The Emerging Discord: Russia’s Central Bank and Kremlin Clash Over Inflation and Currency Troubles

Russia is currently facing challenges with rising inflation and a depreciating currency, highlighting a growing disagreement between the Kremlin and the country’s central bank.

In an emergency meeting on Tuesday, the Central Bank of Russia (CBR) raised interest rates by 350 basis points to 12% in an effort to stabilize the ruble currency, which plummeted to a 17-month low of nearly 102 to the dollar on Monday.

This sudden move came after Maxim Oreshkin, President Vladimir Putin’s economic advisor, wrote an op-ed stating that loose monetary policy was causing the acceleration of inflation and the weakening currency, and that the central bank had the necessary tools to address the situation.

The central bank justified its rate hike by stating that it aimed to limit risks to price stability, as inflationary pressures were building up. Over the past three months, price growth has averaged an annualized 7.6% on a seasonally adjusted basis, with core inflation rising to 7.1% during the same period.

The central bank’s board explained that steady growth in domestic demand, exceeding the capacity for output expansion, was increasing underlying inflationary pressure and impacting the exchange rate of the ruble through elevated demand for imports.

Despite the central bank’s previous decision to halt foreign currency purchases on the domestic market until 2024, the decline of the ruble persisted. Russia often sells foreign currency to offset decreases in oil and gas export revenues and buys when running a surplus.

Before the intervention of the Kremlin, the Bank of Russia attributed the inflation and currency issues to the country’s shrinking balance of trade. Russia’s current account surplus fell more than 85% year on year from January to July.

Anatoly Aksakov, chairman of the Duma Committee on Financial Markets, stated on Monday that “the ruble exchange rate is under state control,” according to a Google translation.

After coordinating measures to restructure the Russian economy and minimize the impact of economic isolation and sanctions from Western powers, the Kremlin and the Bank of Russia now appear to have differing views on the causes of the currency troubles.

Analysts suggest that the government’s direct influence on the central bank’s monetary policy actions reflects the challenges faced by the country’s economy.

Agathe Demarais, global forecasting director at the Economist Intelligence Unit, explained that the central bank’s initial assessment of the collapse in Russia’s current account surplus being the main factor behind high inflation was correct. She highlighted that Western sanctions were curbing Russia’s hydrocarbon export revenues and increasing import costs, further exacerbating the situation.

Since Russia’s full-scale invasion of Ukraine and subsequent imposition of Western sanctions, the ruble initially dropped to 130 to the dollar in February 2022. The central bank implemented capital controls to stabilize the currency, eventually bringing it back to a range of 50 to 60 to the dollar by the summer of 2022.

The central bank later eased these capital controls to support the economy as the impact of sanctions intensified. Alongside a period of low interest rates, this further contributed to the ongoing challenges faced by the ruble.

Demarais stated that blaming the central bank had become an “easy tactic” for the Kremlin due to the lack of tangible options to improve the situation.

Reports suggest that Russian authorities are now considering the reintroduction of capital controls, including compulsory sales of foreign currency revenues for exporters. The central bank’s rate hike only slowed down the depreciation of the currency.

Back to Capital Controls?

Stephanie Kennedy, economist at Julius Baer, predicts that the most likely scenario is for the CBR to strengthen capital controls and enforce the rule that exporters must convert their earnings from US dollars into rubles.

Kennedy explained that currency collapses are often prompted by nervous international investors or domestic capital flight. Sanctions and capital controls have isolated Russia from the international financial system, resulting in thin trading of the ruble, particularly against the US dollar. The devaluation is driven by the relative flow of exports (earning foreign currency) and imports (requiring payment in foreign currency).

Although the current account surplus has decreased significantly from its peak in June 2022, it remains at a tolerable level within its historical average. A weak currency benefits Russia’s oil revenues but also increases import costs.

In June, Russian Deputy Prime Minister Andrey Belousov stated that a ruble value of 80-90 to the dollar was ideal for the country’s budget, importers, and exporters.

Julius Baer expects capital controls to be reinforced and the rule on exporters to be introduced. However, they anticipate the ruble to reach around 92 to the dollar in three months and 95 in 12 months.

Kennedy concluded that while this may indicate a spot appreciation with significant carry, the ruble remains difficult to trade, and uncertainty about its outlook remains high.