Running Russia’s central bank is not an enviable job. Elvira Nabiullina, who has headed the institution for the past 12 years, is between the rock of the country’s slow economic growth, and the hard place of the ruble’s persistent high inflation expectations.
On October 25, the central bank cut the base rate by just 50 basis points, citing sticky inflation and the risks from rising budgetary spending, still-growing salaries due to a tight labour market, and external headwinds. This leaves the rate at 16.5%, still painfully high for businesses and consumers alike.
After two years of fiscally fueled growth, signs of slowdown are everywhere. Manufacturing is stagnating or declining in all non-military sectors, car sales are down, consumer imports from China are flagging, and bad loans are rising for both consumers and the construction sector.
The government has recognized how close Russia is to stagnation, with the Economic Development Ministry this month cutting its GDP growth expectations to 1% this year (down from 2.5%) and 1.3% next year (down from 2.4%). Even these reduced predictions look optimistic — they are based on assumptions of stable oil prices and the absence of significant sanctions, both of which look overly optimistic (The US administration imposed sanctions on two major Russian oil companies on October 22.)
The International Monetary Fund (IMF) has also cut its forecasts for Russia, putting it at odds with the rest of the global economy and most countries, which saw a bump-up in expected growth. The Washington-based fund reduced its expectation of Russian growth from an already measly 0.9% in July’s forecast to 0.6%.
Expected growth next year was left unchanged at 1%. This puts Russia well below the global average, which Vladimir Putin normally insists Russia should exceed. Awkwardly for the Kremlin, Russia’s growth is forecast to be even lower than in the Eurozone, whose economic struggles have repeatedly been derided by Putin in recent years.
Russia’s high borrowing costs — imposed to fight still-high inflation (running at an annual 7.98% in September — is one major reason for the economic slowdown.
A textbook response would have been a sharp rate cut to stimulate lending, consumption, and investment. However, the Bank of Russia, mandated to keep prices stable, remains reluctant to do so.
Despite the slowing economy, inflation expectations remain high, unemployment is hovering around an all-time low of 2.1%, and proposed tax increases could spark a “supply shock.” According to the Central Bank’s estimates, the proposed VAT increase could push up inflation by 0.6-0.8 percentage points in the early winter months.
The government is not reining in its spending, the war sucks workers from the labor market to the front line and the military plants, and sanctions prevent companies from borrowing cheaply abroad and dent their profits. The Bank of Russia sees the recent fall in inflation as seasonal and unsustainable, while the economic slowdown has failed to cool rising prices, and consumer inflation expectations are too high — not the ingredients that warrant an aggressive rate cut even in the face of pressure from industrialists and politicians.
Analysts recently surveyed by the central bank said they expected higher inflation and interest rates in this year and next, and lower economic growth for the entire forecast horizon. They predict the average interest rate will be 19.2% this year, dropping to 13.7% in 2026 (0.5 percentage points higher than in the previous forecast). Markets don’t expect a big cut anytime soon, as investors do not anticipate a base rate lower than 16% at any point next year.
Economists surveyed by the Central Bank also said they expect more headwinds to come the way of the Russian economy from a stronger ruble. If that materializes, it will increase pressure on the government, since a strong currency could mean a bigger budget deficit. The government would like a lower interest rate to help it accelerate economic growth and increase its tax take, while at the same time reducing borrowing costs to help it close the budget deficit.
At present, it expects government debt placements to reach 6.98 trillion rubles ($86bn) by the end of the year. So far, it has borrowed barely half that amount, meaning the market is expecting a rush of government bond auctions in the final months of the year. That means investors will demand either a higher yield or the finance ministry will be forced to issue so-called floaters (bonds linked to interest rates) and therefore take on even more risk of high inflation.
What does all this mean? It suggests Russia’s borrowing costs are likely to stay higher, for longer. That’s because high inflation and weak growth are structural, not temporary.
Rapid wage expansion due to demographics and the war, coupled with stagnant growth, is one factor. Increasing VAT to cover military expenditure is another, as it will trigger a one-time spike in inflation, further putting the brakes on rate cuts.
As a result, businesses will have to struggle for longer, and government borrowing will cost more. The result will be a period of almost zero growth, high inflation, and interest rates — precisely the stagflation scenario this author has been warning about for more than a year.
Alexander Kolyandr is a Non-Resident Senior Fellow at the Center for European Policy Analysis (CEPA), specializing in the Russian economy and politics. Previously, he was a journalist for the Wall Street Journal and a banker for Credit Suisse. He was born in Kharkiv, Ukraine, and lives in London.
More on this and other aspects of the Russian economy in a weekly summary produced by the independent publication, The Bell.
Europe’s Edge is CEPA’s online journal covering critical topics on the foreign policy docket across Europe and North America. All opinions expressed on Europe’s Edge are those of the author alone and may not represent those of the institutions they represent or the Center for European Policy Analysis. CEPA maintains a strict intellectual independence policy across all its projects and publications.
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