Central Bank of Russia (CBR) Governor Elvira Nabiullina said that the economy is stabilising and the initial shock caused by the West’s imposition of extreme sanctions is starting to wear off in her statement delivered after the regulator decided to keep rates on hold at 20% on March 18.

Nabiullina also announced that the domestic bond market will re-open on March 21 and the CBR will launch its own version of quantitative easing (QE) by buying up bonds in “the needed amount” to prevent a meltdown. The central bank will sell the entirety of this portfolio again when the markets are more stable, she added.

In the meantime, Nabiullina said that the stability of the financial situation has been restored and the initial shock is subsiding. The CBR flooded the banking sector with liquidity to shore up the financial sector that was reeling after the West imposed the SWIFT sanctions that cut many banks off from using the dollar, including the country’s two largest lenders Sber (formerly known as Sberbank) and VTB Bank.

The SWIFT sanctions caused a run on foreign exchange accounts at the two big banks, as the CBR countered with its decision to cap withdrawals at $10,000 and other capital controls. Nabiullina says the banking system is now “operating smoothly” after the initial shock has worn off.

“The liquidity situation has stabilised. We provide liquidity to banks in the amounts they need. At the peak, the funds provided reached RUB10 trillion ($97bn). The structural liquidity deficit that arose in early March and totalled RUB7 trillion has decreased more than twofold by now,” Nabiullina said.

Fast action by the regulator seems to have already allayed the worries of depositors, who had rushed to withdraw money but are now returning their cash to the banks.

“At the end of February, banks faced a considerable outflow of ruble funds from household accounts, but these funds have been returning to time deposits during the recent two weeks,” Nabiullina said in remarks following the monetary policy meeting. “This has become possible predominantly owing to the increase in the key rate. As regards lending, its growth has continued in the last few weeks. However, this was most probably associated with the drawdown of the credit limits approved earlier. Further on, we expect lending activity to edge down.” 

Nabiullina promised that CBR's decision to hike rates by 10.5% to 20% on February 28 was a “temporary anti-crisis measure” and that when the situation becomes sufficiently stable, “interest rates will go down.” 

Economic impact 

Nabiullina went on to say that the inflation that soared in February and early March was driven by ballooning non-food demand. As the ruble went into free fall in parallel with the start of the war on February 24, Russians rushed out to convert their rubles into goods to preserve their value. This is a time-honoured tradition during currency crashes. While the official exchange rate immediately plummets after an event such as a default or invasion so that it is already too late to convert rubles into dollars to protect their value, the price of things like jewellery or washing machines takes several days or even weeks to be adjusted to reflect inflation or the new exchange rate. These items can be sold again later as “almost new” and become stores of value that are priced at their pre-devaluation values even after the devaluation has happened.

“The acceleration of inflation in late February-early March was provoked by soaring demand, mostly for non-food goods. People were actively buying household appliances, cars, electronic devices and furniture, fearing that the range and affordability of these goods will decrease drastically due to the imposed sanctions, the exit of some foreign companies from the Russian market, and a weaker ruble. During the second week of March, this feverish demand declined somewhat,” Nabiullina explained.

Russian rocketing demand for non-perishable food items also drove up inflation as many rushed to stock their kitchens in preparation for shelves emptying.

“Another segment showing a surge in consumer activity is non-perishable food products, including cereals, flour, pasta and sugar. These products are mostly manufactured in Russia using domestic raw materials. Russia has sufficient stocks of these products, and companies continue to manufacture them,” Nabiullina said, adding that production of these goods continues and as there are no shortages both supplies and prices will return to normal. “As the soaring demand decreases, price dynamics in this segment will return to normal. Moreover, prices for some products might even lower.” 

Her comments come as long queues have formed outside supermarkets for food and especially sugar, as consumers fear that sugar will disappear from the market. One of the biggest impacts of the current crisis that will extend its effects is supply chains have largely collapsed and companies are already looking for alternative suppliers after they have been cut off from imports.

“Further inflation trends will depend on how fast the economy adjusts to the new conditions,” Nabiullina said. “Today, almost all companies are experiencing disruptions in production and logistics chains and their settlements with foreign counterparties… Due to the contraction of imports and the closure of some foreign markets, this demand will shift increasingly more towards domestic goods. It is critical in the current situation to restore supply as soon as possible. Companies have already started to search new opportunities, including new target markets and new suppliers of equipment, technologies and components for manufacture.” 

