MOSCOW BLOG: Nabiullina’s unorthodox adventure

MOSCOW BLOG: Nabiullina’s unorthodox adventure
CBR Governor Elvia Nabiullina is famous for being the "most conservative central banker in the world" but did she really drop the ball and drag her heels on hikes that caused the ruble to crash? More likely, she just had an unorthodox adventure that went badly wrong. / bne IntelliNews
By Ben Aris in Berlin August 15, 2023

The Central Bank of Russia (CBR) came in with a much bigger rate hike than I, or most commentators, were expecting. After the ruble slid below RUB100 to the dollar yesterday – one ruble is worth one cent now – the CBR announced it would hold an emergency meeting this morning and put in a big rate hike.

Most people were expecting a 150bp hike, as that should have been enough to stem the bleeding, but CBR Governor Elvira Nabiullina, as ever, acted decisively and killed the problem dead, in the same way that she did in March 2022 when the ruble last tanked, putting in a 1,000bp rate hike that turned the FX dynamics on a dime and saw the ruble strengthen to an extraordinary RUB53 in a week.

As you are probably aware, I have taken the line that she was weakening the ruble on purpose, as that generates extra rules for the budget to close the hole – and that worked; the deficit has come down from 2.4% of GDP to 1.8% and inside the 2% target. But this comes at a cost: higher inflation. According to the weekly figures, annualised core inflation is now 7.1%, way up on the historically low 2.4% in May, and still rising.

Others have cheered the collapse of the ruble as evidence that sanctions are working, as both oil revenues and the current account surplus have shrunk, putting pressure on the ruble.

Digging into it over the last 24 hours and the truth is, predictably enough, more complicated. Presidential economic advisor Maxim Oreshkin wrote an op-ed for Tass that came out yesterday just as the ruble hit RUB100 to the dollar, slating the CBR for “soft monetary policy” – ie not raising rates fast enough. Nabiullina defended herself, saying the problem was the “large public sector demand” (i.e. military spending) that was made worse this year by growing private sector demand (i.e. rising wages, consumer borrowing and spending as the economy returns to normal). Moreover, things have been made worse by the fact that the amount of cash in circulation has soared, as it seems Russians don’t trust either the banking sector or the currency.

It's hard to judge who is right in this argument between soft money policy and rising public demand, as they are of course both correct. It’s a question of degree. (And it is interesting to see the very public debate within the Kremlin’s liberal elite over real macroeconomic issues. That’s healthy and encouraging.) Plus there are a bunch of other factors that go into the FX dynamics: a serious one is the rise of capital flight as the CBR eases some of the capital controls, and my favourite one is its holiday season, and Russians typically export about $5bn in August while on holiday in Turkey, which is happening now.

But step back a bit and a striking point jumps out. Nabiullina is famous for being “the most conservative central banker in the world” and she has done something very unorthodox. No slouch on fighting inflation, she has even been warning about mounting inflation pressure all year, yet she has not put through rate hikes fast enough. On that score Oreshkin is right.

This is actually pretty shocking. She was the second (after Ukraine) to end easing at the start of 2021 and warned of rising global inflation at a time when no one took her or inflation seriously. She was way ahead of the curve, and as a result Russia coped with the subsequent global inflation wave far better than nearly anyone else. Plus the extraordinary 10% rate hike she put in the first week of the war also shows she is a battle-hardened and a bold warrior in the war against inflation.

And now, suddenly, she has dropped the ball and was slow to hike rates to tackle rising inflation that was in plain sight???

This was the unorthodox bit: she knew inflation pressures were up but was attempting to effectively allow the ruble to weaken for the sake of the budget by dragging her heels on rate hikes. She broke with her rigid orthodoxy of rigorously controlling inflation with the appropriate rate hikes, usually slightly ahead of time, presumably in the hope that there was enough wiggle room to simultaneously manage two contradictory targets: weaken the ruble to get more budget cash AND control inflation.

This was manifest in the surprise 100bp hike in July, as inflation was getting so strong it needed a slap. And everyone was expecting another 100bp in September. (August is normally a holiday month with no CBR meeting.)

The trouble is, she lost control of the situation. The ruble has been falling consistently all year since January, but as it approached RUB100 people started to get nervous. Last week I watched top Kremlin propagandist Vladimir Solovyov deliver a rant against the CBR as the ruble got close to RUB100 to the dollar. Others in the liberal elite have also vocally condemned the CBR for not controlling the exchange rate. (Maybe their homes in France are becoming prohibitively expensive to run?)

These were forces that Nabiullina could not control. Last week she suspended the budget rule, which forces her to buy dollars if there are extra oil tax dollars, which in normal times would have strengthened the ruble, but it had no impact at all in the current climate. Suddenly Nabiullina had run out of tools and the next monetary policy meeting was too far away. If bad things happen in Russia, they always happen in August, remember?

I’m sure that the last thing that Nabiullina wanted to do was put in a big rate hike, as they can take years to unwind once they are in place. And given the budget deficit is down and oil revenues are widely expected to pick up in the second half of the year, it shouldn’t have really been necessary, which is why I, and many others, thought she could get away with a 150bp hike. But Nabiullina being Nabiullina did what she always does: act decisively and take full control of the situation.

Of course, there is a chance that even this hike won’t work, and the ruble will continue to collapse. But I doubt it. If it does continue to fall, the CBR will come up with more actions. She still has the option of intervening in the market, which is another thing she is desperately trying to avoid. Looking at the exchange rate this morning, the ruble trading actively and is at RUB98 to the dollar now, so it seems the rate hike has not had an immediate dramatic effect, but according to Capital Economics, after a big fall it typically takes a currency around five days to find its new equilibrium value.

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