Can Lower Rates Help Russia Recover?

At a Glance

  • Low inflation and a stable currency may allow for further rate cuts in Russia
  • Russia’s yield curve might offer clues to the country’s recovery

The global economy has been hard hit by coronavirus lockdowns and Russia is no exception.  The International Monetary Fund forecasts a 5.5% contraction of Russia’s growth in 2020, which would be the economy’s worst performance since the 7.8% contraction in 2009.

Unlike the downturns that came on the heels of oil price declines in 2008-09 and 2014-15, this time around Russia’s central bank is reacting in a very different manner. In 2009 and 2015, the ruble plunged alongside oil prices.  As the currency weakened, inflation picked up and the Central Bank of the Russian Federation (Bank of Russia) raised short-term borrowing costs significantly in order to bring inflation back down.  This time, however, the Bank of Russia is cutting interest rates and might cut its official rate to a post-Soviet record low.


Russia’s central bank has been able to cut rates largely because the ruble (RUB) has been much more stable in the face of weaker growth this time around than in the past.  During the 2008 global financial crisis, RUB fell by 37% versus the U.S. dollar (USD).  During the 2014-16 oil price rout, the ruble fell by 61% versus USD.  So far in 2020, the peak-to-trough selloff in RUBUSD amounted to 26.5% and RUB has since rebounded sharply.  As of June 11, it was only 12% below its recent January 15, 2020 peak.  Indeed, in recent years, RUB has shown much less reaction to changes in commodity prices than it has in the past, as the following chart shows..

 

Part of the ruble’s recent resilience stems from the nature of the global crisis itself.  In 2014-16, the global economy was doing relatively well except for commodity producers, especially oil exporters. By contrast, in 2020, everyone seems to be in the same boat. Thus, the problems afflicting the Russian economy in 2020 mirror those in the U.S., Europe and elsewhere.

With Russia’s interest rates still far above zero, its central bank has the option to cut rates to stimulate growth.  In many other economies where rates are stuck near zero, stimulus has taken the form of unprecedented large fiscal stimulus, something that Russia has largely avoided so far.

A Steeper Yield Curve

As Russia’s central bank cuts rates, it has been gradually steepening the yield curve.  As of mid-June, Russia’s 1-10 year yield curve was the steepest that is been since 2011, although with a 106 basis point (bps) spread between one-year and 10-year rates, it’s a long way from its steepest level ever.

Depending upon the behavior of Russia’s long-term interest rates, further cuts to short-term rates might steepen the yield curve even more.  If so, that would most likely be good news for the Russian economy.  Over the past 13 years, there has been a strong positive correlation between the slope of Russia’s yield curve and subsequent GDP growth – though, this time around, the course of the pandemic both in Russia and globally will play a big role as well.

Higher Rates Than U.S., Europe

Even with lower interest rates, depositors in Russia will enjoy about a 5% spread over depositors in the U.S. and Europe.  The cumulative impact of such interest rate gaps can become extremely large over time.  For example, had one stuffed one hundred dollars’ worth of rubles in a sock in January 2011, those rubles would currently be worth about $44.

By contrast, had one deposited $100 worth of rubles in a bank in Moscow in January 2011, with the accumulated interest, it would be worth about 82% as much as if one had placed the $100 in a U.S. bank account.  The more central banks cuts interest rates towards U.S. and European levels, however, the smaller that buffer is likely to become.  When it comes to rate cuts, Bank of Russia’s main limitation on cutting rates further may be continued low rates of inflation.  So long as inflation doesn’t pick up and RUB remains relatively stable, the central bank may feel little need to tighten policy.

Finally, Russia has so far spent about 2% of GDP on fiscal support aimed at fighting the impact of the coronavirus lockdowns.  With public debt amounting to only 15.5% of GDP, the Russian government retains substantial borrowing capacity should it choose to deploy it.

Erik Norland is a Senior Economist at CME Group.

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