Russia cuts rates in an attempt to cool the rapid rise of trouble

Russia’s central bank cut interest rates for the third time since early April, aiming for a dizzying rally in the ruble, which has seen the currency more than double against the euro. dollars since March.

The Central Bank of Russia on Thursday cut its main interest rate from 14% to 11%. The drop marks a continuation of a rise to 20% earlier this year at a time when authorities were trying to stabilize the ruble after the ruble plunged in the early days of Russia’s invasion of Ukraine.

The cut in borrowing costs is a sign that Russian authorities are growing increasingly uncomfortable with the currency’s rapid rise, said investors and economists.

The power of trouble not only demonstrates the struggling domestic economy, which is expected to fall into a severe recession this year, but also puts pressure on government finances by lowering the value of local currency of oil and gas revenues in dollars, they argued.

The coin rallied to $51 this week, a level last seen in 2015, then briefly dropped to 150 in early March. It fell back to around 60 after the rate cut.

Column chart Current Account Balance (USD billion) shows Russia's current account surplus growing sharply as imports fall

Sofya Donets, an economist at Renaissance Capital, said: “Such an unusual price increase starts out as a financial stability issue, not to mention risks to economic activity. In addition to hurting the government’s budget balance, a strong ruble will make life difficult for some Russian exporters, Donets said, adding that the sudden interest rate cut “is clearly due to the currency. rubles get stronger”.

The recovery since March, which has made the ruble the best-performing currency in the world this year, has been fueled by strict capital controls that limit Russians’ ability to buy foreign currency. It was also fueled by a drop in Russian imports fueled by unprecedented economic sanctions combined with a continued flow of energy exports.

Russia’s current account surplus rose to a record $58 billion in the first quarter of 2022 and could top $250 billion for the full year unless new sanctions halt oil and gas exports. , according to Elina Ribakova, deputy chief economist at the Institute of International Finance.

“While this is not a free-market-determined exchange rate, the stability of the ruble is at the same time ‘real’, in the sense that it is driven by the flow of money into the current account,” she said. Russia’s all-time high,” she said.

A stronger ruble has helped curb Russia’s inflation, which has begun to ease in recent weeks, slowing for the first time since last summer in the week to May 20, statistics show. gorvernment’s. Annual inflation fell to 17.5% on May 20, from 17.8% in April, it said.

The central bank said on Thursday there had been a “significant decline in inflation expectations of citizens and businesses”, saying that a stronger currency had helped ease price pressures in the economy. It forecasts inflation to slow to 5-7% next year and 4% in 2024. Previously, it had estimated this year’s inflation at 18-23%.

Line chart of Ruble per dollar shows Russian ruble recovering strongly from post-invasion lows

However, a stronger currency is not a sign that the economy is resilient to Western sanctions, according to Polina Kurdyavko, head of emerging markets at BlueBay Asset Management. Instead, she argues, the ruble’s rally is actually a sign of sanctions’ effectiveness in isolating Russia from the global economy.

Along with the exodus of foreign companies from Russia, companies including Russia’s largest carmaker Avtovaz have been forced to suspend production due to a lack of imported components.

“What does ruble strength really mean? Certainly not that the economy is healthy,” Kurdyavko said. “Growth will be deep in negative territory. Inflation is in double digits. Obviously pain. At the most basic level, businesses are shutting down because nothing can be imported.”

In this environment, the Bank of Russia will have to be cautious in finding ways to tame the currency’s rally, according to Ribakova.

“The Russian central bank is trying to loosen capital controls because they think the ruble is too strong,” said Ribakova. “But the central bank is in dire straits; if they keep easing, they could open up capital outflows out of the country. In previous crises, $200 billion left the country in just a few months.”

“The bottom line is that while the ruble is stable and Russia runs a current account surplus in the short term, the economic downturn from the Ukraine invasion will weaken the Russian economy in the long term.”

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