The Bank of Russia has raised its key interest rate to 17 per cent from 10.5 per cent in a desperate move to boost its currency and rescue its troubled economy.
The action comes after the ruble’s value has sunk roughly 50 per cent since January, battered by Western sanctions imposed over the conflict in Ukraine and plunging worldwide oil prices. The falling ruble is threatening to escalate Russia’s inflation to dangerous levels and paralyse the economy.
The bank’s aggressive move illustrated the magnitude of the financial perils confronting Russia. It reflected fears that the ruble’s decline could trigger consumer panic, incite a run on banks and deepen Russia’s economic problems
They did it as a lure to encourage people to keep their rubles at home rather than continue to flee the currency and the country,” said Barry Eichengreen, an economist at the University of California, Berkeley.
“It’s a way of buying time. It doesn’t solve any of the underlying issues that the Russian economy has” – falling energy prices, Western sanctions and widespread corruption.
Russia’s economy is highly dependent on petroleum revenue, leaving it at the mercy of financial markets. The average price of a barrel of oil has dropped below $56, down from a summer high of $107. The government recently downgraded its growth forecast for next year, predicting that the economy will sink into recession.
Russia’s latest action carries dangers of its own. By jacking up rates to try to contain inflation, the Bank of Russia risks inflicting further economic damage, Eichengreen noted. High rates can stifle growth by making it harder to borrow and spend.
The central bank had already tried unsuccessfully last week to stem the ruble’s slide. On Thursday, it boosted its key rate by 1 percentage point to 10.5 per cent, citing a surge in consumer prices and a “significant inflation risk.” The bank said then that it expected prices to rise 10 per cent for 2014 and climb further in the first quarter of 2015.
But the ruble plunged further on Monday, dropping from 55 rubles to the dollar on Thursday to about 65 rubles to the dollar.
A falling currency increases the cost of imports, thereby stoking inflationary pressures. At the same time, plummeting oil prices give the government less money to combat a downturn and can force it to borrow more.
The sanctions have magnified Russia’s economic turmoil.
In September, the United States and the European Union imposed a new round of sanctions for Moscow’s actions in Ukraine, which included blocking Western financial markets to key Russian companies and limiting imports of some technologies.
The additional sanctions were expected to cause enough pain to put Russia into recession for one or two years, predicted economist Alexei Kudrin, who served as finance minister under President Vladimir Putin for 11 years until 2011.
The potential for a prolonged downturn caused investors to pull their money from the capital, causing the ruble to further lose value.