The Central Bank believes that a high key rate will stabilize the ruble exchange rate at a new level by the summer of 2024

In its Monetary Policy Report (MPR) published on November 7, the Bank of Russia presented a detailed description of a model in which expansion of domestic demand and higher-than-expected economic growth causes, among other things, a weakening of the ruble. A high key rate for one or two quarters, the Central Bank assumes, will stabilize the rate at a new level by the summer of 2024. The main thing in the logic of the Bank of Russia is that obvious overexposure to stimulation in the economy led to a very rapid recovery of economic activity, which adaptation mechanisms simply cannot keep up with.

The autumn report of the Bank of Russia on monetary policy, presented on November 7, contains a fairly detailed description of the situation in which the regulator found itself in August-September due to the rather sharp depreciation of the ruble against world currencies, the inevitable surge in inflation in such a situation and the risk of a strong acceleration of inflation expectations. Previously, the Central Bank (in the status of a highly probable hypothesis) spoke about a mechanism in which the growth of domestic demand in the economy provokes a weakening of the exchange rate. In parallel, since mid-August, other possible components of the situation, which was not very expected, were discussed, including by representatives of the Bank of Russia: a possible “underreturn” of foreign exchange earnings by large exporters, an increase in foreign trade volumes in rubles, a significant reduction in the trade balance surplus due to the expected decrease export volume (in monetary terms) in the spring of 2023, the impact of hypothetical large transactions with foreign assets in the Russian Federation with the export of capital. The report on the monetary policy provides a detailed analysis of the situation, explaining the regulator’s logic and suggesting its further actions – this happened three months after the events began, which, among other things, led to the introduction of “stepped” export duties on non-core exports from the Russian Federation (see “Kommersant” dated September 21), and later – to the partial restoration of exchange controls in relation to 43 large exporters, the list of which remained unpublished (see “Kommersant” dated October 13).

The report on monetary policy itself describes the most optimistic version of the previously proposed – a picture of a frontal recovery of the Russian economy.

Thus, the Central Bank states, based on the results of the first half of 2023, “record values” of gross fixed capital formation, further (albeit slightly less) growth in investment activity, maximum capacity utilization (it is slightly lower in production, but here it also exceeds the levels before 2019), record expectations in all sectors of the economy (the most positive in the agricultural sector). Consumption in mid-2023 exceeded the level of the fourth quarter of 2021; according to the results of the third quarter, this excess, according to Central Bank estimates, remained, and the growth rate of household consumption accelerated. Triumphant private consumption will, according to the Central Bank’s forecasts, be the main factor in GDP growth by the end of 2023, together with gross capital formation, and both exports and imports will make a negative contribution to the dynamics of economic growth.

In general, the situation as described by the Central Bank is very similar to 2021, when the economy recovered from the “Covid” collapse faster than expected, but no one expected this after the G7 countries introduced unprecedented packages of sanctions (due to the Russian military operation in Ukraine). “Economic growth is following a higher trajectory” than could have been expected, the Central Bank believes. This is confirmed by the financial results of Russian companies in 2023 – according to the regulator, at the end of the year it will be slightly lower than 2021 (mainly due to sanctions problems in metallurgy and chemistry and ongoing losses in the auto industry), but significantly higher than 2019.

The reasons for the faster-than-expected recovery are not entirely clear, although the Central Bank mentions maintaining an expansionary fiscal policy. Analysts of the Bank of Russia do not express (including those following from the explanations of the head of the Central Bank Elvira Nabiullina after the board of directors of the Central Bank on the key rate, see “Kommersant” dated October 28) assumptions that the volume of fiscal stimulus in 2022-2023 was designed for a deeper decline in GDP and financial results. Nevertheless, such assumptions are obvious, including based on the results of the analysis of the situation in construction.

The answer to the question why, in the midst of this over-prosperity, the ruble was devalued and not strengthened can hardly be trivial – we recall that the Central Bank is acting in a situation of bilateral capital restrictions introduced from March-April 2022, which greatly distort the factors of the dynamics of the balance of payments and trade balance. The Bank of Russia adheres to the least exotic explanation: “the expansion of domestic demand with a decrease in net exports and export earnings (trade balance) is one of the most significant factors in the depreciation of the national currency. The dynamics of the Russian ruble exchange rate are also consistent with this logic,” showing similar situations for Turkey and Norway and complementing this with a number of other factors specific to the Russian Federation in the summer of 2023, including a decrease in uncertainties for households and a transition to a decrease in the savings rate.

The Central Bank records four stages of the economy’s adaptation to new trading conditions, suggesting that from the third quarter of 2023 it entered the fourth, from which we can expect the beginning of stabilization of the trade balance de facto “on the horizon from several months to six months.”

“However, if the volume of ruble demand in the economy… continues to grow at a high rate,” the Central Bank believes, with unchanged exports, this will continue to lead to a weakening of the exchange rate. Therefore, the Bank of Russia intends to maintain high loan rates for this period, including to “limit devaluation trends associated with the rapid growth of imports.” Restrictions on capital movements, the Central Bank believes, can prolong stabilization and increase exchange rate volatility over the long term.

Dmitry Butrin