to 71 roubles per dollar. In effect, the rouble has returned to its pre-war range of 71-75 roubles per dollar, prevailing in the second half of 2021. According to Bloomberg, the rouble has outperformed analysts’ depreciation forecasts for a second consecutive year, making it the world’s best-performing currency against the US dollar.
The strengthening of the rouble increasingly appears to be a structural feature of Russia’s contemporary economic model. According to the Central Bank and economic analysts, this is supported by a large trade surplus, the absence of significant capital outflows, the suspension of foreign currency purchases by the Ministry of Finance under the fiscal rule, and the expansion of external trade settlement mechanisms that bypass the dollar, including cryptocurrencies and rouble-denominated transactions. As a result, the share of imports paid for in roubles has reached almost 60%, according to Central Bank data. High interest rates have also contributed by suppressing consumption and reducing corporate demand for investment-related imports.
At the same time, a substantial appreciation of the national currency predictably stimulates demand for imports by increasing consumers’ purchasing power. Higher-quality imported goods become more affordable in rouble terms. This effect became particularly evident in the first quarter of 2026. Following two years of stagnation in 2024-2025, during which imports declined cumulatively by 2.2%, merchandise imports increased by 6% year-on-year in January-March 2026, according to preliminary customs data, rising from $62.9 billion to $66.9 billion. The largest increase was recorded in the category of machinery, equipment and transport vehicles, where imports expanded by $3.5 billion, or 12%. Food imports increased by $0.7 billion, or 7%, while imports of chemical products rose by $0.7 billion, or 5%. The appreciation of the rouble is therefore producing a process of ‘reverse import substitution’.
Table 1. Structure and dynamics of goods imports in the first quarter of 2025 and 2026, in billions of dollars
The Russian Federal Customs Service (FCS) does not disclose data by individual country, but figures released by China’s General Administration of Customs suggest that China accounted for virtually all of the growth in Russian imports. In January-March 2026, Chinese exports to Russia increased by almost 22%, rising from $22.7 billion to $27.7 billion. By the end of April, cumulative exports had reached $38 billion. In other words, Chinese deliveries increased by approximately $5 billion during the quarter, while Russia’s total imports rose by only $4 billion. As a result, China’s share of Russian imports increased from 36% to 42%, both because of rising Chinese exports and because Chinese goods displaced imports from other supplier countries.
The growth in Chinese exports is primarily driven by the engineering sector and high-tech products. Since the rupture with Western markets, China has become the near-exclusive source of technological equipment for the Russian economy. Imports of Chinese transport equipment increased by $1.07 billion, or 41% year-on-year, rising from $2.62 billion to $3.69 billion. Imports of electrical machinery and equipment increased by $0.86 billion, or 26%, from $3.2 billion to $4.04 billion. According to FCS data, imports in the category of ‘machinery, equipment, transport vehicles and other goods’ increased by $3.5 billion in the first quarter of 2026, from $28.8 billion to $32.3 billion. More than half of this increase was attributable to Chinese suppliers.
A further notable rise occurred in imports of Chinese goods classified under the residual category of unclassified products (Chapter XXII). Exports in this category almost quadrupled during the first quarter, increasing from $480 million to $1.78 billion. According to Andrei Gnidchenko, an expert at the Centre for Macroeconomic Analysis and Short-Term Forecasting (CMASF), these goods largely consist of personal-use items imported under simplified customs procedures. The surge appears to be linked to the experimental visa-free regime introduced between Russia and China on 15 September 2025, which facilitated the emergence of a new generation of so-called shuttle traders. It is likely that this channel, together with online marketplaces, has enabled Chinese goods to replace a substantial portion of Russia’s remaining imports from third countries.
China, however, whilst the largest, is not the only beneficiary of the growth in the Russian economy’s revenues, which is reflected in the increase in imports. Somewhat unexpectedly, Europe also accounts for part of the gains, due to an increase in pharmaceutical supplies (which have not yet been subject to sanctions), as can be seen from the corresponding Eurostat data. In January-February 2026, the latest period for which data are available, European pharmaceutical exports to Russia increased by 11%, rising from $4.97 billion to $5.5 billion. More than $500 million of this increase came from medicines alone, whose exports rose from $1.47 billion to $2.15 billion.
Demand not on the rise
Throughout 2025, the growth rate of consumer demand slowed significantly. Retail trade growth, for example, decelerated from 8% to 4%. However, Rosstat data indicates that demand accelerated again in March 2026, with retail turnover increasing by 6.2% compared with March 2025. Meanwhile, food products continued to slow down, while growth shifted towards non-food goods. In March, year-on-year growth in food and non-food retail sales amounted to 3.1% and 9.1% respectively. Yet the renewed acceleration in demand has not translated into gains for civilian manufacturing industries, contrary to producers’ expectations.
