Tough choices for Russia’s Central Bank

Hello! Welcome to your weekly guide to the Russian economy – written by Alexandra Prokopenko and Alexander Kolyandr and brought to you by The Bell. This week our top story is about the Central Bank’s upcoming decision on whether to raise interest rates and risk the ire of government and business, or leave them on hold and see higher inflation. We also look at upcoming United States and European Union sanctions on Russian oil.

Independence at stake in upcoming rate decision

Russia’s Central Bank will hold its final board meeting of the year on Dece. 20 to discuss interest rates, which are currently at a record 21%. Central Bank head Elvira Nabiullina and her colleagues face a difficult decision. Rising prices and growing inflationary expectations suggest another rate hike should be the logical choice. But the Central Bank has faced harsh – at times vulgar – criticism from bankers and businessmen over the course of the last month. And large swathes of business, Russia’s parliament and some government ministers don’t want to see interest rates go up any more–ideally, they’d like to see cuts.

Stubborn inflation

There is not yet enough evidence to be sure that Russia’s economic growth is slowing, Central Bank analysts wrote in a report published this week – a sign that inflation might be easing. In October and November, there was strong growth in the consumer sector, wholesale trade and manufacturing compared (higher than in the extraction industries, transport and agriculture). Corporate lending, which has been growing all year, finally began to slow in November, according to the Central Bank. Economic activity in the third quarter also increased just 3.15%, down from 4.1% in the previous quarter (this downward trend is likely to continue, reducing inflationary pressures).

Nevertheless, inflation continues to accelerate. On Dec. 9, annual inflation reached 9.32%. Prices went up 1.1% in November and, in annual terms, they are up over 13%, according to Capital Economics. Annual inflation on food prices is currently at 9.9%. The steady growth in food sales, coupled with a plateau in production, suggests food price inflation is due to supply issues, noted analysts at the Central Bank. 

A weakening ruble, which is suffering from new U.S. sanctions on the Russian financial sector, is another pro-inflationary factor. And inflation is unlikely to slow after the New Year holiday, given the indexation of the recycling fee on cars due on Jan. 1, as well as index-linked fare increases for freight and passenger rail services.

Central Bank under pressure

The market appears to expect another rate hike from the Central Bank next week. This was visible in increased yields on short-term OFZs (1-2 years), which are up as much as 171 base points since early November. Analysts also believe that inflation will remain stubbornly high. Last week’s consensus survey by the Central Bank saw the inflation forecast for 2025 go up to 6% (from 5.3%) and for 2026 to 4.5% (from 4.1%). The expected interest rate for 2025 is up from 18% to 21.3% (suggesting economists no longer believe the regulator will reduce rates next year). In 2026, they anticipate a rate of 14.6% (up from 12.5%).

At the same time, businesses are insisting that the Central Bank stops tightening. Sergei Chemezov, head of state defense corporation Rostec, has twice publicly threatened to cease arms exports due to the high cost of borrowing. And a third of Russian freight haulers have said they fear bankruptcy next year due to increased costs and rates. Andrei Repik, head of the Delovaya Rossiya lobby group, last month warned of “guaranteed bankruptcies” among businesses. A quarter of businessmen surveyed by the Russian Union of Industrialists and Entrepreneurs in November reported deteriorating financial circumstances.

Companies that have done very well because of increased state spending are most at risk. As of June, the highest interest-to-profit ratio was in the mechanical engineering sector, as well as wood processing, leather production, automobiles and metals. In several sectors, including construction and coal mining, the return on working capital (i.e. the ratio of profit minus losses to equity) was lower than the interest on loans.

The Center for Macroeconomic Analysis and Forecast, a think tank that has long opposed high interest rates and which has connections to Defense Minister Andrei Belousov, recently reached the counterintuitive conclusion that high rates are driving inflation more than increased salaries. Almost 19% of the economy (when measured by revenue) is threatened with bankruptcy due to interest rate rises next year, it said, with the risk highest in telecoms, trade, transport, construction and heavy engineering. Only a few industries – oil, gas and mineral extraction, transport, printing and chemicals (without pharma) – offer profitability greater than risk-free investment in OFZs, according to the think tank. “As a result the interest rate is a powerful de-stimulator for investment, which means less increase in supply (and with it, a decline in inflation) in the future,” the Center concluded.

