Face the facts

Putin may dismiss sanctions, but he can’t ignore stagflation

April 25, 2014
April 25, 2014

At a press conference Thursday, Russian president Vladimir Putin said that Western sanctions would “probably” inflict some damage on the Russian economy, but the impact was “not critical.”

In fact, Putin said, sanctions had some benefits—namely, accelerating steps to “enhance economic sovereignty.” With US president Barack Obama warning that another round of sanctions is “teed up,” Putin may soon get more chances to test his economic theories.

For its part, Russia’s central bank does not appear to share Putin’s sanguine view. It unexpectedly hiked interest rates today, citing the impact of the weaker ruble on rising inflation. The bank “temporarily” ratcheted up rates last month, when Russian markets took a dive in response to the occupation of Crimea. Now it looks like higher rates are here to stay, crimping credit for local borrowers.

Adding to the misery, Standard & Poor’s downgraded Russia’s credit rating today, to one notch above “junk.” Although Russia isn’t a big borrower in bond markets, the government’s finances are rapidly deteriorating; in 2008 it could balance the budget with an average oil price of $55 per barrel, but today it takes $110 per barrel to cover its spending, according to S&P.

Russia will be lucky if economic growth reaches 1% this year, and could stagnate (or even contract) if stricter sanctions sever critical industries from customers, suppliers, and investors abroad. Meanwhile, the tumbling ruble is pushing up inflation, primarily by making imports more expensive. Prices have been rising at a 7.2% annual rate so far this month, the central bank said, well above its 5% target.

Thus, Russia is facing the dreaded prospect of “stagflation,” or low economic growth mixed with high inflation:

Annual-change-in-Russian-economic-indicators-Inflation-GDP_chartbuilder

Hiking interest rates, as the central bank did today, is the best way to bolster the ruble and tame rising inflation. But it’s the last thing that an economy on the brink of recession needs, which is what makes stagflation such a daunting development. And there’s no way of spinning it as anything other than a disaster for the people forced to live through it.

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