In annual terms, industrial production rose by 1.9% in April, according to Rosstat data. Compared with March, seasonally and calendar-adjusted output rose by a modest 0.4%. Within this total, extractive industries contracted by 0.5%, while manufacturing output increased by 0.7%. As in previous months, however, manufacturing growth remained concentrated in military and military-related sectors. Output of fabricated metal products increased by 23% year-on-year, production of other transport equipment rose by 57.4%, and pharmaceutical products and materials expanded by 15.4%. When manufacturing output is separated into military and civilian components, a markedly different picture emerges. Estimates of civilian manufacturing output, defined as manufacturing excluding military-related industries, point to ongoing contraction. According to calculations by CMASF, civilian output declined during the first three months of the year and stagnated in April. Estimates produced by the Higher School of Economics (Bessonov) indicate that the contraction was concentrated specifically in April, as indicated by CMASF’s April review (Figure 2). Both calculations lead to the same conclusion: despite the rebound in consumer demand observed in March, there is no evidence of a corresponding recovery in civilian manufacturing activity.
Figure 2. Industrial production and civilian-sector output, 2021-2026, seasonally adjusted; 2021 monthly average = 100
Military normalisation
However, since the start of 2026, a number of analysts have questioned the reliability of Rosstat’s industrial production figures, suggesting that the downturn may be more severe than the official data indicate. The statistical agency has switched to a new base year for calculating industrial production indices, replacing 2018 with 2023, but the old and new series are not fully consistent with one another, according to a review of industrial production trends by the Centre for Macroeconomic Analysis and Short-Term Forecasting (CMASF). For example, the published data shows industrial production increasing by 2.3% year-on-year in March. However, seasonally and calendar-adjusted chain indices imply growth of 4.6%. Similar discrepancies persisted in April. CMASF estimates that annual industrial growth did not exceed 1.5%, rather than the 1.9% reported by Rosstat. According to CMASF analysts, following the transition to the new base year (2023) Rosstat has not reconciled chain indices (month-on-month changes) with year-on-year indices, creating inconsistencies in the published series.
However, questions about statistical consistency are only one consequence of this ostensibly technical revision. The adoption of a new base year also changes estimates of the structure of Russian industry itself, because sectoral weights within industrial production are derived from the chosen base year. The previous revision was carried out in 2018, shortly after the economic downturn of 2015-2016 and during a period of relatively neutral commodity price conditions. By contrast, 2023 was a year of profound structural transformation. Following the shock of sanctions, the government channelled substantial budgetary resources and investments from the National Wealth Fund into the economy. These resources were directed towards the rapid expansion of military production, emergency import substitution programmes and the construction of new infrastructure to redirect trade flows. As a result, the share of value added generated by these sectors increased significantly. Under the new methodology, their output will therefore carry greater weight in aggregate measures of industrial production and economic activity as a whole.
Unsurprisingly, the change in the base year has substantially increased the statistical weight of military and military-related industries. This means that continued growth in these sectors, sustained by budgetary support, will have a greater influence on headline industrial indicators. In turn, this will make it easier for the authorities to obscure contraction in civilian industries by offsetting it with growth in military production. Under the new weighting system, the share of extractive industries in the industrial production index has declined slightly, from 38.9% to 38.3%. This is significant because oil extraction is expected to stagnate or contract in the coming years. Manufacturing, by contrast, has gained weight, particularly in categories closely associated with the war economy. The share of fabricated metal products increased from 5% to almost 7%. This category includes heavy military equipment and has been one of the principal drivers of manufacturing growth since the second half of 2022. The share of computer, electronic and optical products increased from 3.8% to 5%, reflecting rapid expansion driven largely by military demand. The weight of pharmaceutical products and medical materials also rose substantially, from 1.5% to 2.2%, in a sector that has shown sustained growth, plausibly linked to the increasing number of wounded personnel returning from the war.
Thus, the transition to a new base year in Rosstat’s calculations contributes to the normalisation of a militarised economic structure while obscuring negative trends in industries producing goods for domestic civilian consumption. More favourable aggregate indicators may conceal the accumulation of structural imbalances within the economy. As long as export revenues remain elevated, these imbalances can be offset through higher imports. Under less favourable external conditions, however, they are likely to manifest themselves in shortages of consumer goods and rising prices driven by inadequate domestic supply.