Russia's Slow Walk To Financial Independence

Authored by Tom Luongo,

I’ve been critical of the Bank of Russia’s slow-rolling their interest rate cuts for more than a year now.  This ultra-conservative approach has worked to also slow the growth of the domestic Russian credit cycle, keeping borrowing costs well above the demand for Russian debt.

Last Friday the bank lowered its benchmark lending rate 25 basis points to 7.50%.

And in a completely counter-intuitive turn of events, the ruble strengthened as a result.

But what is so noteworthy is how commonplace that reaction from the ruble to a central bank rate cut is.

It tells you just how starved the Russian economy is for its own currency.   The ruble is supposed to drop on increased supply, which is what lower rates imply.  When, in fact, the opposite occurred.  Demand for the ruble rose to because borrowing costs were lower.

This speaks to just how much the Bank of Russia’s policies are holding back what should be a much more robust expansion at this point.

Overly tight interest rates are just as bad as overly accommodative rates.  They both bias economic investment along the wrong points in the structure of production, by mis-pricing risk.

Austrian Business Cycle Redux

Usually Austrian Business Cycle Theory is applied to western Central Banking models to criticize Keynesian-style counter-cyclical policy which lowers interest rates in the face of falling aggregate demand.

The problem with this analysis, and Keynesian/Mixed-Monetary Theory economics in general, is simply that there is no such thing as aggregate demand. 

Demand for goods and services is unique to the individual markets.

And as such, so is the risk-tolerance of the investors in said markets.  So, there really is no one interest rate for an economy. It’s why all central banking schemes will eventually end up in the gutter.

The decisions to expand or contract output in any particular markets is dependent on the cost of capital.  And the cost of capital is dependent on the cost of money, i.e. the rate of interest to borrow.

More complicated projects with longer rates of return require lower interest rates.  Whereas shorter-term projects can absorb higher interest rates because the payback period is itself shorter.  And the borrowed funds function more as activation energy to kickstart a project rather than the lifeblood the project needs to get to completion and begin paying back investors.

So, while I applaud the Bank of Russia for being miserly with easy loan capital to ensure this current expansion is built on a solid footing with a vast pool of real savings, I also feel that the rates it is charging are well above what the market is demanding.

In other words the Bank of Russia is still looking at the Russian economy as too immature to take on bigger projects and the market is saying otherwise.  Why?

Two Steps Forward, One Rate Cut Back

The proof is in the structure of the Russian yield curve.  For loans in the interbank market, which are less than one-year in duration, the yield curve is 1) still inverted with higher yields occurring at shorter time frames and 2)  higher than Russian Sovereign Bonds of greater than seven-years in maturity.

Russian Yield Curve

That said, this yield curve is far better than it was a year ago where overnight rates were as much as 2% higher than sovereign bond yields.  But this situation speaks to why the Russian economic expansion continues to happen in fits and starts.

It’s why industrial GDP output has been so slow to find its feet and begin spinning up great returns.  Big purchases like industrial equipment are impossible to finance at 10+% rates.

So are mortgages.  The latest numbers out of the Russian auto market saw a 31% year over year increase in January.

The implication of this chart is that Bank of Russia President Elvira Nabullina has room to cut rates right now by another 75 basis points and it wouldn’t harm anything except current growth.

With the number of people within President Putin’s government that still want good relations with the West at any costs, most especially that of Russians themselves, this policy is suspect as it continues to keep Russia’s economy weaker than it needs to be.

But with the Fed resolutely moving forward with its balance sheet normalization and commensurate higher rates, the demand for non-ruble denominated credit in Russia should be abating.

This is one of the knock-on effects of incredibly tight monetary policy, it subsidizes domestic foreign-currency lending based on the spread between central bank policy rates.

With the U.S. and ECB at the zero-bound it was hard to get Russians to borrow in rubles, when dollars and euros were plentiful in Russian banks and the rates far lower.  Now those spreads are tightening quickly but they are still quite high, more than 3.5% on 10 year debt (U.S. vs. Russia).

This is why Nabullina needed to move quicker with rate cuts, in my opinion.  It was keeping the market for U.S. dollar and euro debt robust while Putin and his economic advisors were trying to improve the ruble’s profile as a lending currency.

