August 15, 2023, 4:15 p.m
Prolonged wars are costly and economically damaging. Ancient Rome understood this, as did the US in the 1960s, when the conflict in Vietnam became one of the pressures on the dollar, which eventually led to the collapse of the Bretton Woods fixed-currency system.
«The decision of the Russian Central Bank to raise interest rates from 8.5% to 12% to protect the collapsing ruble is the latest example of this age-old truth.”, writes The Guardian economic editor Larry Elliott in his article.
After 18 months of war with Ukraine, Russia’s current account surplus is shrinking and inflationary pressures are rising. The currency is not bearing the load, and the trigger for the emergency move on Tuesday appears to be the fact that on Monday the rate fell to 100 rubles to the US dollar.
Until now, politicians in Russia have tried to demonstrate that they are doing well, despite Western attempts to impose an economic blockade. The IMF has revised its growth forecasts for this year, and official data show the economy grew by almost 5% between the second quarters of 2022 and 2023.
The Russian economy is now showing clear signs of overheating as it faces capacity constraints. Inflation over the past three months has been above 7% year-on-year, well above the official target of 4%.
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«In a sense, this is inevitable, given the Kremlin’s decision to continue spending large sums on the war. This meant that the economy had to be warmed up. Efforts to maintain living standards in order to keep ordinary Russians supportive of the war have revived rising costs. And now, when the fall in world energy prices has led to a sharp reduction in exports, sanctions are starting to bite harder“, the article says.
Russia’s central bank hopes that the latest tightening of the screws will have the same impact as the announcement of raising interest rates to 20% shortly after the invasion began. This helped stabilize the currency, which reached 150 rubles to the dollar at some stage last year. The Russian ruble has fallen by 30% this year.
There is an opinion among analysts that the increase in the cost of official borrowing is a delay, since the problem will be solved only when the hostilities stop.
“As long as the war continues, the situation will only get worse for Russia, the Russian economy and the ruble. Raising the discount rate will not solve anything, it can temporarily slow down the rate of depreciation of the ruble due to slower real GDP growth, if the main problem is not solved: war and sanctionssaid Timothy Ash, strategist at RBC Bluebay Asset Management.
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The message is clear. Further tough measures will be needed to slow the pace of capital outflows, reduce the current account deficit and improve Russia’s financial position. This means even higher interest rates, cuts in non-military spending and a slowdown in the domestic economy. As has happened so many times in the past, war will mean problems for the Russian people.
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