As 2024 comes to an end, Russia is experiencing one of the most intense bouts of economic hysteria since the first weeks of the war in Ukraine, when the collapse of ‘Putinomics’ seemed inevitable to many. After two years of growth fuelled by massive injections of money into the military-industrial complex, the creation of a well-paid army of mercenaries, significant deregulation of foreign trade and adept sanctions evasion, the economy is still facing visible challenges: accelerating inflation, declining investment and a slump in the construction sector.
The government has been forced to raise taxes to balance the 2025 budget, but the most alarming symptom is the rapid increase in the Bank of Russia’s key interest rate, which recently hit a record level of 21% and is likely to climb even further by year-end. Dozens of commentators point out the stark gap between this rate and the inflation rate, arguing that such levels simply leave little room for economic growth.
Such commentaries and speculations raise a number of questions.
First of all, it is surprising how the same experts can simultaneously express sincere indignation at the Bank of Russia’s policies and distrust official inflation statistics. The latter indicate that the year-to-date consumer price index has just reached 6.57%, yet we see numerous reports about food prices rising by 30−60%, detailed studies about the ‘Olivier salad index’ surging by almost 70% and speculation that inflation is approaching three-digit figures. If even part of this is true, then how can the Central Bank be faulted for setting a rate of 21%, which is three times lower than the growth rate of prices on the ingredients of the popular salad? If, however, the rate is indeed excessive, it implies that producers cannot keep raising prices at an appropriate rate, suggesting that the real inflation may not be as high as alarmists claim.
Equally notable is that the criticism of the Bank of Russia now comes not only from independent and opposition-minded authors, but also from the system insiders. Consider the emotional speeches by Sergey Chemezov, the head of Rostec; the complaints of the leaders of the Russian Union of Industrialists and Entrepreneurs (RSPP) demanding that the Bank of Russia should coordinate monetary policy with the government, and even warnings from the Centre for Macroeconomic Analysis and Short-Term Forecasting (CMASF) about a potential recession. The same group of ‘pragmatic managers’ has long criticised the Central Bank’s credit policies for hampering industrial growth and the government for hoarding excessive reserves. It is hard to believe Chemezov’s claims that the defence industry is on the brink of profitability or that the Ministry of Finance provides only modest advances for the production of armaments (when we look at the budget expenditures of January and February in any of the recent years, we can clearly see a substantial scale of these advance payments), while other funds have to be borrowed. Meanwhile, the Bank of Russia has recently released a detailed study estimating the share of interest payments in production costs at 3−3.5% (this is based on 2023 data, which means that the figure may have reached 4.5% considering the rising interest rate).
However, all these observations do not remove the problem: the Russian economy is grappling with real difficulties caused by high interest rates and rising inflation. Stricter mortgage lending conditions have caused a sharp drop in housing demand; the balanced financial results of companies and organisations in the second half of this year look worse than in the same period last year; and the previously rapid growth in wages is beginning to slow down. Entrepreneurs are increasingly sharing doubts about their prospects due to deteriorating lending conditions. Dozens of analysts predict that GDP growth in 2025 will slow significantly, to just 1−1.5%.
Unlike most experts, we believe that recent trends will not push the Russian economy into crisis. Tax collection remains robust; the most pessimistic forecasts about declining export revenues have not yet materialised; and the ‘deathonomics‘ model continues to work. Moreover, if active hostilities in Ukraine cease or freeze in the coming year, this will undoubtedly increase the resilience of the Russian economy and (albeit less significantly) reduce the level of military spending. As we noted in a report co‑authored with S. Aleksashenko and D. Nekrasov, Russia has now sufficient economic resources to sustain the current course for at least another three years, which is why I am far from catastrophising. Dimitri Nekrasov’s calculations about Brazil’s economic performance in the 2000s, alongside nearly everything we know about the Russian economic system in the same period, suggest that an economy can operate under high real interest rates for many years if expectations are positive and/or there is substantial budgetary stimulus. That said, now is undoubtedly a good time to consider measures that can be undertaken to counteract the negative trends seen in recent months.
I have recently argued that the period from autumn 2024 to summer 2025 will serve as a ‘second adjustment’ phase for the Russian economy, somewhat resembling the period of adaptation to the new realities in the spring and summer of 2022. To navigate the current stage successfully, unconventional measures and approaches will almost certainly be required—from the Bank of Russia, the government and the Ministry of Finance.
