Russia flags further rate cut, more budget spending

(Reuters) – Russia on Monday flagged a likely further cut in interest rates and more budget spending to help the economy adapt to biting western sanctions as it heads for its deepest contraction since 1994.

Russia faces soaring inflation and capital flight while grappling with a possible debt default after the West imposed unprecedented sanctions to punish President Vladimir Putin for sending tens of thousands of troops into Ukraine on Feb. 24.

Putin said on Monday that Russia should use its state budget to support the economy and liquidity when lending activity has waned. The World Bank expects the economy to shrink by more than 11% this year.

The central bank more than doubled its key interest rate to 20% on Feb. 28 as the first wave of sanctions hit, before trimming it to 17% on April 8. It is expected to lower it further at the next board meeting on April 29.

“We must have the possibility to lower the key rate faster,” Central Bank Governor Elvira Nabiullina said on Monday. “We must create conditions to increase the availability of credit for the economy.”

Although inflation in Russia has accelerated to its highest since early 2002, the central bank “will not try to lower it by any means – this would prevent business from adapting,” Nabiullina said.

The current inflation spike is caused by low supply, not high demand, and the central bank aims to bring it to its 4% target in 2024 as the economy adapts to western sanctions, she said, speaking at the lower house of parliament.

“The period when the economy can live on reserves is finite. And already in the second and third quarter we will enter a period of structural transformation and the search for new business models,” Nabiullina said.

She also said Moscow planned to take legal action over the blocking of gold, forex and assets belonging to Russian residents, while adding that such a step would need to be painstakingly thought through.

Foreign sanctions have frozen about $300 billion of the roughly $640 billion that Russia had in its gold and forex reserves when it launched what it calls its “special military operation” in Ukraine.

Putin, speaking to Nabiullina and other top government officials by a video link, called for an acceleration of the process of switching to national currencies in foreign trade – as opposed to dollars and euros – under the new conditions.

Sanctions bite

Sanctions had mainly affected the financial market, “but now they will begin to increasingly affect the economy,” Nabiullina said.

“The main problems will be associated with restrictions on imports and logistics of foreign trade, and in the future with restrictions on exports.”

She said Russian companies would need to adapt.

“Russian manufacturers will need to search for new partners, logistics, or switch to the production of products of previous generations,” she said.

Exporters would need to look for new partners and logistical arrangements and “all this will take time,” Nabiullina said.

She said the central bank was considering making the sale of forex proceeds by exporters more flexible.

In February, Russia ordered exporting companies, including some of the world’s biggest energy producers from Gazprom to Rosneft, to sell 80% of their forex revenues on the market, as the central bank’s ability to intervene on currency markets was limited.

The bank may soften the terms of the timing and volume of mandatory sales, Nabiullina said.

Nabiullina’s comments “are directly or indirectly targeted at preventing the rouble from firming,” Promsvyazbank analysts said.

But the Russian currency extended gains on Monday, firming to 81.4025 to the euro, a level last seen on April 8, helped by upcoming tax payments that will prompt export-focused companies to convert FX revenues to roubles to meet their liabilities.

(Reporting by Reuters; editing by Barbara Lewis)