It’s not often you get to describe central banking decisions as “wild”, but some of the choices being made in Moscow at the moment are completely out of the box. The famed macro-economic management team are making some extreme choices in what may be one of the most audacious experiments ever. That is especially remarkable as the woman that is making them, Central Bank of Russia (CBR) Governor Elvira Nabiullina, has often been described as the “most conservative central banker in the world.”

The plan that is emerging is that the CBR and Ministry of Finance (MinFin) intend to land the overheated Russian economy to reduce inflation and sky-high interest rates in the same way that you might land a big plane on a short runway by not extending the landing gear.

The ruble dropped below RUB110 to the dollar on November 26 in a meltdown some are saying will spark a currency crisis. Indeed, when the ruble touched on RUB100 to the dollar in the summer, Nabiullina had to act fast with dramatic currency controls and a big rate hike to stave off disaster. This time the ruble blew through RUB100 to the dollar without a major kerfuffle, but plenty of moaning.

The August ruble crisis was a result of Nabiullina’s last unorthodox experiment. Contrary to dogma, she tried to allow the ruble to weaken by keeping interest rates too low. The goal was to boost economic growth with low borrowing costs, but at the same time earn MinFin more cash for the budget from cheaper exports with an undervalued ruble. It nearly went badly wrong after she lost control of the exchange rate, forcing her to take drastic action to prevent a meltdown.

This time round it’s not her fault. Defending herself to a Duma meeting at the start of this week she blamed “external factors” – cheap oil and sanctions on Gazprombank – for the problems, adding that Russia’s full employment and the fact that factories capacity utilisation rate was at a max of over 80% are also stoking inflation, as there is no growth potential left.

All this combines into a wicked cocktail of crushing borrowing costs, rising input and labour costs and falling demand, as the evaporating value of the currency eats into Russians’ real income. This is a recipe for stagflation. And once you get into a stagflation loop it is very hard to get out of it again.

Inflation breakthrough soon

Nabiullina told the Duma not to fret, as she was close to a “breakthrough” with inflation. Rate hikes are not working. So the CBR and the government have teamed up to introduce non-monetary policy methods to cool the economy and bring inflation down. Nabiullina said she expects to be able to start cutting rates again in the New Year.

How is this going to work? This is where it starts to get really crazy. Rather than cutting spending, slashing rates to boost growth (or at least keeping it on an even keel), the CBR and Ministry of Finance are going to do the opposite for now; hike rates and increase spending, but also to crush growth selectively, but on purpose.

The Ministry of Finance intends to fuel more growth, selectively, by not cutting military spending, as previously promised, but to boost it significantly. The Duma just approved the next three year 2025-2027 budget that will see military spending increase rise to 6.1% of GDP, but at the same time reduce social spending for the first time in decades.

This is a wild piece of economic management. Instead of tweaking the economy with carefully selected 25bp tweaks to the prime interest rates every now and again, Nabiullina is letting the currency crash and cutting off access to big swaths of credit, while Russian Finance Minister Anton Siluanov is using a sledge hammer of credit-funded massive spending increases to boost growth in other parts of economy. The war machine must be kept going at all costs, but cuts will be made elsewhere to bring about a soft landing. And as these spending increases have been written into the budget for the next three years; both the CBR and MinFin seem to think this model is sustainable.

Balancing act

Russia’s macro team have won plaudits for their superb management of the economy so far. Russia’s was expected to crash after the first extreme sanctions were introduced in the first week of the war; especially after $300bn of CBR reserves were frozen and Russia was banned from the SWIFT system. But not only did it not happen, but the decisive and radical action Nabiullina took in those weeks nipped the meltdown in the bud and by the summer Russia’s economy started to boom, against all expectations. Two and half years on and it is the EU that is in crisis, not Russia, thanks to the boomerang effect of sanctions.

If anything the crisis in early 2022 was even worse than this one. The fall of the ruble, which passed RUB110 to the dollar this week, pales in comparison to the RUB150 to the dollar exchange rates in the first quarter of 2022. Nabiullina hiked rates a massive 1000bp points overnight in the first week of the war to 20%, halting the ruble’s meltdown in its tracks, before it rallied to regain all its losses and then some more.