Nabiullina speculated that autarky will create new opportunities for Russian manufacturers, but in doing so hinted that the nature of the Russian economy has been fundamentally changed and implied that she expects sanctions to remain in place for a long time. The governor attempted to put an upbeat spin on this fundamental problem by highlighting there will be new opportunities for Russian businesses as they attempt to fill the hole left in the market by the departing foreign producers and their imports.

“Previously, it was unprofitable to produce certain goods inside the country, whereas now this is becoming more interesting for businesses. This is how the economy is adjusting to the changing conditions, which unavoidably involves changes in relative prices in the economy and a temporary rise in inflation,” Nabiullina said.

The governor went on to say that the state will not impose “manual” price controls or caps, which will only exacerbate the supply problems and make inflation worse.

“I would like to stress that administrative price regulation will slow down the adjustment of the economy to the new conditions. Moreover, it is crucial to prevent abuse of dominance by companies and cartel agreements,” she said, adding that while this process goes on prices will remain high until the economy can adjust to the new realities.

“This means that inflation will stay elevated for a certain period, but we will prevent inflation from spiralling out of control,” the governor said.

Nabiullina remained vague about the size of the shock and how specifically the CBR’s forecasts will change given the speed of events but admitted that all the central bank’s previous forecasts are no longer relevant.

“GDP will decline in the next quarters. We are going to present a new macroeconomic forecast at our core meeting in April,” she said.

Trade relations decline 

Foreign trade conditions are the key uncertainty amid the increasing pressure of sanctions, and the details of the sanction mechanisms and how vigorously they will be enforced remain a key unknown for the outlook of Russia’s economy.

“The restrictions imposed affect a considerable part of exports and imports. In addition to the official sanctions, foreign companies’ decisions to suspend their operation in the Russian market may also have a significant adverse impact on the situation,” Nabiullina said stating the obvious, adding that existing inventories will cushion the blow for the meantime.

“Today, [inventories] enable companies to continue their current operations. The period of the economy’s adjustment to the new conditions will depend on companies’ ability to replenish these stocks, including replacing imported goods with domestic alternatives.” 

Emergency measures

The governor went on to list the main measures the regulator has taken to fight the crisis.

“Firstly, we have implemented some elements of capital controls. This was a forced decision, as the Central Bank’s opportunities to use international reserves are limited. The mandatory sale of foreign currency earnings and a number of other measures ensure an inflow of foreign currency needed for foreign trade transactions into the domestic market,” she said.

“Secondly, we have approved a wide range of anti-crisis measures to support the financial sector. In recent years, we have been making significant efforts to improve the autonomy of Russia’s financial infrastructure and enhance the stability of the banking system. As a result, the Russian payment infrastructure ensures the continuity of payments even amid the imposed restrictions. Moreover, banks are able to meet the needs of their clients, those companies and individuals who are facing hardships, and restructure their loans,” Nabiullina added.

“Thirdly, as regards the real sector, the Bank of Russia jointly with the government is taking measures to support lending to businesses. An additional RUB500bn ($4.8bn) has been allocated under the programmes for encouraging lending to small and medium-sized enterprises [SMEs]. This will enable them to raise working capital loans for up to one year and investment loans for up to three years. Furthermore, jointly with the government and banks, we are now elaborating measures to mitigate the consequences of drastic changes in the conditions for servicing floating rate loans for companies,” she said.

Trading on Moscow Exchange (MOEX) was suspended immediately after the war started “to avoid sharp fluctuations” but it is rumoured the market will be opened again in the coming days, opening the access to bonds first, while trading in equities will remain closed for the time being. Nabiullina added that the CBR plans what will be in effect its own quantitative easing programme – something the Russian government has avoided until now – with the central bank buying up bonds from the market to ensure stability.

“Today, we are ready to resume trading gradually. On Monday, the stock section of the Moscow Exchange will restart trading in federal government bonds,” Nabiullina said. “To prevent excessive volatility and ensure a balanced liquidity position in this segment at the stage of the reopening, the Bank of Russia will purchase federal government bonds. These purchases will be made in the amounts needed to prevent risks to financial stability. After the situation in financial markets stabilises, we plan to sell the entire portfolio of these bonds in order to neutralise the impact of this operation on monetary policy.” 

“When making our decisions, we will consider the need to carry out a large-scale structural transformation of the economy. We will pursue our monetary policy in such a way as to ensure that the economy has sufficient time to adjust to the new external conditions while keeping in mind that inflation should be brought back to the target in 2024. The support measures implemented by the Bank of Russia and the government will help Russian companies and people overcome this challenging period,” Nabiullina concluded.