As Russia’s central bank raised interest rates, an executive at a leading state lender likened the policymakers’ challenge to their “Waterloo,” a crucial battle against inflation with profound implications for the country’s financial institutions and markets.
The interest rate hike was twice the forecast of most economists, leaving Russia with one of the world’s highest rates when adjusted for inflation. This decision marked a shift in official thinking regarding the risks of spiraling inflation as Russia’s financial commitments expanded due to its war in Ukraine, alongside upcoming presidential elections.
The Bank of Russia, after four rate hikes that doubled the key rate to 15%, could increase rates by up to a percentage point next month if inflationary pressures persist, according to insiders.
For President Vladimir Putin, this means that the central bank has the freedom to raise rates, which may pose challenges for businesses and households. These rate hikes are part of a strategy to fund a war budget aimed at ensuring victory, leading to Russia allocating more resources to its military than any other single item next year.
Dmitriy Pianov, Deputy President of VTB Bank PJSC, Russia’s second-largest lender, compared the situation to the famous battle of Waterloo, indicating that the central bank’s decision would significantly impact financial and banking markets in 2023 and 2024.
The central bank’s role has grown this year, with recent pressure to adopt a more dovish tone and government decisions like the reimposition of capital controls. Despite increased expenditure in 2023, the Finance Ministry’s draft budget anticipates a 25% increase next year, reaching 36.6 trillion rubles ($393 billion).
However, inflation remains a top concern for Russians as consumer prices face pressures from labor shortages and extensive government spending. In the third quarter, price growth averaged an annualized 12.1% in seasonally adjusted terms, more than doubling from the previous three months.
The costly war expenses and upcoming elections have hindered coordination between the Finance Ministry and the Bank of Russia, resulting in the central bank’s monetary policy independence over the next six months.
The central bank’s recent rate decision, combined with updated forecasts indicating faster-than-expected inflation, has driven borrowing costs to the highest level since April 2022, risking an economic downturn. The central bank projects an average key rate of 12.5%-14.5% next year.
While this approach is seen as necessary to maintain price stability, it could be overly stringent, especially since the impact of earlier rate hikes has yet to fully materialize. The financial market, including unsubsidized mortgages, consumer, and corporate lending, may face threats, particularly as floating-rate debt makes up over 40% of consumer credit.
The central bank’s strategy presents a delicate balance between curbing inflation and preventing a recession, and the path forward remains uncertain in Russia’s evolving economic landscape.