Russian President Vladimir Putin is also calling for increased supply to slow down inflation. Speaking last week at VTB’s “Russia Calling” forum he reasserted his faith in the Central Bank, but he also instructed Nabiullina to work closely with the government to bring down prices. In turn, he said the government should keep encouraging growth, although it must also strive to balance the budget. Thus, the government is being ordered to reduce inflation while increasing the supply of money by boosting output and labor productivity. This is effectively impossible in a heavily sanctioned economy pursuing import substitution.

Why the world should care

The intense pressure on the Central Bank ahead of its next board meeting shows that the stakes are unusually high. Historical experience shows that Central Bank independence, as well as the confidence of economic actors, are fundamental to an effective monetary policy and a healthy economy. And giving in to political pressure to cut rates in support of the economy does not accelerate growth, but prolongs high inflation. In effect, Nabiullina has to choose: preserve the institutional independence of the Central Bank, or become the sworn enemy of a large part of Russian business.

US and EU coordinate on upcoming Russia oil sanctions

A new round of sanctions on Russia are expected to be approved and imposed by the European Union and the United States in the coming weeks. First and foremost, they are aimed at reducing the profitability of Russian oil exports.

• EU ambassadors on Wednesday agreed on a 15th round of sanctions, which are expected to be approved next week. The latest U.S. sanctions are still under discussion, but are likely to be unveiled before the Christmas holidays.
• The EU will blacklist 52 Russian tankers as part of the measures, Politico reported Wednesday. That will bring the total number of Russian vessels banned from EU ports on suspicion of carrying Russian oil to 79.
• At the same time, according to Bloomberg, the U.S. is also planning to impose restrictions on Russia’s oil exports. It seems that the outgoing administration of President Joe Biden are also looking at blacklisting Russian oil tankers. However, few details have yet been made public.
• Both sets of sanctions will add to the lists of sanctioned Russian companies and individuals. In addition, they will reportedly target third-country individuals and businesses violating bans on exporting prohibited goods – primarily dual-use items – to Russia.
• The Biden administration, no longer constrained by worries about rising domestic fuel prices, is keen to up the pressure on Russia before Donald Trump takes office next year. It’s widely expected that Trump will not impose any more sanctions on Russia (at least in the short term). 
• Discussions of the recent measures in the EU revealed divisions. Before the ambassadors’ meeting, 10 European countries issued a joint statement calling for new sanctions on Russian gas, aluminum and nuclear energy. In addition, Latvia and Lithuania sought to put greater pressure on European companies to leave Russia. Ultimately, the EU is expected to limit itself to non-binding recommendations on these issues.

Why the world should care

The news of the upcoming sanctions pushed oil prices higher, and that may continue if U.S. sanctions turn out to be tougher than expected. For example, a ban on banks servicing Russian oil transactions would be a significant escalation, and would hurt banks in China, Turkey and India. Like the October sanctions against Russia’s state-owned Gazprombank, this could also end up exerting pressure on the ruble. However, it’s more likely that we’re looking at an extension of the list of sanctioned tankers in Russia’s “grey fleet.” Either way, there’s no sign of sanctions pressure on Russia easing.

Figures of the week

Between Dec. 3 and Dec. 9, weekly inflation in Russia slowed from 0.5% to 0.48%, according to the Ministry of Economic Development. At the same time, annual inflation increased from 9.07% to 9.32%. Food prices were up 0.76% over the week, mostly on fruit and vegetables. For non-food products, inflation was 0.51%. 

The Central Bank has reported increased revenue from Russian exports. According to the regulator, since the start of the year, its foreign financial assets increased by $58.8 billion. In November alone the increase was $5.8 billion (compared to $4.9 billion in October). That’s a direct consequence of the problems facing Russian companies trying to settle international payments. The sanctions against Gazprombank have further complicated this issue.

The Finance Ministry said Wednesday it had placed 1 trillion rubles of government bonds with a variable coupon. The total demand for this issue was 1.8 trillion rubles. This is December’s second trillion-ruble placement. Usually, the Finance Ministry prefers to place bonds with a fixed coupon to escape any inflation risk. However, the market prefers variable coupons that move with inflation. 

According to Central Bank data, Russia’s consumer credit portfolio fell 1.7% last month after increasing 0.4% in October. There was also a slowdown in the growth of the business credit portfolio, from 2.3% in October to 0.8% in November.

Further reading

The cross-Channel reset: Trump, Putin, and shifting EU-UK opinion

Can Russia Reach a Deal With Syria’s New Rulers?

What Does Regime Change in Syria Mean for Russian-Turkish Relations?