This is part of the reason why Putin fired his long-time ally Alexei Kudrin in 2015 and brought in Stolypin Group leader Sergei Glazyev.  Glazyev has been outspoken in his criticism of Nabullina’s overly-tight monetary policy.

While Glazyev wanted much lower rates much faster, Nabullina stubbornly stuck to her inflation-targetting approach. But she’s way past her mark. And as such, now needs to aggressively cut rates below 7%, if not all the way to 6%.

Mixed Monetary Signals

There have always been questions surrounding people like Nabullina and Prime Minister Dimitri Medvedev and their true loyalties for years.  I believe the past few years of increasingly belligerent U.S. policy make those fears overblown. As in, Putin has more allies now than just three years ago.

But, it’s hard to overcome your training.

Nabullina is cautious as is Putin.  She was trained in the West, so IMF-style austerity dominates the thinking within the Bank of Russia.  There are plenty of other officials within the Bank of Russia and the Ministry of Finance who are opposed to Russia’s chosen paths for financial independence.  Though I no longer consider Nabullina among them.

I talked about some of the implications of this in a recent post regarding draft Ministry of Finance rules on Bitcoin and cryptocurrencies in general.

It finally took Putin demanding they put a draft together by the end of this year to get something from them.  Deputy Finance Minister Alexei Mosieev has been very hostile to Bitcoin and the legislation is a reflection of this.

And, for the life of me, I have to wonder what he’s thinking when it is obvious that Putin wanted something far more progressive than this backwards looking bill.

For all of the talk about how Putin runs Russia with an iron fist for his own enrichment, it was he who pushed for regulations and legislation to be drafted. And for the MoF to come back with this along with the Bank of Russia’s blessing is telling.

I’ve always heard that it is the Russian banking system and the politicians connected to it that are the real Fifth Column within Russia that Putin has yet to get under full control.  The Bank of Russia’s adherence to  IMF-style austerity in the wake of the ruble crisis in 2014 has made this clear.

Now we have this announcement this morning that Russian banks are prepared to function if cut off from the global interbank communications market, the markets are getting mixed signals.

Russia’s Deputy Prime Minister just declared its financial independence from the U.S.-controlled SWIFT network.  They are the first country to officially do it, though China has its own system.

It’s not like SWIFT is that hard to implement.  It’s a protocol.  It’s software.  The formatting of the information is public knowledge.  Reverse engineering a protocol to be compatible with SWIFT transfer numbers shouldn’t have taken four years to implement if the people in charge of the project were amenable to it.

Just like it shouldn’t have taken the Ministry of Finance three years to put together a draft cryptocurrency bill either.  But it did.

At this point Russia’s biggest enemies exist not in the United States where the ham-fisted machinations of Cold War simpletons like John McCain and Bill Kristol still dominate policy think tanks, it’s the fifth columnists within Russia herself.

It seems the changes are happening despite the endless knuckle-dragging.  Trump is fighting the same battle here at home.  It’s a war against the Bureaucracy.  His budget proposal is the next shot across that bow; looking to streamline all of the cabinet departments to realign the spending.

But, it’s more than that.  It puts the bureaucracy on notice that, like it or not, change is coming.  Just like Putin’s message to his Atlanticist back-benchers, adapt or be replaced.


Heros cossack55 Thu, 02/15/2018 - 05:52 Permalink

As long as Russia is an IMF member, Putin will toe the BIS line.  If the US tries to throw Russia out of Swift then they will be removing more incentives for Russia to cooperate and remain in the IMF. 

At some point, when an undefined red line is crossed, Russia will leave the IMF, and the the fireworks will really get started.  Blockades, embargoes.

In reply to by cossack55

ZH Snob Cesare de Borgia Thu, 02/15/2018 - 05:57 Permalink

the radical change that Russia and the entire world needs is to finally realize that social-engineered debt-based economies are backwards.  what Russia and the rest of the world will eventually be forced to do is to rebuild, from the ashes, a new asset-based economy, one in which it is the assets themselves that do the talking instead of these tired, ivy league so-called economists.  making currencies and debt derivative instruments more valuable than real things with tangible value is backwards and thank God coming to an end. 

the biggest trouble now are those who insist on hanging on and patching what is essentially a flawed and broken system.  they create misery and fear for everyone as they heroically attempt to tweak this interest rate or that currency exchange rate.  they unnecessarily extend something that really needs to go away, once and for all--for everyone's good.  and as we all know, the debt patient needs to die first, as these pencil-necked geeks will never, ever admit they were wrong, were educated wrongly and are the cause of this grand failure.

