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Financial analyst Alexander Kolyandr explains Russian policymakers’ dwindling options amid growing monetary grief

Source: Meduza

This fall, Russian monetary officials raised the cost of credit for banks by hiking the key interest rate to 21 percent — higher than it’s been in more than a decade. On December 6, Sberbank CEO German Gref warned that the Russian economy is slowing, particularly in the housing construction sector. Even Central Bank head Elvira Nabiullina has acknowledged that Russia’s economy is becoming less responsive to rate hikes, but driving up the key rate remains the government’s primary tool for managing inflation, which isn’t expected to fall any time soon. Earlier this week, Nabiullina warned that her office might raise the rate even higher amid the ruble’s tumble, causing further inflationary pressure. (Russia’s inflation is expected to end the year at 9 percent.)

To find out how Russia’s monetary policy struggles are affecting the economy and the public, Meduza spoke to financial analyst Alexander Kolyandr, a scholar with the Democratic Resilience Program at the Center for European Policy Analysis.

— Last month, Economic Development Minister Maxim Reshetnikov said the ruble isn’t so much weakening as the U.S. dollar is strengthening. Is there anything to this claim?

 — Reshetnikov is right, but only partially. It is true that the dollar is strengthening against all the emerging-market currencies and even against the euro and the pound sterling. That’s largely the market’s reaction to Donald Trump’s victory. However, it’s only partly true because ruble has its own, shall we say, homegrown problems.

The exchange rate is always a result of supply and demand, as with any other commodity or price. What's happened with the supply and demand of dollars in the past several months? Starting from the end of the second quarter, Russia's trade-balance surplus narrowed.

It was mostly a two-way street. First, the price of Russian commodity exports declined somewhat. On the other hand, the demand for imports was higher. Second, the sanctions attacked from different fronts. They were strengthened against intermediaries. It became more expensive for Russian importers to pay for imports, and it became more difficult for Russian exporters to sell Russian exports and to get money for it.

In other words, the cost of sales for exporters and buying things for importers increased. As a result, the net profits from sales declined, leaving fewer dollars in their pockets, while the price of imports increased. 

— How do all these shifting economic trends affect ordinary Russians’ pocketbooks? Is this the kind of thing that people feel at the household level?

— Whenever the cost of importing stuff rises, the price for that imported stuff also rises. There’s no way around it. Importers are extremely keen to transfer the price increase to the customers. When there is a drop in exchange rates, it leads to rises in the cost of imports. Even if it's domestically produced, it might still depend on tradable goods or imported stuff. So, prices shoot up. Inflation goes up. 

The government injected about 1.5 trillion rubles [$15 billion] into the economy, which creates an oversupply of rubles. You have more rubles; you want to buy imports. It creates more demand. Then, on top of everything, came the sanctions against Gazprombank, the main conduit of gas payments for Russia. So, everyone rushed to buy dollars, but the exporters reduced the sale of their dollars because the Central Bank allowed them to do it in October. So, there were fewer dollars to buy and more rubles to sell.

The sanctions against Gazprombank pushed the stone and created the avalanche. Just three years ago, before the war, that would have led to a very predictable market reaction because everyone would expect the Central Bank to up the base rate. The markets were open then. Foreigners would rush in to buy rubles, Russian bonds, and Russian assets, expecting the higher rate to bring them more rubles for their buck. And then they could convert it back and pocket the difference.

That always cushioned huge exchange rate fluctuations, but now Russia is completely isolated from the international financial markets. Before, it was like dropping a small stone in the sea: It creates only small ripples. Try that in a tiny bucket, and it splashes everywhere. This is what happened in Russia. There’s no extra liquidity, and that pushed the ruble down. 

The Central Bank is quite unable to raise the rate substantially. Because when the base rate is at 21 [percent], you need to increase it by — I don’t know — five, six, seven percentage points to do something material. And that would just strangulate whatever is left of the non-military economy.

So, the Central Bank is in a pretty peculiar position. They need to raise the rate, but they find it difficult to do that — especially after what Putin said yesterday when he indicated that the exorbitant rates are not so good. 

— Has the Central Bank run out of policy options? 

— Nothing prevents the Central Bank from intervening if they see it as a danger to the national banking system, but I don’t think they see it like that. And second, they don’t have much because of the sanctions. They have $30-32 billion remaining in their National Wellbeing Fund. That’s what they can use for buying rubles. They don’t have much to intervene. There were also verbal interventions, basically soothing the market and telling everyone that everything’s fine. And that’s about it. 

The only gun left in the holster is to ask Putin to make a phone call to exporters — namely, to oil companies — and kindly ask them to sell a bit of their dollars on the market. And that’s about it. 

While the Russian economy is running at full throttle and has no capacity to increase output, devaluation doesn’t lead to more domestic producers jumping in. If you don't have the capacity to produce more, you simply do not produce more, regardless of the exchange rate. That means the inflationary effect of devaluation is greater than before the war. So, yes, on the one hand, they need to keep inflation under control. On the other hand, they have very limited abilities to do that. So, I suppose they will do very little. 

The Russian economy has become so isolated from the international markets, the market so narrow, and the sanctions pressure so lasting that I believe the ruble is destined to be unstable. It could go up by five or down by five without anybody complaining. And it is also destined to weaken over time. 

— In your view, what’s the Central Bank’s time horizon for its current policies? Does the bank’s planning assume indefinite sanctions and a permanent war in Ukraine, or is there the expectation that things will return to pre-war conditions sometime soon?

— I think their time horizon is much bigger than the government’s. They have their four-percent inflation target at the bank, and it doesn't matter whether or not they are successful at the end of the day. All that matters is what they do to achieve it. 

The government’s time horizon is limited by a single fiscal year at best. It caters to the Kremlin’s political agenda, which at the top of everything is war, as far as we can tell. And nobody knows the Kremlin's true aims in this war. 

— Would it be fair to say that the Central Bank is the most independent state institution in Russia?

— I think the most independent institution in Russia is President Putin.

— Well, the Central Bank is the most independent from him, rather.

— I would put it this way: It has a lot of independence. And Putin does observe it. It’s down to his decision to keep the Central Bank’s policy independence. It’s not independent to the extent that Nabiullina could stand up and accuse Putin of waging an unjust war, obviously. But within the general frame of aims and targets, the Central Bank is given a free hand to use whatever means it finds necessary.