Stability at Any Price: Nabiullina's High-Rate Gamble

Russia’s Central Bank raised its key interest rate to a two-decade high of 21% in late 2024 after a surge in inflation. Since then, it has pursued a policy of monetary easing, with the cut from 14.5% to 14.25% on 19th June marking the ninth consecutive cut. This has surprised some analysts, who were expecting a 50-basis-point cut. More broadly, it reflects the cautious approach that Elvira Nabiullina, Governor of the Central Bank of Russia, has taken toward the economy, with efforts to maintain economic stability during the Special Military Operation (SMO) prioritised over calls to cut rates to lower borrowing costs and stimulate growth. 

On 15^th June, annual inflation in Russia was 5.6%. The central bank had maintained a forecast that inflation would cool to 4.5-5.5% later in 2026, falling to the target of 4% in 2027. However, according to Reuters, analysts projected in June that the 2026 inflation forecasts were higher than in May, from 5.5% to 5.7%. This provides context for the central bank's decision to reduce interest rates only slightly, given higher inflation expectations.

Subtracting inflation from the policy rate yields a real interest rate of 9-10%, indicating the inflation-adjusted cost of borrowing. The nominal cut is thoroughly consistent with disinflation to date, leaving the real rate broadly unchanged even as forecasts for the rest of the year have increased. Businesses tend to borrow at 12-13% while consumers who take out mortgages or car loans face a greater burden, having to pay, in some cases, more than 20%.

Nabiullina attributed the modest 25bps cut to higher gasoline prices, with the increase in fuel prices driven by the global energy crisis stemming from the Israel-Iran conflict and recent Ukrainian drone attacks on Russian refineries and supply lines. The latter may have caused shortages in parts of the country, with the average price of gasoline having increased 6.6% since the beginning of the year. On the other hand, the bank projected the looser-than-expected fiscal policy would likely require a higher rate path. This, proponents have argued, is attributed to budget deficits, which have proved persistent, surpassing 6 trillion rubles, equivalent to $83.5 billion in the first five months of the year.

Before assessing the merits of this decision, it is important to contextualise the performance of the Russian economy. It contracted 0.2% in annualised terms in Q1 according to Rosstat. It was expected that GDP would grow by only 0.4% this year, down from the previous estimate of 1.3%. The S&P Global manufacturing PMI increased to 50.3 in June from 48.8 in May. It crossed the 50-point growth threshold for the first time since the beginning of the year. This was because of the fastest rise in factory output since January 2025. 

However, export orders fell for an eighth consecutive month – foreign consumers have bought less from Russian manufacturers every month since last autumn. In June, the decline accelerated, marking the steepest monthly decline since September 2025. The reasons are low overseas demand, competition, and the strong ruble, which has made Russian goods more expensive abroad and created unfavourable exchange-rate movements. At the same time, manufacturers cut jobs for a seventh month, having reduced workforces since the start of the year. Workers voluntarily leaving are not being adequately replaced, with firms suggesting they have spare capacity, and low demand means shortages are not an immediate issue.

This raises questions about Nabiullina’s justification for retaining real interest rates near 10%, as she assumes the economy runs at full capacity, and that stimulus would overheat it and generate inflation. Surveyed manufacturers, who are reporting underutilised capacity and reduced workforce levels, imply that there may be more slack in the economy than the central bank purports. There may therefore be scope for further rate cuts without generating further inflation.

In addition, the split economy is recognised by analysts, who note record defence spending even as civilian manufacturers report labour shortages, high borrowing costs, and restrictions on access to imported components.

At SPIEF in June 2025, Sberbank CEO Herman Gref warned that high rates and a strong ruble could stunt investment for two to three years. At a Sberbank annual shareholder meeting on 30 June 2026, he argued that extensive growth through adding labour and capacity has been exhausted, meaning future growth must come from productivity-enhancing investment and technological development, both of which require cheaper credit. Investment in fixed assets fell by 14.3% year-on-year in Q1 2026, according to preliminary Rosstat data. This is a key indicator of growth. This matters because Gref argues that investment projects are unprofitable at a 10% real rate, and that companies in Russia typically fund investment with their own capital, with only 30% from loans. At the same time, using monetary policy to counter non-macroeconomic drivers of inflation, such as the fuel price shock caused by strikes on infrastructure, would be ineffective.

