Russia’s inflation spike sets the Kremlin and the central bank on a crash course

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Russian President Vladimir Putin (L) and Governor of the Central Bank of Russia Elvira Nabiullina

Alexei Nikolsky \ TASS via Getty Images

Russia’s rising inflation and currency collapse have revealed a growing rift between the Kremlin and the country’s central bank.

The Central Bank of Russia (CBR) at an emergency meeting on Tuesday raised interest rates by 350 basis points to 12% in an attempt to stop the rapid depreciation of the ruble currency, which fell to a 17-month low of nearly 102 to. the dollar on Monday.

The sudden move came after President Vladimir Putin’s economic adviser, Maxim Oreshkin, wrote an op-ed arguing that the recent acceleration of inflation and the sinking currency were the result of “policy loose money” and that the central bank has all the necessary tools. to normalize the situation.”

The Bank said its emergency rate hike on Tuesday was aimed at “limiting price stability risks” as “inflationary pressures are building”, with current price growth over the past three months giving its -in an average of 7.6% annually on a seasonally adjusted basis and core inflation over it. the same period rising to 7.1%.

“Sustained growth in domestic demand is outstripping the ability to expand output, increasing underlying inflationary pressure and affecting the dynamics of the ruble’s exchange rate through high demand for imports,” the board said. central bank.

Last week, the central bank had stopped buying foreign currency on the domestic market until 2024 to reduce volatility, but this did not stop the decline of the ruble. Russia often sells foreign currency to offset falling oil and gas export revenues, and buys it if it runs a surplus.

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Before the Kremlin began to intervene, the Bank of Russia blamed the country’s declining trade balance for inflation and currency weakness, as Russia’s current account surplus fell by more than 85% year-on-year after a year from January to July.

Anatoly Aksakov, chairman of the Duma Committee on Financial Markets, said on Telegram on Monday that “the ruble exchange rate is controlled by the state,” according to Google translation.

After coordinating steps to reshape the Russian economy and ease the effects of Moscow’s economic isolation and punitive sanctions from Western powers, the Kremlin and the Bank of Russia now appear to be confronting the causes of the money problems.

Analysts suggested that the government’s direct arming of the central bank in monetary policy action was a sign of the problems facing the country’s economy.

Agathe Demarais, director of global forecasting at the Economist Information Unit, told CNBC that the central bank was correct in its earlier assessment that the fall in Russia’s current account surplus was the main reason behind high inflation.

“This is due to Western sanctions, which are both reducing Russia’s hydrocarbon export earnings and fueling import costs,” she told CNBC via email.

“A weak ruble will contribute to this trend by increasing import costs. In other words, the Russian currency has entered a vicious circle that will be difficult to escape.”

The ruble first fell as low as 130 to the dollar in February 2022 following Russia’s full-scale invasion of Ukraine and the subsequent heavy imposition of Western sanctions. In response, the central bank implemented capital controls to stabilize the currency, eventually returning it to a range between 50 and 60 to the dollar by the summer of 2022.

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The central bank has since loosened those capital controls to jump-start the economy as sanctions began to bite, Demarais said along with a period of low interest rates that led to into the “vicious circle” for the ruble.

“The combination of these factors shows that the Russian government’s room for maneuver is shrinking: the Russian leadership must now make a choice between fighting inflation or promoting growth – both key drivers of social stability,” she said.

“Higher interest rates will not be enough to stabilize the ruble, let alone help it appreciate against other major currencies. This is because the negative factors behind a weak currency are largely in the direction of -outside the control of the Central Bank of Russia.”

She said that blaming the central bank has thus become an “easy tactic” for the Kremlin without any substantial options to improve the situation.

Several news outlets reported on Wednesday that Russian authorities are considering reinstating capital controls soon. This would take the form of a forced sale of foreign exchange earnings for export, as the central bank’s rate hikes were only likely to slow down the currency’s decline.

Back to capital controls?

Stephanie Kennedy, an economist at Julius Baer, ​​agreed that the most likely scenario from here is for the CBR to double capital controls and the rule that exporters must convert their earnings from US dollars to rubles.

“Currency collapses are often triggered by nervous international investors or fleeing domestic capital. Sanctions and capital controls have left Russia isolated from the international financial system,” Kennedy said.

“Therefore, trade in the ruble, especially against the US dollar, remains thin. Therefore, the devaluation is not caused by a speculative movement but by headwinds from the relative flow of exports (which earn foreign currency) against imports (which have to pay ​for him. with this employment).

The value of exports has fallen since G7 countries imposed a $60 price cap on Russian crude oil in December, and imports have risen as the government tries to get supplies to support its war effort. expand and improve.

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Although the current account surplus fell more than 85% year-over-year from its peak in June 2022, it remains at a tolerable level and within its historical average, Kennedy noted, while money cheap raises the ruble value of Russia’s oil income, but also its import costs.

Russian Deputy Prime Minister Andrey Belousov said in June that the value of 80-90 rubles to the dollar was ideal for the country’s budget, imports and exports.

“Although the CBR could raise another 100 to 200 basis points to deal with the recession, it is unlikely to walk aggressively as seen at the beginning of the war,” said Kennedy.

“Higher interest rates would hurt consumers and local businesses mostly, thus weakening public support for the war. “

So Julius Baer plans to double down on capital controls and introduce the rule on exports, but he believes the ruble will still be around 92 to the dollar in three months and 95 in 12 months. .

“Although this means a spot appreciation, which is accompanied by a large carry, the ruble is hardly tradable and uncertainty about the outlook is high,” said Kennedy.

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