Russia hopes to stimulate its economy by lowering interest rates

Since last year, Russia has had territorial disputes with Ukraine in the Crimean Peninsula. Russian aggression in this region are highly disapproved by the West, has been met with numerous Western sanctions against Russia. Such sanctions include restriction to Western finance, oil technology and services, Mark Thompson writes on CNN.

And if that’s not all, plummeting oil prices, in part caused by OPEC’s refusal to cut production despite lower global demand. Has further hit the Russian economy, one that is heavily dependent on oil.

As a result, the Russian ruble has plummeted along with the price of oil.

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Picture taken from xe.com, Ruble to USD exchange rate.

 

In the early stages of the crisis, the governor of the Central Bank of Russia (CBR), Elvira Nabiullina, aiming to prevent loss of reserves, and expecting OPEC to cut oil production, allowed the ruble to fall freely, Frances Coppola writes on Forbes. But it turned out that OPEC decided to maintain its market share and maintained their oil production.

The fall of the ruble, combined with the fall of oil price, served to cripple Russia’s banking sector and oil companies. The CBR began to hand out billions in bailouts to Russian banks, however the cash fails to reach firms.

Anatoly Aksakov, president of Russia’s regional banking association and deputy chairman of parliament’s financial markets committee, said the central bank must cut rates this month to 15% from 17%, then gradually to 10.5%, the level they were at before the current financial crisis. A central bank rate of 17% meant some companies were having to pay as much as 30% to borrow.

The state media has also reported an inflation rate of 11.4% in 2014, cause in part by the collapse of the ruble as well as oil prices.

The Fisher Equation stipulates that real interest rate is nominal interest rate minus expected inflation rate. This means that a 10.5% nominal interest rate, which the CBR can achieve if it chose to, would mean a -0.9% real interest rate. A negative interest rate, which would drastically increase the velocity of money, would serve to stimulate investment activity, which would save many of Russia’s firms.

Currently, however, the CBR’s reserves are being heavily drained. Falling oil prices and sanctions are taking a heavy toll on the Russian economy and at this rate the SBR will not be able to withstand them much longer. But the question remains, how long before Russia withdraw from the Crimean Peninsula to save its economy?

One thought on “Russia hopes to stimulate its economy by lowering interest rates

  1. Yichuan Wang

    So the reason that the Russian central bank raised rates was to stem the currency slide. This is relevant if the economy has lots of dollar liabilities, as the Russian economy does. How do you think cutting rates would affect the balance sheets of Russian companies? It seems that it could end up having an even stronger negative effect.

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