Sberbank's finance chief told Reuters the bank would cut its 2026 corporate lending forecast. It cited worsening borrower finances and dispiriting trends in loan quality. VTB, the second-largest lender in Russia, announced it would boost its reserves as fuel prices drive inflation. The provisioning for bad debts by the country’s two biggest banks highlights the credit squeeze Gref elucidates.

Putin recognised how economic growth in Russia had subsided and the need to return to sustainable domestic economic growth as early as next year. This indicates that the Kremlin is likely to pressure for the easing of interest rates in 2027. Nabiullina’s decision not to cut rates to fight inflation focuses on the supply-driven nature of inflation. Gref, regarded as one of Russia's more economically liberal policymakers, described it as completely irrational.

Ultimately, the issues with Nabiullina’s decision stem from the fact that the 10% real rate was intended as a short-term emergency measure to cool the economy rather than for long-term use. Economic activity contracted during January and February before rebounding in March and April. Growth slowed again in May, before the manufacturing PMI indicated tentative expansion in June. This could lead to recession or to fall short of the 4% inflation target. Notably, Nabiullina’s prolonged period of tight policy led inflation to undershoot the 4% target in 2017-2018. There is likely, however, spare capacity to enable a modest easing to inspire growth without necessarily causing overheating.

Those most hurt by this policy are small and medium-sized businesses and households that rely more on credit. In contrast, large industrial companies such as Rostec and Rosatom are better able to finance investment from retained earnings. The concern is that this could disrupt the economy and harm SMEs essential to the consumer economy, including those in food production and agriculture.

The central bank could argue that the risk of inflation still looms and thus the need for real rates remains. Real wages and wealth have increased, and the manufacturing PMI has returned to expansion territory. For example, UBS data indicate that average Russian wealth increased by 37% between 2020 and 2025, while median wealth, a better indicator since most people do not own property, rose by over 9%. It is believed that people feeling wealthier may sustain inflationary pressure. The central bank believes that the need to suppress growth to curb inflation, support investment, and enable capacity expansion would create conditions for a later relaxation of interest rates. However, that point has yet to materialise. Nabiullina is likely overcompensating for her decision to cut interest rates aggressively in 2022 from the emergency 20% to 7.5%. They were held low into mid-2023 and were hiked again in July 2023 after overheating.

Furthermore, a policy rate, as a demand-side instrument, cannot mend a bombed refinery. The approach of squeezing credit to offset the supply shock fails to lower petrol prices and instead risks deepening the economic slowdown. Moreover, an increase in inflation forecasts to 5.7% should be offset by the collapse in the growth forecast from 1.3% to 0.4%. Focus should be placed not just on inflation risks but on whether they outweigh the risk of recession, which the evidence suggests they do not.

While it is true that the Kremlin seeks an increase in the rate of economic growth, stability is at the forefront of Putin’s concerns. The risk of hyperinflation is therefore minuscule with an anti-inflation policy. It is true to say that Nabiullina successfully cleaned up the banking system, stabilised the exchange rate, and stabilised the economy in 2022. Perhaps Putin is reluctant to part ways with Nabiullina for this reason. He is known to reward those who have been loyal to him. In 2019, she only cut interest rates after Putin pressured her, which increased growth. Albeit this was before the pandemic and the SMO. 

In conclusion, it is important to highlight the Russian economy's immediate resilience amid the SMO and the tide of Western sanctions, which have failed to bring about a collapse in its energy exports. Focus now needs to be put on the credit squeeze that negatively impacts SMEs and consumers. Nabiullina’s caution may recognise the fuel shock and widened deficit that pose a risk of inflation. But she needs to park the false pretence that this judgment is based on, that the economy is operating at full capacity. She should stop overcompensating for historical overheating. If not, it may be a case of waiting for the Kremlin to press for a policy change in the new year.

Image: Wikimedia Commons/State Duma of the Russian Federation (Duma.gov.ru)

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