A Phantom Target: The Central Bank has cut the rate despite not believing in the reliability of disinflation
For the first time in two and a half years, the Central Bank lowered its key interest rate on 6 June. However, this move is largely symbolic and does not indicate that the Russian economy is firmly on the path of disinflation.
On the one hand, cutting the rate by one percentage point, from 21% to 20%, will not have a significant impact on lending to the economy. A more meaningful cut would have brought it down to at least 19%. On the other hand, this step serves as a compromise, signalling the Central Bank’s willingness to accommodate the demands of the industrial and fiscal lobbies.
The dynamics of prices, inflation expectations, and consumer demand all pointed to the fragility of the disinflation trend. This was acknowledged by the Central Bank itself. Another pro-inflationary factor is the absence of any notable signs that the government intends to meaningfully restrain budget spending.
On the contrary, the continuation of military operations in 2025 will almost certainly require further growth in defence expenditures. At the same time, there is strong evidence of a slowdown in the Russian economy, especially within the civilian sector of industry, where more and more sectors are cutting output.
While military sectors continue to show impressive year-on-year growth, even they are nearing stagnation on a month-to-month basis. Against the backdrop of high interest rates, all this leads to a deterioration in the financial position of companies, with a growing number struggling to service their debt.
Ultimately, the economic slowdown is hitting budget revenues. With the export component declining, the government intended to compensate through domestic taxation. This helps explain why Finance Minister Anton Siluanov was among those lobbying for a rate cut. Inflation traditionally serves as a way to rebalance the budget when revenues are under pressure.
Although the Central Bank’s concession on the rate is almost symbolic, it reflects a shift in the balance of power surrounding economic policy. The ideology behind the current Central Bank policy, with its inflation target of 4%, was formed in a time when Russia aspired to OECD standards, and low inflation was associated with hopes of attracting foreign investment. Today, this is an entirely different economy: significantly more closed, betting on state rather than private investment, with large defence expenditures and a dirigiste military-industrial mindset.
Although the Central Bank continues to insist that its goal is to reach the 4% target by 2026, a more realistic benchmark for the Russian economy, given its current structure, is a much higher inflation rate over the coming years, in the range of 7–9% or even higher, and the Central Bank is unlikely to be able to do much about it.
The Central Bank at a crossroads
On 6 June, for the first time in two and a half years, the Central Bank cut its key interest rate, from 21% to 20% per annum. This outcome was perhaps the most expected. Overall, in our view, the Central Bank had three options at its disposal.
The first was to keep the rate unchanged. This would have most closely aligned with the Central Bank’s own understanding of current economic and price dynamics, and most forecasters leaned in this direction. However, such a decision would have amounted to an overt display of the Central Bank’s 'hawkishness' and a direct challenge to those lobbying for a rate cut. It was no coincidence that VTB head Andrei Kostin had suggested a ‘bet on 10 clicks’ that the rate would indeed be cut. A firm decision to hold would have unleashed a torrent of criticism personally directed at Elvira Nabiullina, painting her as an 'enemy of Russian economic growth.'
Ahead of the board meeting, the pro-cut camp launched a full-scale offensive. A torrent of news stories about troubles in various sectors of the Russian economy suddenly flooded the media. A considerable number of government officials joined the business community’s chorus of panic. Finance Minister Anton Siluanov stated that since 'inflation is falling,' the Central Bank had 'room to take any necessary decision.' 'After we cool down, we’ll hit the gas again and continue to grow – that’s the cyclical nature of our economy, our life,' the minister reflected. Deputy Prime Minister Dmitry Manturov, who oversees the military-industrial complex, made a similar statement. Prior to this, Vladimir Putin asked the Central Bank to avoid ‘freezing the economy’ at a meeting with business leaders.
The second scenario, riskier but in our view viable, was to cut the rate straight to 19% (from which it had been raised to 21% in late October 2024), while firmly stating that the next move would not come for some time. Such a decision would have given economic agents a clear signal about the conditions they should prepare for over the medium term. A two-point cut could have improved the position of the stronger market players.
Finally, the third scenario – the one that was ultimately adopted – may symbolically meet market hopes for a rate reduction, but is unlikely to have any meaningful impact on companies’ access to credit.
Unstable disinflation
Why would holding the rate steady have been the most consistent course of action?
