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The Trump-Putin summit in Alaska ended with no peace deal, which was not a surprise*. However, we suspect that an agreement to end the fighting will happen within the next few months, because there are strong incentives for all parties to bring the destruction to an end. For Putin and Russia’s political elite, the incentives are economic and are becoming stronger as time goes on.

In our 29th January 2025 commentary, we discussed the effects of Russia’s invasion of Ukraine on the Russian economy. Here’s how we described the situation:

“Due to the government’s control of the commercial banking system, there won’t be a [financial/debt] crisis. However, the cumulative costs of waging the war in Ukraine will lead to long-term weakness. In effect, a lot of resources are being drawn from the broad economy and then destroyed as part of the war effort, reducing the total amount of wealth.

The war-related wastage of resources (destruction of wealth) is not evident in the financial statements of the Russian government due to the ‘sleight of hand’ that has been used to keep a large part of the war financing off the government’s books. The sleight-of-hand involves directing the commercial banks to provide whatever financing is required by the manufacturers of armaments…[which] has led to a massive expansion of corporate credit in Russia.

A consequence is that although the government’s balance sheet still looks healthy, the effects of the war-related spending are evident in the inflation rate. The official inflation rate is around 9%, but the fact that the central bank considers a short-term interest rate target of 21% to be appropriate suggests that the actual inflation rate is 15%-20% or higher.

The government’s control of the banking system will prevent a crisis, but Putin certainly has strong economic incentives to bring the war in Ukraine to an end.”

Since then, the war has continued to grind on, with Russia’s invading forces making slow but steady progress. The cost has been high (it has been estimated by the Carnegie Endowment for International Peace that the war will cost the Kremlin about US$170B this year), and making matters worse for the Russian government is that its oil-related tax revenue dropped by about one-third from July of last year to July of this year. This is not because sanctions are working, but because the oil price is now about 25% lower in US$ terms while the Russian Ruble has gained about 10% against the US$.

The following chart shows that the Ruble has strengthened significantly against the US$ since the start of this year (the line on this chart declines when the Ruble strengthens) and is now roughly where it was in early-2022, immediately prior to the start of the war with Ukraine.
 

As a result of the on-going wealth destruction, the adverse effects of the war on Russia’s economy are becoming increasingly apparent. This is why we say that Putin has an incentive to strike a peace deal that is becoming stronger with the passage of time. In short, the longer the war drags on, the worse will be the outcome for Russia’s economy. However, a peace deal will require the acknowledgement, on the part of NATO/Ukraine, that Ukraine will never be part of NATO and that about 20% of Ukraine is now Russian territory.

*It also wasn’t a surprise that Trump portrayed the meeting as a significant step towards peace. Further to a comment we made a week ago, this could enable him to back away from his “secondary sanctions” threat and substantially reduce tariffs on India.

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