- The Central Bank of Russia will try to reduce high inflation and encourage growth to counter the economy's rapid deterioration.
- However, the bank probably will not be able to rely on its biggest tool — the interest rate — to do so, instead turning to less effective means that will have little impact on inflation.
- While the central bank's efforts to reform the banking sector will not yield many immediate gains, they could spur growth in the long run by encouraging investment in Russian businesses.
- Meanwhile, the Kremlin will use its limited resources to prop up Russia's most important sectors, including agriculture and the military.
- Still, unrest will likely grow throughout the year as inflation continues to put pressure on the Russian people.
Low oil prices have thrown a wrench in many of the world's economies, but perhaps nowhere more so than Russia. Depressed energy prices have sent the value of the Russian ruble tumbling and inflation soaring, and much of the Russian population is struggling to make ends meet.
The Central Bank of Russia, under pressure to find a solution to the country's deepening economic crisis, is exploring all of the monetary policy options at its disposal. But the bank will find that its primary tool for combating the inflation wreaking havoc on the Russian economy — adjusting the country's key interest rate — may be difficult to actually use under the current circumstances. As a result, bank officials will likely be forced to turn to secondary, less effective measures to keep the Russian economy from sliding even further into disrepair.
An Overburdened Welfare System
After years of sanctions and declining oil revenues, the outlook for the average Russian is looking increasingly grim. Unemployment is rising, and average wages — already at their lowest since October 2005 — are still declining. Meanwhile, a growing share of the population (likely as much as 14 percent in 2015) is falling below the poverty line. The dauntingly small budget of Russia's welfare system, which is meant to provide a robust safety net for the poorest of Russian society, is buckling under the weight of its burden, and the government is having trouble keeping its poorest citizens from sinking into utter impoverishment. Social tension is mounting, and unrest will likely only grow as the year progresses.
Many of these socio-economic problems stem from inflation. Though inflation is expected to fall, first from 12.9 percent in 2015 to around 10.5 percent in 2016 and then again to near 7.1 percent in 2017, it remains high. This, combined with a devalued ruble and lower incomes and employment levels, has substantially reduced the spending power of Russian citizens. Consequently, nearly a quarter of Russians are considered to be "at risk."
Russia's central bank is looking for ways to lessen this inflationary pressure and encourage development to improve the country's economic health. Historically, it has primarily fought inflation by intervening in currency markets to prop up the ruble, as it did during the 1998 ruble crisis and the 2008-2009 global financial crisis.
However, this approach often requires the bank to draw heavily from Russia's foreign currency reserves. After the crash in 2008-2009, Moscow drained nearly $200 billion from its reserves to keep the value of the ruble from tanking. Thanks to high oil and natural gas revenues, Russia managed to rebuild its shrinking reserves to $545 billion by August 2011. But yet another attempt to artificially buoy the ruble in 2014 sapped those supplies once again. As of Jan. 21, the country's foreign currency reserves had dropped to about $368 billion and the ruble had rapidly devalued by over 50 percent, reaching around 80 rubles to the dollar.
Balancing Inflation With Federal Debt
With its foreign currency reserves dwindling, Moscow may have to turn to issuing debt to make up for its budgetary shortfalls. (Issuing debt allows a government to borrow money from lenders with the promise to repay them at some point in the future.) This is especially true since the central bank, in the wake of its massive effort to sustain the ruble in 2014, has vowed to let the ruble float freely rather than again intervening to prevent further devaluation.
But with Russia's low credit ratings, it would likely have a hard time attracting buyers for its debt unless the central bank raised interest rates — something that would align with the bank's goals of lowering inflation but would also limit consumer spending and hike up costs for Russian businesses. This would in turn increase their reliance on government subsidies to stay afloat, at a time when low oil prices have already cut into the Kremlin's funds. Thus, the interest rate tool that is typically a central bank's greatest policy lever is, in fact, a double-edged sword for the Central Bank of Russia: Raising rates would help manage inflation and attract foreign lenders, but it would slow the economy while expanding the government's subsidy burdens and future debt.
Central bank chief Elvira Nabiullina has made tightening Russia's monetary policy a priority, but being unable to adjust interest rates will hamstring her efforts to reach her target of "low deficit, low debt and low inflation." Still, there are other measures she can resort to, though each has its own problematic consequences.
Russia's Other Options
The first and most easily accessible measure is to adjust the Russian banking sector's capital reserve requirements, or the amount of cash banks must keep on hand at all times. After the financial crisis broke out in 2008, the Basel Committee on Banking Supervision — of which Russia is a member — issued guidelines aimed at preventing banks from overexposing themselves to volatility in niche markets such as housing or technology. The Basel III accords suggest requiring banks to maintain higher levels of reserve cash, a move that could lower inflation by taking money out of circulation. Most Russian banks, especially those that are state-owned, are resistant to raising capital reserve requirements because doing so would cut into their profits and their ability to lend money out. That said, Russia's central bank has already begun to push ahead with this line of reform, though it will take time to fully implement.
In the meantime, central bank officials have started to pursue an alternative strategy to keep inflation in check: lowering liquidity. Under this strategy, the government essentially reduces the amount of money available by printing fewer rubles and absorbing excess cash through deposit auctions, in which the central bank agrees to compensate banks for holding on to money for short periods of time. Hypothetically, the central bank could also reduce liquidity by issuing more debt to soak up investors' available funds, but with the heavy subsidy obligations it faces, Moscow is hoping to minimize its debt as much as it can. Lowering liquidity also has its risks: It often discourages lending, which can stand in the way of economic development.
Nabiullina's final option is to raise the lending standards set for Russian banks, which would make it more difficult for them to lend under risky circumstances. This move would result in greater restrictions on banks' ability to both lend and borrow, as well as on consumers and businesses seeking credit, slowing economic activity overall in the process. However, the Kremlin has an array of subsidy programs in place that are meant to encourage targeted lending to specific, critical industries. This combination of lending standards and targeted subsidies has been successful to some extent over the past five years, but it has also enabled more unprofitable businesses to seek refuge under the growing subsidy umbrella.
Half Measures Will Give Little Relief
As it stands, none of these options will likely be enough to do what adjusting the interest rate would: lower inflation. But unless oil prices change significantly enough, whether up or down, to force the central bank to re-evaluate its course of action, it will have to make do without its primary policy tool. Consequently, the Russian government will use the secondary measures it has to help stabilize the financial sector while funneling the few resources it has to the areas of the economy that matter most, including agriculture, transportation, manufacturing and the military.
Meanwhile, raising capital reserve requirements and continuing to subsidize loans for Russian businesses will do little to make a dent in the high inflation putting strain on the Russian people in the short term. With social unrest already high and expected to escalate throughout 2016, the Kremlin could find itself in a precarious political situation as parliamentary elections at the end of the year draw near.