On the one hand, inflation in Russia is indeed slowing. It peaked at a monthly rate of 1.43% in November 2024, but fell to 0.65% in March and then to 0.4% in April. In the week from 27 May to 2 June, prices rose by just 0.05%, and the average weekly inflation in May stood at 0.055%. Some other indicators also point to the effectiveness of the Central Bank’s tight monetary policy. The consumer lending portfolio has been shrinking since October, contracting by 11.5% over that period, according to Central Bank data. The annual growth of the portfolio declined from 9.9% in January to 3.1% in April. Business price expectations, according to Central Bank surveys, have also been falling for five consecutive months: from 27.6 percentage points in December to 18.8 in May.
The Central Bank already softened its rhetoric at its April meeting, shifting its guidance from 'moderately tight' to 'neutral,' thereby allowing for the possibility of a rate cut, provided that inflation expectations showed sustainable decline. However, according to the 'inFOM' surveys, inflation expectations have instead begun to rise again. In April, they increased by 0.2 percentage points compared to March, reaching 13.1%, and rose by a further 0.3 percentage points in May. Interestingly, April's increase was driven by respondents with savings, while in May, it came from those without savings. In its latest issue of the bulletin What the Trends Say, published on 27 May, Central Bank analysts admitted there was still no convincing evidence that inflation and inflation expectations were moving in the right direction. The data does not allow for a clear assessment of how much of the decline is due to 'sustainable factors related to more balanced demand dynamics,' and how much is temporary or random. Analysts identified the strengthening of the rouble, particularly in the durable non-food goods segment, as the key driver of disinflation. At the end of 2024, the dollar was trading at nearly 110 roubles; it now holds at around 80. However, they caution that the factors behind this appreciation are themselves unstable.
Despite a sharp slowdown in wage growth at the beginning of 2025 — with real wages in April effectively flat year-on-year (+0.1%) — the cooling of wage inflation is likely to be constrained by persistent labour market shortages. Consumer sentiment has declined only slightly compared to the peaks of spring 2024, and the main factor behind this drop has been the rising cost of consumer credit. This has led to a sharp deterioration in how citizens perceive the economic conditions for purchasing housing and vehicles (areas where credit plays a crucial role). However, attitudes towards buying durable goods have not seen a similar decline (→ Re:Russia: Undercooling). Finally, although the rate of deposit growth has slowed – household savings grew by 2 trillion roubles in the first four months of the year compared to 11 trillion roubles across 2024 – this is still a substantial increase, especially given the reserves built up last year. Altogether, this suggests that inflationary pressure from consumer demand remains present in the economy.
Another pro-inflationary factor, according to analysts from the Gaidar Institute, is the widening budget deficit. The deficit itself is not inherently inflationary. Rather, the issue lies in the increase in government spending, which has risen by 20.8% year-on-year to 15.5 trillion roubles. This surge, against a backdrop of falling revenues, has led to a doubling of the federal budget deficit. Moreover, as the MMI channel rightly points out, we should expect another now-traditional autumn revision of budget expenditures, particularly due to a further increase in the military component. Our own assessments also indicate that the continuation of military operations in 2025 will necessitate a reassessment of military spending(→ Re:Russia: Three-Way Fork); however, we believe the government will mostly seek to offset this through cuts in non-military areas.
The accumulated inflationary overhang from consumer demand and the lack of any serious restraint in government spending are the two main pro-inflationary forces in the Russian economy. In justifying its decision to lower the rate, the Central Bank stated that 'current inflationary pressure, including persistent elements, continues to ease,' but then listed the same risks that prevented easing in April: 'inflation expectations remain elevated,' and 'domestic demand continues to outpace the capacity for expansion in goods and services supply.'
Budget and industrial lobby
The primary reasons behind the rate cut are not the durability of the disinflation trend, in which, as we have seen, the Central Bank openly expresses doubts, but rather the slowing pace of economic growth, the deteriorating financial state of enterprises, and the shortfall in budget revenues.
In the first quarter, the economy grew by 1.4% compared to the first quarter of 2024, after growing by 4.5% year-on-year in the fourth quarter of 2024, according to Rosstat. However, GDP declined compared to the previous quarter. According to Raiffeisenbank analysts, the decline was 0.5%, while Bloomberg Economics placed it at 1.2%. Both expect the economy to shrink again in Q2 compared to Q1, which would mean Russia enters a technical recession (→ Re:Russia: Military Hangover).
While overall industrial activity in April showed stagnation rather than recession, this 'positive' performance was largely due to increased oil extraction and refining, analysts at the government-aligned Centre for Macroeconomic Analysis and Short-Term Forecasting (CMASF) observed. In contrast, output in other civil industries has been declining since the start of the year, averaging a 0.7% monthly decrease between January and April. In Q1, for the first time since 2022, food production also declined, according to CMASF data. Furthermore, the centre’s analysts noted a drop in the production of machinery and equipment in 2025.
