Russia struggles to tame inflation in ‘overheated’ war economy

Russia’s central bank is expected to raise its key interest rate beyond a record 21 percent on Friday, as policymakers struggle to tame inflation in what Vladimir Putin has described as an “overheated” war economy.

Elvira Nabiullina, the hawkish governor of Russia’s central bank, faces a growing body of criticism from officials and oligarchs who say her efforts to rein in inflation are stifling business. Its insistence on raising interest rates even with inflation out of the bank’s control highlights the extent to which policymakers have failed to balance priorities that cannot be resolved during a crisis period. warAccording to leading Russian businessmen and economists.

“You either have massive spending, or you have a stable foreign exchange rate and market economyA former senior energy executive said. “You have to sacrifice one of those. You can’t have it all at once.”

Demand consistently outstrips supply, and the central bank has a limited toolkit beyond high interest rates to address inflation amid low unemployment and weak productivity.

Many economists expect inflation to reach 10 percent by the end of 2024, driven by lavish defense spending and a corresponding boom in the consumer sector. The Russian Central Bank estimates the annual inflation rate at 9.6, far exceeding its target of 4 percent.

The ruble has fallen about 20 percent since its lowest levels in the summer, trading at about 103 rubles to the dollar, affected by sanctions that limit Russian energy exports and its ability to deal internationally. Unemployment rates hover around just 2.3 percent, as arms manufacturers work three shifts around the clock, paid for by ever-increasing budget spending, and the civilian sector struggles to keep up.

The economy was receiving “much more money than it could ‘digest’,” the Russian Central Bank acknowledged in its latest report issued in early December.

A hike in the Russian central bank’s interest rate from 16% in July has drawn several high-profile critics out into the open in recent months, including longtime Putin associates such as Igor Sechin, the head of the oil company Rosneft, and Sergei Chemezov, who runs the defense manufacturing company. Rostec. On Wednesday, Sergei Mironov, head of a Kremlin-run opposition party, accused Nabiullina of “sabotage” and said higher interest rates had worsened inflation.

Nabiullina, 61, has led Russia through several economic crises since she took power in 2013, including the 2014 financial crisis that followed Putin’s annexation of Crimea and the repercussions of the comprehensive invasion of Ukraine in 2022.

This has given her ample time away from Putin, who has acknowledged the criticism but continues to support her in private, according to people who know them.

At his annual press conference on Thursday, Putin acknowledged the presence of “inflation” and “a certain overheating in the economy,” but said that “the government and the central bank are actually tasked with reducing the pace.”

Putin’s bluster, as Russia maintains the upper hand on the Ukrainian battlefield, masks growing concern about how long the Kremlin can sustain the war effort, according to a former senior Russian official. “He can survive for two or three years like this. But he knows that the economy cannot grow at these interest rates. It is a disaster.”

They added that the bleak economic outlook could push Putin to reach an agreement to end the war sometime next year. He knows that the Soviet Union collapsed due to the arms race and economic mismanagement. He keeps saying that we cannot repeat the mistakes of the Soviet Union. “He needs to stop the war,” the former senior official said.

Many indicators point to deep problems in the economy Spending boom Economists say this phenomenon is increasingly struggling to hide.

The first is the growth in wages of unskilled workers due to the hiring spree in the defense sector. Some salaries rose by as much as 45 percent in the first half of this year, according to Russian classifieds site Headhunter.

“Your welder is lured to the defense plant for a huge paycheck,” the former senior energy executive said. “Now there is either no one to hire or you have to raise salaries, and how are you going to make money? Interest rates are so high that you cannot attract money, and construction stops.”

Elena Rybakova, a senior fellow at the Peterson Institute for International Economics, said the hiring spree was simply aimed at “throwing people on the front lines and producing Kalashnikovs. This is not productivity growth.”

Skilled workers are also in short supply. Deputy Prime Minister Alexander Novak said earlier this month that Russia faces a shortage of 1.5 million highly skilled workers, especially in the construction, transportation and utilities sectors.

The ruble’s recent decline also indicates how the Russian economy is under greater pressure as Western sanctions target Moscow in more creative ways.

Last month, the United States blacklisted Gazprom Bank, the main conduit for Russian energy exports and one of the few banks not already subject to Western sanctions. The list closed one of Russia’s few open windows on the global economy and the SWIFT payment system, forcing importers and exporters to resort to increasingly complex and expensive solutions to deal internationally.

One person involved in international payments said the economy was “overheating because the huge commissions to brokers” involved in these transactions were driving up the prices of “everything.” “There’s nothing you can do about it, and it’s a big problem for the economy.”

It is ordinary Russians who have felt the greatest financial pressure. Across the country, the price per square meter of housing has risen since the start of the war by 30 percent, according to a SberIndex data set compiled by Russia’s largest state-owned bank.

This, combined with rising mortgage rates and the cessation of subsidized lending, has put the dream of owning a home out of reach for many. “I regret very much not getting a mortgage when interest rates were low. Now it seems like we won’t be able to afford it – at least not in this country,” said Arina, a single mother in her 30s from Moscow.

Since they could not buy an apartment, the Russians rushed to rent it. In Moscow, renting a one-bedroom apartment now requires nearly 74 percent of the city’s average salary — up from 63 percent just two years ago, according to RBC Real Estate data.

Rybakova said that the reality of managing the economy in wartime meant that Nabiulina had few options.

“It could try to interfere with the subsidized loans of the military-industrial complex. “No one would let her do that,” she said. “This is not the priority. The priority is stronger growth in production and the military-industrial complex, so inflation is secondary.”