First of all, it must be recognised that inflation in Russia today is not purely monetary in nature. Indeed, the Bank of Russia pumped money into the economy in 2022 and 2023, after achieving relative stabilisation in the summer of 2022, but the growth rate of monetary aggregates today is substantially lower than the average over the last 18 months, which means that the Central Bank is acting appropriately. The issue lies more in rising cost pressures from government-authorised increases in utility tariffs (natural monopolies), higher taxes, the effect of the appreciation of major currencies against the rouble, rising logistics costs, and increased commissions for international transactions (for instance, since 1 July, electricity prices were indexed by 9.1% and gas prices by 11.2%, the dollar exchange rate has risen by over 16.5% since 1 July, and fees for settlements with China, the main foreign trade partner, have surged 3.5−4 times). All these factors will continue to exert upward pressure on prices, and this kind of inflation cannot be curbed by raised interest rates alone.
How can Russia address this situation? There is an obvious need to freeze tariffs and tighten antimonopoly legislation, although the latter can only follow the former. Yes, the profits of major companies will shrink, but this is far less damaging than rising tariffs, which impact the entire economy. Yes, their investment programmes will be reduced, and costs will decrease, but this is precisely the additional demand squeeze that the Bank of Russia is already seeking through higher rates. Such measures are vital for a new wave of adjustments in the economy to address the current realities: just as major companies were forced to adapt to extremely low dollar exchange rate in the summer of 2022, which limited their profits on foreign markets, they must now temper their ambitions on the domestic market. And, needless to say, they are already going through tough times: Gazprom’s loss last year was due to numerous write-offs of assets lost in Europe and a targeted increase in mineral extraction tax (MET) by 550 billion roubles, yet the company returned to profitability in 2024, and the authorities decided against levying an additional MET in 2025.
Moreover, as far as the interest rate is are concerned, one should bear in mind that there are two problems with its high level. On the one hand, and this is usually emphasised, it restricts the availability of credit (for instance, the full mortgage rate in Russia has now exceeded 30%), thereby dampening consumer demand and reducing investment opportunities. On the other hand—a point that is often overlooked—high interest rates underpin extremely expensive deposits. There is now increasing talk in Russia that entrepreneurs, who have realised that they cannot generate significant profitability, prefer to place their surplus funds in banks rather than investing in production. This situation suggests an obvious countermeasure.
The Bank of Russia may well try—albeit not unambiguously using a market mechanism—to curb the inflow of cash deposits. The simplest method in this case would be to diversify the reserve rates for attracted funds (currently, it is set at a uniform level of 4.5% for liabilities in roubles). To weaken the inflow of money into deposits, the rate could be reduced to zero for demand deposits and raised, for example, to a prohibitive 25% for funds deposited at 15% or higher. This would sharply reduce banks’ willingness to attract high-rate deposits, lowering the overall cost of liabilities (and, consequently, the cost of loans), potentially eliminating the need for further key rate increases by the Bank of Russia. Such a move is unlikely to trigger an inflation spike since about half of Russians have no savings at all, and recent statistics indicate that about 70% of deposit growth comes from accounts holding 3 million roubles or more. By limiting the incomes of wealthy citizens, the Russian authorities are unlikely to exacerbate the economic crisis.
In conclusion, three points should be noted.
Firstly, the current situation in Russian monetary policy is highly uncertain in terms of the main statistical indicators. The inflation rate and the lending rates could align much more closely if inflation were to be assessed more objectively (for instance, the so-called ‘socially perceived’ annual inflation, according to the Bank of Russia’s calculations, currently reaches 15.3%). Therefore, the 21% interest rate alone does not appear catastrophic—except for the construction sector, which had long relied on below-market financing rates and is now grappling with the abrupt withdrawal of subsidised mortgages.
Secondly, a real interest rate of 6−10% is not extraordinary or inherently detrimental to economic growth, especially in Russia, where no significant technological modernisation is currently underway. The experience of many countries suggests that inflation can remain at high levels for extended periods, which does not preclude growth (for instance, Turkey recorded growth of 4.5% in 2023, and may achieve just over 3% this year despite inflation not falling below 50%). Therefore, it is possible that if the authorities cannot combat inflation now, they might be better off ceasing their attempts for the time being.
Thirdly, if the Kremlin and the Bank of Russia intend to suppress inflation ‘at all costs’ (and this will indeed come at a high price), this requires clear and coordinated measures, including tariff caps, targeted exchange rate policies, a freeze on budgetary allocations at least at 2025 levels, stronger action against monopolists and increased pressure on banks to prevent rapid growth in deposit yields. If such measures are announced and prove effective for at least six months or more, conditions will emerge for lowering the key interest rate and gradually normalising the situation, with the Bank of Russia’s inflation targets likely to be reached in 2026.
In any scenario, however, we do not foresee inflation accelerating to above 20% year-on-year, nor do we consider the business credit burden to be incompatible with economic growth over the next one or two years. Beyond this timeframe, either the government and the Bank of Russia will be forced to intervene more actively in the current situation, or the economy will find a new equilibrium, particularly if external conditions change significantly.
