/ world today news/ In the last three months, the Central Bank of the Russian Federation has increased its base rate twice, explaining this with the need to fight inflation and the depreciation of the ruble. But the decisions of the Central Bank have already caused a sharp increase in interest rates on loans.
In the next few months, this will at best lead to a slowdown in the growth of the Russian economy or even a new recession. But prices will still rise.
Why are betting games necessary?
Since July 2023, the Central Bank of the Russian Federation has raised the key interest rate four times. As a result, in a little more than three months – from July 21 to October 27 – the rate increased exactly twice: from 7.5% to 15% per year.
In its press release after the last meeting of the board of directors at which the decision to raise the rate was taken, the Central Bank explained its decision with the need to fight accelerating inflation.
Everyone has already felt the increase in the price of goods and services in recent months, and even Rosstat reported that in September prices increased by an average of 6% compared to September last year.
Many economists forecast a further acceleration in inflation in the coming months, while the Central Bank expects to slow it down to its target level of 4% mainly by raising the key interest rate.
How does this Central Bank mechanism work? A bit of theory
All banks periodically turn to the Central Bank for money – in much the same way that many citizens intercept paychecks from friends.
Naturally, the central bank provides them with funds at a certain rate, the amount of which depends on the main interest rate, which the central bank itself determines at meetings of its board of directors.
What happens when the central bank raises interest rates? Interest rates on loans granted by the Central Bank to banks are increasing.
On the one hand, this leads to the fact that it becomes more profitable for banks to more actively lend money elsewhere – first of all, of course, from depositors. Banks are starting to raise interest rates on deposits (anyone who has anything to deposit in a bank account has seen this in recent months).
Those who have money usually in such cases try to deposit more funds to get maximum benefit from the high interest rates on deposits.
But the less free money remains, the less a person can buy any goods – from an apartment to new shoes (in the language of the Central Bank, this is called “the population switched to a savings model of behavior”).
As a result, sales of goods and services begin to decline, and sellers, seeing this, begin to lower prices to attract more buyers. And inflation is slowing down.
On the other hand, the more expensive it is for a bank to borrow funds, whether from the Central Bank or from depositors, the more expensive it must be to issue those funds to its borrowers in order to remain profitable.
Everyone has already noticed the increase in interest rates on loans in recent months. Generally, the higher the interest rates, the more reluctant people are to take out loans, unless, of course, they find themselves in a situation where borrowing money is absolutely impossible.
The fewer loans issued, the fewer goods and services are purchased. And again, everything is the same – a decrease in sales forces sellers not to raise prices, which again leads to a slowdown in inflation.
From theory to practice
In practice, it often turns out to be quite different. Loans are needed not only by people who do not have enough of their own money for large purchases, but it takes a long time to save the necessary amount (not to mention the fact that this money will depreciate due to inflation).
The manufacturers themselves also need loans – to buy components and raw materials, to buy new equipment, to start more advanced production lines, or even more so to start a “project from scratch”.
Naturally, enterprises are forced to include higher interest rates on loans in the cost of products, that is, to increase prices to such an extent that they cover the increase in loan payments.
After all, no one likes to trade at a loss. Not to mention the fact that not many companies can afford for a long time – until the next “key rate cut cycle” – to sell their products below cost and not go bankrupt.
Therefore, the increase in the main interest rate in the first months is often followed not by a slowdown in inflation, but by its acceleration.
The central bank insistently tells the country’s top political leaders that it is fighting inflation. But actually he speeds it up.
“In real life, the following happens: the banks will receive money from the Central Bank at 15%, respectively, the banks will add another 2-3% to the business. In total, the business will receive a loan at 17-18%. To repay such a loan, the profit of the business should be at least 20%”, explains the founder of “Tsarigrad” Konstantin Malofeev.
“Thus, when at a basic rate of 7% the business needed an income of 10%, now it will need an income of at least 20%. Where to get this profit? Raise the prices of your services and products. This is how increases inflation. Plain and simple,” he explained.
“wrong effect”
A decrease in lending due to a rise in interest rates and the resulting decrease in sales of goods and services has a bad effect on the economy as a whole.
Less sales means less need to make cars, refrigerators and other things, build houses, etc. Less production means less components, raw materials, electricity, services of transport companies to transport, and finished goods and what they are made of are needed. As a result, economic growth gives way to decline, while unemployment begins to rise.
We are now seeing exactly this consequence of raising the prime rate in the European Union, where the European Central Bank (ECB) is following exactly the same policy.
