The recent hike of the Central Bank’s refinancing rate to 21% and the extremely strict message sent to the market by the leadership of the institution have dramatically changed the sentiment of the corporate sector, which had previously remained relatively calm in the face of tighter monetary policy.
The Central Bank has already acknowledged that it will not be able to reduce inflation to the target of 4% by 2025 and does not promise a noticeable reduction in the interest rate (with an average level expected between 17-20%). Meanwhile, many Russian borrowers are in a difficult position: on one hand, they continue servicing loans and bonds issued before the rate hikes began, while on the other hand, they were hoping for a swift reduction in rates and did not believe that economic authorities would maintain a strict monetary policy amid the war and sanctions.
Furthermore, it is possible that the actual inflation rate in Russia has been higher than the one officially reported by Rosstat; if this is the case, the real cost of money – or the real rate (nominal rate minus inflation) – was lower than indicated. Elvira Nabiullina, the head of the Central Bank, has essentially urged evaluating monetary policy stringency in this way, noting that the effective rate is determined by subtracting inflation expectations from the nominal figure. Using this approach, the real rate in Russia remained negative up until late last summer.
In any case, another year of a nominal rate around 20% is a heavy burden for many businesses. Shopping centres have stated that they will not be able to repay their loans, and monitoring by the Russian Union of Industrialists and Entrepreneurs has recorded a twofold increase of non-payments between companies (noted by around 40% of firms). The Centre for Macroeconomic Analysis and Short-Term Forecasting believes that the high rate will constrain the activities of about 40% of Russian industrial enterprises.
As we have previously reported, the fact that the refinancing rate hikes over the past year have been accompanied by both economic and inflationary acceleration signals deeper problems for the economy that are being postponed for the future. Analysts had expected a planned economic slowdown this year, but now Russian authorities are faced with a stark choice: runaway inflation or recession?
The Central Bank's leadership is essentially advocating for the latter, acknowledging that today's interest rate level, expected to persist for about a year, will lead to a crisis-driven restructuring of the economy. However, the Bank still has to defend its position against strong political pressure, especially since, in Vladimir Putin’s vision, the economy must continue to grow while maintaining macroeconomic stability.
The Central Bank’s recent hike of the key interest rate to 21% last week, along with a hint at another possible increase before year-end, had an unexpectedly strong impact on Russian economic agents. Previously, they had responded to rate increases with surprising calm, but now they seem to be viewing the situation with new apprehension, contributing to a rapid rise in gloomy and almost panic-stricken sentiments.
In principle, an increase in the key interest rate should lead to a reduction in inflation and a slowdown in growth. However, over the past year, as rates gradually increased, the Russian economy continued to accelerate, and inflation kept rising. In our reports, we warned that such a scenario is fraught with even more severe economic consequences, albeit deferred to the future (→ Re:Russia: Long-Awaited Stagflation). At the beginning of the rate hike cycle, analysts spoke of inevitable growth deceleration, but today it is clear that Russian economic authorities are facing a difficult choice between runaway inflation and a recession. The prospect of a recession, in this case, is not a result of excessive rate hikes but rather the economic stimulus measures (expanded government spending and subsidised lending) that the government actively implemented in 2022-2023, resulting in high economic growth rates from Q2 2023 to Q2 2024 (averaging 5% annually).
In the final version of the 'Basic Guidelines for Monetary Policy for 2025 and the Period of 2026 and 2027', published recently, the Central Bank acknowledged that it would not be able to reduce inflation to the target level of 4% next year. A scenario previously called 'pro-inflationary' in earlier drafts has now become the baseline. In 2025, inflation is expected to average between 6.1% and 6.8% over the year. By the final month of the year, the Central Bank hopes to see 4.5-5%. The target inflation rate may be achieved by 2026, and under the new pro-inflationary scenario, not until 2027. The forecast for the average key rate in 2025 has been raised from 14-16% in the July version of the document to 17-20%, which is even higher than the previous pro-inflationary scenario (16-18%).
The latest rate hike, the promise of further increases, and the revision of monetary policy scenarios for next year have made economic agents believe in the Central Bank's serious intentions. Until now, they seemingly assumed that, given the war and sanctions, Russian authorities would have to ease monetary policy and believed that the Central Bank's leadership lacked the political clout to resist fiscal stimulus. Elvira Nabiullina herself indirectly alluded to this at a press conference following the Central Bank board meeting, noting that businesses’ expectations of a faster rate reduction were one of the factors explaining the market’s weak response to the regulator's disinflationary efforts.
However, this is not the only factor at play. Following the rate increase to 21%, several analysts and economic Telegram channels pointed out that Russia has one of the highest real interest rates in the world. Typically, the real rate is understood as the difference between the Central Bank’s nominal rate and inflation – the effective cost of money that is not offset by rising prices. Venezuela tops the global list, with a key rate of 59.26% and inflation at 25%. Russia comes in second at 12.4%, followed by Mozambique (11.05%) and Pakistan (10.6%).