In reply to by Cesare de Borgia

HopefulCynical ZH Snob Thu, 02/15/2018 - 07:48 Permalink

Nicely stated, and I agree. Debt-based money is the foundation of our current dysfunction and malaise. It's only true purpose is to siphon a society's wealth into the pockets of the moneychangers who run it. They then buy off/position politicians solely on the basis of defending and expanding the reach of this system. It must end because it cannot sustain itself, but the longer it is propped up, the worse the pain and suffering of the society when it finally disintegrates.

In reply to by ZH Snob

Koba the Dread ZH Snob Thu, 02/15/2018 - 08:28 Permalink

I think that those who insist on hanging on and patching what is essentially a flawed and broken system don't have any idea what to do to correct the system. They're hanging on and patching in hopes that some deus ex machina will come along and save the farm. They've led their wagon train so far into Indian territory for the last 35 years. Now their only plan is to circle the wagons and hope the cavalry can ride to the rescue. It can't.

Or think of Custer on the promontory: "Where'd all those Indians come from?" And Major Reno and Captain Benteen, just a few hundred yards away, couldn't do anything to help.



In reply to by ZH Snob

new game Thu, 02/15/2018 - 05:33 Permalink

i have novel idea! let the market set the cost of interest rates. yup, it can be done. to low banks clam up. to high nobody barrows.

simple shit maynard. oh, but then can't manipulate the money system, couldn't have that>>>majority of people might just not get fuked over in a free market banking system. imagine saving money with a 5-6 percent return. this is very elementary stuff...

Brazen Heist Thu, 02/15/2018 - 05:40 Permalink

Cryptocurrencies, smart contracts and blockchain will help countries bypass stinking US sanctions and back towards financial independence, given the rampant weaponization of the US dollar.

Brazen Heist . . . _ _ _ . . . Thu, 02/15/2018 - 05:53 Permalink

I would assume there are a few globalist cabalists at the Bank of Russia and various banks and NGOs to drain. A few parasites (Zionists) too.

The most dangerous Zionists by far are the eastern-bloc variety (Ashkenazis). Alot of them left Russia and went to Israel and the US, and seek revenge on Russia. They have infested US policy-making, hence the clusterfucks. Putin cleaned house in the 1990s, I doubt he would want a re-run of that any time soon, so he probably is keeping a check on the influential ones who never left.

In reply to by . . . _ _ _ . . .

octomancer roddy6667 Thu, 02/15/2018 - 13:44 Permalink

One of my friends is fluent in Russian, dated a Russian lady while he lived there, has travelled a fair bit around the country. The version of the story he told me was that Putin was instrumental in the process by which the oligarchs collected all the micro-shares in the Russian oil & gas industry that were distributed to the workers. He was director of the FSB at the time, how could he not have known? And if he knew, he must have colluded, surely? Do you have a different narrative? I'm genuinely very interested in a version of the story where Putin is in opposition to the oligarchs ...

In reply to by roddy6667

octomancer Thu, 02/15/2018 - 05:55 Permalink

Maybe Putin has watched America hollow out future supply/demand with usurious practice to bring it into the present. Maybe he's watching America staggering under the weight of the monkey on its back. Maybe he wants the Russian economy to go slowly because he wants to live in a country that has a pot to piss in, and more besides, in 50 years time. Maybe he thinks the relentless pursuit of inflation and productivity growth is not the only model. Maybe Russia and China have been acquiring gold because they think a currency backed by a finite resource is a good idea. Maybe the only threat that Russia and China pose to the US is their unwillingness to hallucinate value into the petrodollar.

Pinche Caballero octomancer Thu, 02/15/2018 - 07:06 Permalink

Agreed! If I understand the article correctly, Russia's conservative approach has been to make sure the value of it's own fiat currency isn't in the race to the bottom...Where I disagree with the author is that he thinks they should be lowering ruble borrowing costs to compete with the dollar/euro. If in the face of impending economic upheaval Russians default on hundreds of millions of Ruble denominated loans, that's Russia's problem. If Russians default on tens of billions of dollar/euro denominated loans, that's other countries problems. In essence, if the dollar/euro collapsed today, ruble holders will have come out ahead twice, first for having borrowed at the lower rate, and then paying off the debts in those Russian banks with gold-backed rubles for next to nothing. That would seem like a huge boost to the Russian economy and industry if decoupled from the dollar. Ultimately, it is winner (ruble) takes all.