Likewise, during the August 2024 ruble crisis, Nabiullina stepped in again with decisive action that halted another meltdown with another big rate hike and the re-imposition of tough currency controls. However, she sacrificing all her growth and budget revenue gains from her unorthodox experiment in the process.

But this time round she has an even bigger challenge to face down. The governor has already hiked rates to an all-time high of 21% and is expected to hike by another 100-200bp in the coming months. Her main problem is that rate hikes no longer have any effect, as inflation is not a monetary problem any more. The overheated economy is maxed out and employment is beyond full capacity so this is a supply problem that can’t be fixed as long as the war continues. Moreover, the government is intending to pump even more money into the economy in the next three years, and Nabiullina is actively preventing taking that money out of circulation but discouraging banks from putting their cash on deposit to take advantage of the sky-high interest rates with a new tax. It's a blunt way of forcing growth by making companies invest and grow instead of parking their spare cash in the vaults and taking the no-risk interest payments. This is not a standard central banking ploy.

The skill will come in by trying to manage these various tectonic forces and blunt tools in an attempt to selectively boost growth and at the same time restrain it. It is an audacious plan.

Already the CBR has pulled the rug out from under the real estate sector by cancelling the generous mortgage subsidies scheme on July 1, that has rocked the housing market. It has hiked the macro-prudential rules on consumer borrowing that has collapsed growth there. It is now targeting the corporate loan market, with less success, but a slew of big lax state-owned borrowers have been cut off from loans by MinFin. And so on. The team are coming up with new measures every week.

For its part MinFin can still fund all the military spending by tapping the domestic bond market, by almost doubling its issue of the domestic OFZ domestic bonds to RUB4 trillion a year – equivalent to about a trillion more than this year’s forecast budget. And there is plenty more of that money as the banking sector has some RUB19 trillion in liquidity that can be tapped in addition to just under RUB5 trillion that remains in the liquid part of the National Welfare Fund (NWF).

Tax revenues will also be boosted by the ruble-denominated oil tax revenues thanks to the weaker ruble. Siluanov said on November 27, surprisingly MinFin was not concerned by the ruble’s tumble, adding that Russia’s weak ruble will benefit exporting companies, offsetting the negative impact of the Central Bank’s high benchmark interest rate.

“I am not saying whether the exchange rate is good or bad. I am just saying that today the exchange rate is very, very favourable for exporters,” Siluanov told a financial conference in Moscow.

A lot of the military spending will also recouped by increases in both personal income tax and VAT, which together account for two thirds of budget revenues. A progressive income tax will be levied for the first time from January, amongst other new sources of funding available to MinFin.

Robust or not?                                      

A race is on between the CBR’s ability to bring inflation down and cut rates and the economy slipping into the stagflation loop where it could be trapped for years. Nabiullina told the Duma deputies that the effects of the various schemes were already making themselves felt and inflation has already fallen from the 9.1% peak at the end of July to about 7.4% as of the middle of November.

A recent spate of articles and speeches have warned that Russia will be hit with a wave of bankruptcies in the New Year due to the high cost of borrowing, yet in her speech to the Duma, Nabiullina pointed out that non-performing loans (NLPs) are still at the same 4% they have been all war.

Russian companies have borrowed heavily in the last two years to retool their factors with non-sanction equipment or take over departing western businesses, and many took out floating rate loans, the share of which in the total loan book have soared and are now very expensive. But Russian companies have never been heavily leveraged. During the boom years they took out credits, but the 2008 crisis and its “margin calls” cleaned the system out of much of its debt and with more sanctions in 2014 following the annexation of the Crimea companies didn't have much chance to leverage up again, especially as the annexation was followed by a four-year long recession. Moreover, Russian business has never made heavy use of credit, typically preferring to fund up to three quarters of its investments using retained earnings. The oil export subsidy Russia Inc. earns means Russia has always been a cash rich place.