However, these calculations are accurate if official inflation figures accurately reflect reality. As we recently wrote (→ Re: Russia: Prices in the Fog of War), there are strong arguments that actual inflation in Russia may be higher than Rosstat's figures due to insufficient accounting for changing consumption patterns. Elvira Nabiullina essentially used the same argument in her press conference, stating that understanding the real rate (the rigidity of monetary policy) requires focusing not on current inflation but on expected inflation (the 'real-plus' rate). The Central Bank calculates expected inflation monthly based on 'inFOM' surveys. As shown in the chart below, if we use Nabiullina’s criterion or assume that actual inflation was higher, the Central Bank's 'real-plus' rate remained negative from spring 2022 until late summer 2023 (when the first rate increase was made). Today, it stands at 7.5%.
The spread between nominal and real interest rates, as well as the difference between the real rate in the conventional sense and the real rate in the context of high inflation (expected or higher actual inflation), explains why most borrowers had so far remained relatively calm about the Central Bank’s tightening measures and why they were so taken aback by the latest rate hike and the sharp remarks from the regulator's leadership last week.
On one hand, a significant portion of loans and bonds in their portfolios are funds raised at fixed rates before the key rate hikes began. According to the ‘Basic Monetary Policy Guidelines’, over half of corporate ruble loans at fixed rates have interest rates of up to 10% per annum. Approximately 16% of loans carry rates from 10% to 15%, a little over 28% have rates from 15% to 20%, and only 6% of corporate loans have rates exceeding 20%. The cost of money only exceeds the current 'inflationary backdrop' for the last two categories. However, scenarios in which the rate remains at ultra-high levels next year sharply alter the outlook for companies in the first two groups: it raises not only the cost of acquiring new funds but also the cost of refinancing existing loans.
Nevertheless, the Central Bank still faces a serious political battle over its inflation-curbing scenario. The choice in favour of strict policy, which we see as a choice in favour of recession, was clearly articulated by the regulator’s leaders, Elvira Nabiullina and Alexei Zabotkin, at a press conference they held.
At their press conference, Elvira Nabiullina stated that the Central Bank analysed the impact of interest payments on the economic performance of roughly 300,000 companies and concluded that businesses generating about one-third of Russia’s GDP do not incur interest expenses. She emphasised that these 'efficient companies' should capture greater market shares, rather than those 'who have taken on loans'. Financial and labour resources should flow toward these efficient businesses. Nabiullina and Zabotkin urged companies to focus on improving efficiency, seeking new business models and niches, scaling back operations, or selling to more successful competitors. They warned that even 'established industries' should not expect government support as they did in past crises. With 'all economic resources already fully utilised', a market redistribution is necessary, in their view. Elizaveta Danilova, head of the Central Bank’s financial stability department, later stated that bankruptcies in this situation should be seen as a positive development. This vision of the economy aligns with a scenario of crisis-driven restructuring.
However, just before the Central Bank’s board meeting, at which the key rate was raised to 21%, Reuters published a collection of opinions from owners and managers of Russia’s largest companies. Alexey Mordashov, owner of Severstal, Maxim Sokolov, president of AvtoVAZ, Kirill Lipa, CEO and co-owner of Transmashholding, among others, expressed concerns that the high cost of borrowing was not only constraining the launch of new projects but already impacting ongoing operations. Even Sergey Chemezov, head of Rostec, complained about the high rates, noting that even arms exports do not generate margins sufficient to service loans necessary for production cycles longer than a year. The sentiment of the business community was summed up in a recent interview by Dmitry Alekseev, co-owner of the electronics retailer and manufacturer DNS and a member of the Forbes list: 'There is no vision of the future. Thinking about long-term plans mostly leads to depression. It’s difficult to come up with a business idea that could compete with a deposit in Sberbank'.
The owners of shopping centres have already made public appeals to the government for support. An industry association reported that at least 200 shopping centres with floating-rate loans are at risk of bankruptcy: their debt burden is approaching 80% of the value of their assets. More such requests are likely to follow.
The Russian Union of Industrialists and Entrepreneurs informed RBC that 'a certain deterioration in the financial condition of companies, including due to reduced access to borrowed funds’, has been one of the reasons for the rise in payment defaults. According to a recent survey by the union, non-payments have become the top problem for large businesses, cited by nearly 37% of respondents, compared to 20% a year ago.
According to the government-affiliated Centre for Macroeconomic Analysis and Short-Term Forecasting (CMASF), the high cost of commercial credit is a limiting factor for more than 40% of manufacturing enterprises. Experts from the centre contrast their assessment with Rosstat's data, which suggests that only 25% of enterprises face this issue. The CMASF analysts argue that Rosstat uses an unrepresentative sample. Significant shifts occurred in this sample first in 2021 and again in 2023. During the pandemic, businesses frequently transitioned from one type of activity to another. In 2023, a substantial number of companies were removed from the sample ‘due to the special military operation’.
At an event titled 'All for Victory!' earlier this year, Vladimir Putin confidently declared that the Russian economy would maintain not only economic stability but also high growth rates moving forward. By autumn, it became clear that this would not be possible. A choice between stability and growth will have to be made. However, what this choice will actually look like will become apparent over the next 6-12 months.