And when you hear “the US economy faces a hard landing due to the Fed’s rate hike,” then it’s all the same again.
The “hard landing” refers precisely to the economic downturn following the cascade of consequences described above, caused in America’s case by the increase in the main interest rate of the US Federal Reserve System (FRS).
In fact, it is the worsening economic situation and rising unemployment that usually lead to a slowdown in inflation.
Due to the fact that people who are unemployed are reluctant to spend much money on goods and services due to their unavailability, sellers are forced to lower prices even if they have to sell at a loss. Simply because it is impossible to store goods in a warehouse indefinitely. And warehouses aren’t free either.
Therefore, when choosing between two evils – losses or great losses, you should choose the lesser. However, an economic crisis such as the US subprime crisis of 2007, which developed into the Great Recession of 2008–2009 (not to be confused with the Great Depression of 1929–1933), is clearly too high a cost to slow down inflation.
Currency matters
In addition to the impact on interest rates on deposits and loans, the increase in the main rate of the Central Bank should also contribute to the strengthening of the ruble.
It looks like this: after an increase in the interest rate, the income that can be received in rubles from placing money on deposits or from buying bonds – securities on which interest is periodically paid – increases.
This usually leads to an influx of money from foreign investors who exchange their dollars, euros and other yuan for rubles in Russia and buy Russian bonds with them. And the more foreign currency is sold on the stock exchange, the stronger the ruble becomes.
The only problem is that now the situation can hardly be called normal. After the annexation of Crimea and especially after the start of the special military operation, Western countries imposed many sanctions against Russia.
Therefore, even if Western investors were not prohibited by their own governments from investing in Russian securities, they themselves would be unlikely to take such risks.
Therefore, you should definitely not count on an inflow of dollars and euros after the Central Bank raises the key rate. At the same time, the government’s earlier decision to mandate the sale of foreign currency earnings to exporters has already led to a strengthening of the ruble – the dollar, which recently jumped to 100 rubles to the dollar, retreated to 93 rubles by October 31.
Who wins?
The biggest bonus due to the Central Bank betting games goes to the “rich Russians”. The average maximum interest rate (the Central Bank calculates it as the average for deposits in 10 banks that attracted the most money from the population) has already increased almost one and a half times – from 7.827% per annum in the second decade of July to 11.436% in the second decade of October.
Even the largest Russian banks raised interest rates on deposits for large amounts – up to 12-14% per year, and now offer 15% to VIP customers.
Investing money at such interest rates with official inflation of 6% allows you to get a very decent real, that is minus inflation, income without breaking a finger.
In addition, the richer the depositor and the larger the amount of the deposit, the higher the interest and, accordingly, the income. The same is true of the biggest speculators in the stock market.
After all, following the prime rate, bond yields will begin to rise, promising their owners very good profits.
And, of course, let’s not forget about various types of microfinance organizations and just loan sharks. Although they, of course, do not use loans from the Central Bank, they are already reacting to the situation.
After the Central Bank’s prime rate and bank lending rates, microfinance organizations have also started increasing their lending rates. When loans become less and less accessible to the population, this is gladly taken advantage of by those who are ready to charge citizens several times more for loans.
After all, ordinary citizens have to pay for this holiday. Due to the decrease in the availability of loans and rising interest rates, many will have to postpone long-planned purchases or pay for them at exorbitant prices, ending up in debt slavery for years, because the opportunity to refinance at lower interest rates will not appeared soon.
Not to mention the fact that due to the sharp increase in interest rates, banks began to reject applications for mortgage loans that were already approved in August-September: issuing the interest rates that were then acceptable is no longer profitable.
And these are thousands of our citizens who have lost the opportunity to move into new homes. But the leadership of the Central Bank is unlikely to be interested in such “trifles”.
So what?
Thus, it turns out that the increase in the main interest rate of the Central Bank brings more harm than good. It will not help to achieve a serious strengthening of the ruble. But it was the depreciation of the exchange rate that became one of the reasons for the acceleration of inflation.
Russia still imports many different goods, including industrial equipment. And most of these imports must be paid for in foreign currency.
Therefore, the more the exchange rate falls, the more rubles you have to spend to buy the same product. And, of course, sellers have to raise prices to “make up the difference.”
At the same time, the increase in loan rates after the prime rate will force producers to include higher interest rates in their product prices, again leading to accelerated inflation.
At the same time, higher interest rates on loans ultimately lead to lower sales, which is followed by a downturn in the economy as a whole. And it could prove to be much longer lasting than the US Great Recession of 2008-2009.
Translation: SM
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