MOSCOW (AP) — Russia’s central bank on Friday raised its key interest rate by two percentage points to a record high of 21% in an effort to stem rising inflation as massive government spending on the military during the fighting in Ukraine crimps ability of the economy to survive. produce goods and services and drive up workers’ wages.
The central bank said in a statement that “domestic demand growth continues to significantly exceed the scope for expanding the supply of goods and services.” Inflation, the statement said, “is significantly higher than the Bank of Russia’s July forecast” and “inflation expectations continue to rise.” A prospect of further interest rate increases in December was offered.
The Russian economy continues to grow due to rising oil export revenues and an increase in government spending, most of which goes to the military as the conflict in Ukraine enters a third year. That has fueled inflation, which the central bank has tried to combat with higher interest rates that make it more expensive to borrow and spend on goods, theoretically easing pressure on prices.
Central Bank Governor Elvira Nabiullina said inflation is expected to double the bank’s annual target of 4%, stressing that the bank remains committed to bringing inflation back to target levels.
Nabiullina noted that inflation has exceeded targets due to increased government spending and relaxed banking regulations that are pushing commercial banks to offer more loans. Years of price growth that exceeded targets have led to high inflation expectations among consumers, she added.
“There is high inertia in inflation expectations as inflation has been above target for four years,” Nabiullina said. “The more inflation exceeds targets, the less people and businesses believe it can fall back to low levels.”
This is the highest policy rate in Russia since it was introduced in 2013 and effectively replaced the refinancing rate, a similar instrument. The previous high was in February 2022, when the central bank raised interest rates to a then-unprecedented 20% in a desperate bid to support the ruble in response to crippling Western sanctions that followed the Kremlin’s deployment of troops to Ukraine.
The Russian economy grew by 4.4% in the second quarter of 2024, while unemployment was low at 2.4%. Factories are largely running at full capacity and an increasing number of them are focusing on weapons and other military equipment. Domestic producers are also stepping in to fill the gaps left by a drop in imports, which have been hit by Western sanctions and the decisions of foreign companies to stop doing business in Russia.
Government revenues are supported by economic growth and by continued exports of oil and gas under less-than-airtight sanctions and a $60 price ceiling imposed by Western governments on Russian oil. The cap is enforced by banning Western insurers and shippers from handling oil priced above the cap. But Russia has managed to avoid the price ceiling by setting up its own fleet of tankers without Western insurance, earning some $17 billion in oil revenues in July.
Chris Weafer, CEO of the consulting firm Macro-Advisory Ltd., noted that the central bank’s interest rate hike aims to “highlight its concerns about the imbalances that have emerged in the economy” that could lead to “serious problems down the road that could even could lead to perhaps a crisis or a recession.”
He noted that soaring defense spending, with more than a third of next year’s budget allocated to the military-industrial complex, has boosted economic growth, along with rising consumer spending, but also the imbalances in the economy have deepened.
Labor shortages caused by a population decline and exacerbated by workers leaving factory jobs to join the military have led to a massive wage increase and a consumer boom. “The central bank is trying to keep interest rates as high as possible to cool interest rates as they warn about the overheating of the consumer economy, which could obviously destabilize the economy in the foreseeable future,” Weafer said.
He described the rate hike as “not so much a cry for help, but a cry of pain from the central bank,” sending a signal to the government that the current high level of spending on military issues cannot continue indefinitely.