The recession in the civilian industrial sector began at the end of 2024, following a period of stagnation earlier in the year (→ Re:Russia: Inflate and Dominate). This trend is also reflected in the 'Bessonov Index,' which excludes military production from industrial performance metrics (see chart). A brief growth spurt in December proved to be driven by short-term factors.
In April, the industrial production index stood at 101.5% year-on-year, but for civilian non-energy industries, it was only 98.4%, according to CMASF’s calculations based on Rosstat data. In other words, aside from oil refining, the industrial sector is being propped up by the military-industrial complex. Concentrated growth is occurring in areas such as metal products (up 15.5% year-on-year for January–April), computer, electronic and optical products (14%), and other transport equipment (32%). However, even in these segments, monthly figures suggest stagnation, as reflected in Rosstat’s graph.
Industrial production volume according to Rosstat, CMASF and HSE estimates (seasonally adjusted, average monthly data for 2021 = 100)
The Central Bank’s Financial Stability Review records a marked deterioration in the condition of Russia’s largest companies at the end of last year and the beginning of this one. For the whole of 2024, the net financial result of non-financial organisations amounted to 30.4 trillion roubles, a decline of 6.9% compared to 2023. The coal industry, retail trade, and electricity sectors contributed most significantly to this decline. The number of distressed companies (defined as those with an interest coverage ratio below 1), rose from six in the previous edition of the review to thirteen. Debt servicing difficulties are being observed among major borrowers in mining, retail, mechanical engineering, and the light industry. Altogether, they account for less than 4% of the corporate sector’s total debt. In other words, the situation is not yet critical, but because these are the largest companies, the damage will extend beyond them to their numerous suppliers, contractors, and creditors.
Finally, the sharp contraction in the industrial sector is dealing an additional blow to budget revenues. Facing a decline in export earnings, the Russian authorities had hoped to compensate through domestic revenue, and tax increases were meant to support this effort. However, the sharp economic downturn has put an end to such hopes. It is therefore no coincidence that Finance Minister Anton Siluanov has joined the ranks of those lobbying for a rate cut, citing concerns over the slowing Russian economy. In principle, economic growth is the remit of the Ministry of Economic Development, while the Finance Ministry is responsible for the budget. But inflation has traditionally served as a means of rebalancing the budget during periods of falling revenue. Cutting the rate is a step toward maintaining inflation at a relatively high level over the course of the year and thereby improving domestic revenue figures. The interests of the industrial lobby and the government’s financial bloc are aligned here, forming a powerful front against the Central Bank’s leadership.
A shifted target: a tactical victory for inflationists
'Inflationism,' however, is far from a new idea in Russian economic policy. Under current conditions, we must abandon 'attempts to kill inflation at any cost via the interest rate,' argues Dmitry Belousov, head of the traditionally dirigiste CMASF, in an interview with Vedomosti. Otherwise, he warns, Russia faces several years of very slow growth and further technological lag. A rate cut, he says, will increase inflationary pressure but also give businesses an opportunity to boost investment.
Since 2015, when the Central Bank set its 4% inflation target (to be achieved by 2017), annual inflation has hovered near that level only between 2017 and 2019, Belousov notes. In most years, it has been significantly higher: according to Re:Russia, the average monthly value of the current annual inflation rate from January 2015 to April 2025 was 7.3%. In 2024, inflation in developed economies stood at 2.5–3.5%, while in developing ones it was around 8%, he observes. The 4% target was formulated during a time when there were hopes that Russia might become an international financial centre.
Belousov is partly right. The ideology underpinning current Central Bank policy was developed when Russia aspired to meet the standards of OECD countries. One of the main traditional arguments in favour of low inflation was that it helped attract foreign investment. However, as the past decade has shown, not only has Russia failed to move in that direction in practice, but it has also revised its fundamental goals and economic priorities. Today’s economy is a fundamentally different one: largely closed, focused on state investment rather than private, with substantial defence spending and a militarised-dirigiste mindset.
It is worth noting, in fairness, that the 1 percentage point (100 basis points) rate cut is almost symbolic; a modest concession by the Central Bank. But behind this concession lies the real balance of power in Russia’s economic policymaking. Although the Central Bank continues to assert that its target is to bring inflation down to 4% by 2026, the realistic reference point for the Russian economy in its current form will be a much higher inflation rate in the coming years – in the range of 7–9% (and this range may still shift upward). The Central Bank will most likely be unable to do anything about it.