Oct 08, 2024

A likely move to raise a key interest rate to the highest level since the start of Vladimir Putin‘s full-scale invasion of Ukraine is among measures by Russia’s Central Bank showing the continued impact of the war on Russia’s economy.

On September 13, the Central Bank raised its benchmark interest rate by 100 basis points to 19 percent. But with inflation remaining stubbornly high, the institution’s governor, Elvira Nabiullina, has not ruled out that when it meets again on October 25, this will increase to 20 percent the emergency level at the start of the war, increasing the cost of new and variable rate loans.

“The war is beginning to bite on the economy,” said Timothy Ash, an expert on Russia’s economy. “Recent Western efforts to tighten secondary sanctions—and sanctions on the MOEX (Moscow Stock Exchange) are making it increasingly difficult and expensive for Russia to trade internationally,” he told Newsweek.

Newsweek reached out to Russia’s Central Bank for comment.

High Inflation and Plunging Ruble

In June, Russia’s Central Bank announced the suspension of exchange trading and settlements of deliverable instruments in U.S. dollars and euros due to U.S. sanctions against the Moscow Exchange Group. Instead, over-the-counter trading data is used to set official exchange rates for the currencies.

Since then, the Russian currency, the ruble, has lost more than 17 percent against the yuan, 15 percent against the dollar and 10 percent against the euro.

“Hiking rates, tapping foreign exchange reserves and allowing the ruble to weaken all suggest pressures on Russia’s balance of payments,” said Ash. “The Russian economy is overheating because of the war, and this is creating imbalances and foreign exchange shortages.”

GDP Growth at a Price

Nabiullina has shepherded the Russian economy through the turbulence caused by Western sanctions aimed at punishing Putin and curbing his war machine.

While Russia says its predicted GDP growth for this year is 3.9 percent, this superficial clean bill of economic health has been aided by record military spending, which will rise by 25 percent to $140 billion a year.

Huge troop losses and people fleeing the draft have caused a labor shortage fueling wages. Inflation in August was 9 percent—more than twice the 4 percent target.

GDP Growth at a Price

Nabiullina has shepherded the Russian economy through the turbulence caused by Western sanctions aimed at punishing Putin and curbing his war machine.

While Russia says its predicted GDP growth for this year is 3.9 percent, this superficial clean bill of economic health has been aided by record military spending, which will rise by 25 percent to $140 billion a year.

Huge troop losses and people fleeing the draft have caused a labor shortage fueling wages. Inflation in August was 9 percent—more than twice the 4 percent target.

In an article for Project Syndicate, Russian-born economist Konstantin Sonin, a professor at the University of Chicago Harris School of Public Policy, wrote that the increase in war spending “is clearly unsustainable in the long run” and that accelerated wage growth was a cause for concern.

Persistently high inflation expectations prevented the Central Bank from cutting interest rates, and subsidized credits to support military production are “effectively transfers of taxpayers’ wealth to the owners of military industrial enterprises,” he wrote.

This means the market interest rate is playing a decreasing role and, “together with the tight labor market, is limiting the Central Bank’s ability to fight price increases driven by factors such as trade sanctions or increases in world oil prices,” he added.

Vasily Astrov, senior economist at the Vienna Institute for International Economic Studies, said inflationary expectations have forced the Central Bank to act despite recent signs that inflation has become more driven by supply-side factors beyond its control.

“I would argue that one such factor is increased prices of imported goods due to persistent payment problems with China (and) Turkey…because of the fear of secondary U.S. sanctions,” he told Newsweek, which has forced a move towards “expensive intermediaries.”

In addition, state media reported last month that the Central Bank is considering upping the regulatory restriction on the maximum interest rates of subordinated bonds from 15 percent.

“High borrowing costs are restricting banks from issuing subordinated bonds with a maximum interest rate of 15 percent, which are a key source of capital,” said Grzegorz Drozdz, market analyst at Invest.Conotoxia.com.

“Banks that want to grow are finding it difficult to offer these bonds as alternative investments offer better returns,” he told Newsweek. He said revising these limits “could have a significant impact on the banking sector, but a lesser impact on the ruble exchange rate compared to changes in interest rates.”

In August, the amount of gold in Russian banks’ reserves had decreased by 10 percent, or 5.7 tons, according to state news agency Interfax. However, gold could help the Central Bank, which holds around 2.34 tons of the precious metal, accounting for 29 percent of its reserves, and a haven in a time of economic turmoil.

“Its price has risen by 27 percent since the beginning of the year due to geopolitical tensions,” said Drozdz. “Profits from this increase would feed into the state budget next year, which could strengthen the rouble’s position.”

https://www.newsweek.com/russia-central-bank-inflation-1965544