re: Latest Updates: Russia-Ukraine Conflict

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MOSCOW—The opening months of Russia’s invasion of Ukraine last year drove an increase in oil and natural-gas prices that brought a windfall for Moscow. Those days are over.

As the war continues into its second year and Western sanctions bite harder, Russia’s government revenue is being squeezed and its economy has shifted to a lower-growth trajectory, likely for the long term.

The country’s biggest exports, gas and oil, have lost major customers. Government finances are strained. The ruble is down over 20% since November against the dollar. The labor force has shrunk as young people are sent to the front or flee the country over fears of being drafted. Uncertainty has curbed business investment.

“Russia’s economy is entering a long-term regression,” predicted Alexandra Prokopenko, a former Russian Central Bank official who left the country shortly after the invasion.

There is no sign the economic difficulties are bad enough to pose a short-term threat to Russia’s ability to wage war. But state revenue shortfalls suggest an intensifying dilemma over how to reconcile ballooning military expenditures with the subsidies and social spending that have helped President Vladimir Putin shield civilians from hardship.

Russian billionaire Oleg Deripaska warned this month that Russia is running out of cash. “There will be no money next year, we need foreign investors,” the raw-materials magnate said at an economic conference.

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A big part of the dimming outlook stems from a bad bet by Mr. Putin last year that he could use Russian energy supplies to limit Western Europe’s support for Ukraine.

European governments, instead of tempering their support for Kyiv, moved rapidly to find new sources of natural gas and oil. Most Russian gas flows to Europe stopped, and after an initial jump, global gas prices fell sharply. Moscow now says it will cut its oil production by 5% until June from its previous level. It is selling its oil at a discount to global prices.

As a result, the government’s energy revenue fell by nearly half in the first two months of this year compared with last year, while the budget deficit deepened. The fiscal gap hit $34 billion in those first two months, the equivalent of more than 1.5% of the country’s total economic output. That is forcing Moscow to dip deeper into its sovereign-wealth fund, one of its main anti-crisis buffers.

The government can still borrow domestically, and the sovereign-wealth fund still has $147 billion, even after shrinking by $28 billion since before the invasion.

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A large chunk of its telecommunications equipment and advanced oil drilling software is imported.

“This is a little bit like going back to Soviet times, doing everything ourselves,” said Vasily Astrov, an economist at the Vienna Institute for International Economic Studies. “It will be nearly impossible to properly replace what’s missing.” Analysts at the central bank have called the postwar reality “reverse industrialization,” suggesting a reliance on less-sophisticated technology.

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Russia managed to avoid the worst last year, aided initially by high global energy prices. Gross domestic product fell 2.1%, according to official data, far less than some early forecasts of a 10% to 15% drop.

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In January and February of this year, however, oil and gas tax revenue, which accounts for nearly half of total budget revenue, fell by 46% year-over-year, while state spending jumped more than 50%.

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Consumers are ailing, too. Retail sales fell 6.7% in 2022, the worst showing since 2015, according to official data. New-car sales fell by 62% in February year-on-year, according to the Moscow-based Association of European Businesses.

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“We’re not talking about a one-year or a two-year crisis,” said Mr. Astrov. “The Russian economy will be on a different trajectory.”

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