Is this right?

In reply to by octomancer

octomancer Pinche Caballero Thu, 02/15/2018 - 09:01 Permalink

You may be right Pinche, but I can't comment. Economically, I'm a 100lb weakling, almost every poster here would kick copies of Keynes in my face on the beach. 10 years ago, in the aftermath of GFC I, I taught myself about CDOs and CDSs and why they had caused the death spiral. It's been a long road and I ended up lurking on ZH some months ago. But I do understand the abject scam of central banks and fiat currency, and the insanity of perpetual growth on a finite planet.

I stopped reading the article near the start when the author accused Putin of keeping interest rates too high. To my mind, the author is saying "Hey Russia, easy monetary policy is great! Look how well it's worked for the US!"

In reply to by Pinche Caballero

philip88 Thu, 02/15/2018 - 05:58 Permalink

you wrote..swift is just a software...

yes but to have the software working it imply that the Russians maintain positive us$ balances in the US financial system!


So where is the independance?


That is so true that few weeks ago Putin told that it would be an act of war to block their money in the US!

zoghead Thu, 02/15/2018 - 05:59 Permalink

I'm not a finance guy, don't know much about interest rates, cryptos etc etc. But i do know the Russian Govt. is by and large truer to its people than the West. 

pc_babe Thu, 02/15/2018 - 05:59 Permalink

If we are to agree with the author's argument, Russia central bank needs to invert their yield curve? ...Higher cost for capital on the front-end, and lower costs on the back.

Bigger questions ... what's wrong with a gold standard? why even have a central bank?

philip88 Thu, 02/15/2018 - 06:01 Permalink

To be really independant from the US imply

1. to have a different system than swift

2. to have their us$ deposited  in another place than the US..But that I do not know if it is technically possible?

Anonymous (not verified) Thu, 02/15/2018 - 06:03 Permalink

Russia, Russia, Russia.  Hit the "default topic" button and write about Russia.  Again!

It's the 12th largest economy in the world, behind India & Canada let alone China.

In population terms, it's 9th - behind Bangladesh, Pakistan, Nigeria, Brazil & Indonesia.

Why does Russia require so much coverage?

The emphasis makes me highly suspicious that ZH is a Russian propaganda operation.

otschelnik Thu, 02/15/2018 - 06:20 Permalink

This monetary analysis does neglect certain specific traits of the Russian credit markets.  In fact there are only 2 sectors: 1) the oligarch sector, which is a handfull of energy companies that need to finance drilling and pipelines (indeed some have their own bank, like Gazprom has Gazprombank), and 2) the builder / retail banking sector, where a growing usually younger middle class is getting mortgages to upgrade to modern housing and away from dilapidated Soviet era block apartments. 

Other than that, there aren't any credit markets. There is no small or medium size business to speak of, there is no trade finance, and the oligarches even insist on prepayment for export-import operations, leaving this sector mostly to the Swiss banks.

Uncoy otschelnik Thu, 02/15/2018 - 06:46 Permalink

It's not specific to Russia - Rumania operates in a similar way - but transactions in Russia have to be prepaid. There's a whole class of business criminal who specialises in taking the merchandise/asset and running in Russia. They then launder/dispose of the asset quickly and retreat behind private security structures (mafia-like), bribe judges. On big enough dishonest deals, the lead faces on the deal (ironically) take refuge somewhere in the West. There if the money is big enough, the crooks are called "persecuted" oligarchs.

Due to this systemic issue with payment after delivery, pre-payment works much better. Pre-payment does not work in the West as our companies don't budget for it, but in reality a couple of months cash flow on merchandise (terms sixty days is standard in the West) is a drop in the bucket in the grand scheme of running a viable business. A bigger issue was arbitrary seizure of assets by customs bureaucrats. Even under Yeltsin's crooks at the end of the nineties, the juice on this graft was diminishing and from what I understand Putin has reduced bureaucratic graft levels further.

It will be great when the courts work well enough and the muscle boys are completely out of the picture that Russia can move to payment after delivery but in the meantime, if you observe local customs, pre-payment for goods does not make doing business impossible.

In reply to by otschelnik