The growing payment problems and a yuan liquidity shortage that has appeared in recent months has also proven to be something of a phantom crisis, but has nevertheless become a real headache without meaningfully impact Russia’s external trade volumes yet. Players are finding new ways around the US’ increasingly effective financial sanctions in a never ending game of whack-a-mole.

The real estate sector is a good example. The new kid on the block real estate major Samolet is reportedly in financial trouble and may need a bailout, but it has borrowed heavily and grown very fast in recent years. The doyen of the real estate business PIK does not have the same problems and, indeed, stepped in to replace the end of the government-backed mortgage subsidy system with its own subsidised rate to maintain sales. The problem is that like the US subprime mortgages, it offers low rates for a few years, after which payments revert to market rates; buyers are betting that the CBR will cut rates in a few years and if they stay high Russia will face its own subprime mortgage crisis that could bring down the banking sector.

A real debate has begun trying to work out just how bad things are. Vladislav Inozemtsev, a famous Russian economist in exile and former professor at the prestigious Higher School of Economics in Moscow, wrote in a paper recently that the Russian economy is a lot more robust than it looks. Yes, inflation is high, but it is still in single digits and is coming down. Yes, Russia is dependent on oil exports, but that only accounts for a third of revenues and MinFin plans to bring that down to 23% in the next two year. Looking at Russia’s non-oil deficit (the revenue the government earns from everything except oil) and the economy is currently less stressed than it was during the coronavirus pandemic. And the fact that Russia is becoming increasingly powered by domestic consumption and not oil exports is a major advantage and a solid foundation on which to build.

The jury is still out but it’s tempting to trust in Russia’s macro team as they clearly know what they are talking about. Nabiullina is the veteran of multiple crises as detailed in bne IntelliNews’ history of Russian crises and has brought Russia through all of them.

Siluanov also knows his onions. In January 2023 Russia’s reported the largest monthly budget deficit since the 1990s leading economists to predict the full deficit would come in at anywhere between 4% and 12% of GDP in a total disaster for the country. Siluanov stuck to his guns and predicted the budget deficit would be on plan at 2%. It ended the year at 1.9%, despite the massive dislocation in January.

But there is no denying the economy will slow sharply in 2025, according to a pessimistic medium-term outlook published by the CBR in August – well before even the wave of bankruptcies stories appeared. Nabiullina has seen this currently crisis since at least the summer, and probably a lot earlier.

The slowdown is visible now. In October, the volume of incoming payments via the Central Bank’s payment system (about half of all payments made in Russia) was down 2.9% compared with the third quarter average, The Bell reports.

This crash landing style of economic management has upset a lot of top Russian businessmen who are calling for the CBR’s independence to be curbed as the gamut of sectors are showing signs of slowing. Even if the strategy works, it is going to cause a lot of damage in the process.

“The slowdown is not simply due to declining output in the raw material extraction industries (this has been ongoing for several months amid falling export prices), but also a stuttering manufacturing sector. The only place growth is still noticeable is in sectors linked to the military. Everywhere else in the economy growth is absent, or, at best, anaemic,” The Bell said in a note.

Economists have already revised downward their projections for Russian GDP growth this year. Growth is predicted to end this year at 3.8%-4%, but growth for 2025 is now about half the global level and will slow to somewhere between 0.5% and 1.5%, according to the CBR. In 2026, it’s expected to be below 2%.

Russia’s Centre for Macroeconomic Analysis and Short-term Forecasting (CMASF) is now talking openly about possible stagflation, flagging the risk of a recession and falling productivity, especially in low-profit sectors and industries with long project implementation timeframes.

In the first half of the year capital investment was up 10%, but by November it had gone into the red. Russian Prime Minister Mikhail Mishustin has blamed interest rates for reduced investment. He lamented in November that “savings are more profitable than investments.” The head of state-owned conglomerate Rostec, Sergei Chemezov, said shortly after that interest rates were a “brake” on industrial development, warning they could even lead to a halt in arms exports.

He, and others, have called for the CBR to “coordinate” its monetary policy more closely with the government, but Nabiullina is furiously resisting any encroachment on the regulator’s independence and so far Putin has backed her unreservedly in every crisis.