Russia cuts interest rate to 17% as strains show in wartime economy

Key Points

• Russia's central bank has cut its benchmark interest rate to 17% to support its economy as growth slows and the budget deficit widens due to increased spending on the war against Ukraine.
• Inflation in Russia remains elevated at 8.2%, despite easing slightly in recent months, with persistent expectations of high inflation complicating economic stability.
• The budget deficit has surged to 4.9 trillion rubles (approximately $58 billion) in the first seven months of the year, driven by expenditures exceeding planned levels amidst declining oil and gas revenues.
• Despite sanctions and loss of certain energy sales, Russia's economy has shown resilience, maintaining low unemployment and increasing household incomes, facilitated by defense spending and domestic bond sales.

Russia's central bank cut its benchmark interest rate Friday by one percentage point to 17%, a step that could support the economy as growth slows and spending on the war against Ukraine increases the budget deficit.

The bank had raised its key rate as high as 21% to combat inflation, but has begun to retreat amid complaints from business leaders and legislators about their impact on economic activity.

The bank’s inflation warnings in its policy statements underlined the stresses in the Kremlin’s wartime economy.

The bank noted that inflation eased somewhat in July and August but remains elevated at 8.2%. Still, it warned that “inflation expectations have not changed considerably in recent months.”

“In general, they remain elevated,” the bank said. “This may impede a sustainable slowdown in inflation.”

The contrast between a rate cut and continued inflation warnings reflects serious frictions in the Russian economy.

The central bank is focused on containing prices. Yet the finance ministry is pumping money into the economy in the form of defense orders and military recruitment bonuses that have fueled growth, wages and inflation over the course of Russia's 3 1/2 year war against Ukraine.

Year over year growth slowed to 1.1% in the second quarter from 1.4% in the first quarter and from 4.5% at the end of last year. Compared to the quarter before, however, the second quarter figure was a negative 0.6%, indicating the economy has lost even more speed in recent months.

The deficit increased to 4.9 trillion rubles ($58 billion) in the January-July period, up from 1.1 trillion rubles the year before. Spending was 129% of the planned amount, according to the Kyiv School of Economics, which tracks the Russian economy and oil revenues. Meanwhile oil and gas revenues fell 19% compared with the year earlier period, in part due to slack global oil prices.

Despite sanctions that have deprived Russia of foreign investment in some industries and the loss of most of its natural gas sales to Europe, the economy has held up better than many expected at the start of the war. Unemployment is at record lows and household incomes are rising. Recruitment bonuses have pumped cash into poorer regions. Oil shipments have remained steady even as the price has fluctuated.

Meanwhile the government is able to finance its deficit by selling ruble bonds to domestic banks, which are eager to buy the bonds because they anticipate that interest rates will continue to fall.