The Russian central bank urgently raised interest rates by 350 basis points, causing the Russian ruble to drop to a nearly 17 month low. The Russian central bank urgently raised interest rates, and the ruble exchange rate fell

According to foreign media reports, the Russian central bank held a non routine interest rate meeting on the 15th local time, during which it decided to raise the benchmark interest rate by 350 basis points from the previous 8.5% to 12%. The previous day, the exchange rate of the Russian ruble against the US dollar fell below 100 rubles per dollar, marking the first time since March last year that it has fallen below this psychological threshold. After the Russian central bank announced its interest rate hike decision, the ruble has rebounded somewhat.

The Russian central bank significantly raises interest rates

According to reports, the Russian central bank announced a significant interest rate hike on the 15th, stating that as the ruble depreciates and inflation expectations rise, this decision is aimed at limiting the risk of price stability. However, the Russian central bank has previously stated that it has not seen any threat to financial stability from the decline in the ruble.

It is reported that due to the previous drop of the ruble to US dollar exchange rate below 1 to 100 rubles, the interest rate meeting originally scheduled for September 15th has been advanced by one month.

Last month, the Russian central bank raised its benchmark interest rate by 100 basis points to 8.5%. This is also the first time since September 2022 that the Russian central bank has raised its benchmark interest rate.

On August 9th, the Russian central bank also announced that it will stop purchasing foreign currency in the domestic market under a budget mechanism aimed at protecting the economy from the impact of commodity price fluctuations. After the news was released, the ruble exchange rate briefly rebounded, but it continued to decline thereafter.

The Financial Times pointed out that Russian technical officials are struggling to "walk the tightrope" between economic growth and stable currency. The decline of the ruble has also led to rare public disagreements among senior Russian officials.

On the 14th, Maxim Oleshkin, the economic advisor to Russian President Putin, wrote an article on the Russian state news agency TASS stating that a strong ruble is in Russia's economic interest. He said that the current ruble exchange rate has seriously deviated from the basic level, but it is expected to normalize soon.

Oleshkin also attributed the weakening of the ruble to the loose monetary policy of the Russian central bank. He stated that all tools possessed by the Russian central bank can quickly normalize the situation and ensure that loan interest rates are lowered to sustainable levels.

However, the Governor of the Russian Central Bank, Nabiurina, has repeatedly pointed out that the deterioration of foreign trade conditions is the main reason for the weakness of the ruble, while ruling out the possibility of intervention to support the exchange rate.

Why did the ruble decline?

Since the Russia-Ukraine conflict last February, the ruble exchange rate has been in turmoil.

Last March, the ruble to US dollar exchange rate fell to a historic low of 120 rubles per dollar. Subsequently, as Russia took various measures to stabilize the financial market, the ruble exchange rate gradually rebounded, even rebounding to 57 rubles per US dollar.

But recently, the ruble exchange rate has fallen again. Bloomberg reported that the ruble has fallen by about 27% against the US dollar this year, making it one of the worst performing emerging market currencies.

Analysis suggests that the decline in export revenue, the increase in government spending such as military spending, and dependence on imports have all led to an increase in Russia's fiscal deficit, as well as a weakening of the ruble and high inflation.

Data shows that as the West intensifies sanctions against Russia, Russia's export revenue has significantly decreased compared to last year.

According to data from the Russian Central Bank, the revenue of Russian oil and gas exporters in July decreased from $16.8 billion in the same period last year to $6.9 billion.

The data released by the Russian finance department also shows that from January to July this year, the oil and gas revenue in the Russian budget was about 4.19 trillion rubles, a decrease of 41.4% compared to the same period last year. The main reasons for the year-on-year decrease in Russia's oil and gas revenue include a large base last year, a decrease in oil and gas prices, and a decrease in export volume.

While export revenue has declined, Russian government spending is increasing, stimulating import demand and putting pressure on the ruble. According to preliminary estimates from the Russian Ministry of Finance, the government's budget expenditure for the first seven months of this year was approximately 17.34 trillion rubles, a year-on-year increase of 14%.

At the same time, due to lower ruble interest rates than expected inflation and an increasing number of Russian banks being cut off from the global payment system, Russian households have transferred approximately $40 billion to foreign banks, exacerbating the weakness of the ruble.

Double edged sword

The Wall Street Journal believes that the weakening of the ruble will be a double-edged sword for Russia.

On the one hand, currency depreciation helps boost exports, and exporters' foreign exchange earnings calculated in US dollars, Chinese yuan, or euros and converted into rubles will appreciate, which in turn will increase Russian government taxes.

On the other hand, a weakening currency will also increase import costs and push up inflation, which will be a huge hidden concern for Moscow.

The Russian Central Bank stated last month that Russia's current inflation level and inflation expectations are still rising. The sustained rise in domestic demand and the weakness of the ruble exchange rate have significantly increased the risk of inflation. Under the current monetary policy, Russia's inflation rate will be between 5.0% and 6.5% in 2023, and will fall back to 4% in 2024.

Another risk is that a weakening ruble may further exacerbate capital outflows. In addition, as Russia experiences its most severe labor tightening in decades, the depreciation of the ruble will further reduce its attractiveness to foreign labor, especially immigrants from neighboring Central Asian countries.

How will Russia's monetary policy go in the future? In response, Bloomberg cited Russian economist Alexander Isakov as saying that the unexpected move by the Russian central bank aims to increase local currency savings and demonstrate the credibility of the stance of reducing inflation to 4%. He expects that after this round of significant interest rate hikes, the Russian central bank may press the pause button for the rest of 2023.