Russian Rate Hike to Further Undercut Domestic Demand: Analysts

The head of the Research Department "International Finance and Financial Management" at the Centre for European Economic Research explaines that it is very hard for any central bank to fight the devaluation of its own currency.

MOSCOW, December 17 (Sputnik), Svetlana Alexandrova – The rate hike introduced by Russia is a conventional measure that will further dampen domestic demand, EU experts told Sputnik News Agency Wednesday commenting on the ruble's drastic devaluation and the Russian Central Bank's decision to raise its base interest rate from 10.5 to 17 percent.

"Some measures are needed to protect the Russian financial system from the further slide of the currency and from capital flight," a senior researcher at the European Trade Union Institute (ETUI), Jan Drahokoupil, told Sputnik.

Drahokoupil considers the rate increase to be a conventional tool employed by central banks but cautioned that taken in the context of many large Russian companies being prevented from raising capital abroad by EU and US sanctions "such an extreme hike will effectively make it impossible for domestic companies to borrow, further undercutting domestic demand."

Michael Schroeder, the Head of the Research Department "International Finance and Financial Management" at the Centre for European Economic Research, agrees, stressing that it is very hard for a central bank to fight the devaluation of its own currency. He explained that there are limits to the currency reserves held by any central bank. Market players know this, so they already expect the central bank to fail and these expectations are self-perpetuating and fuel the further downward spiral of the currency.

"The strong interest rate increase will only hurt the Russian economy but the devaluation will not come to a halt," the analyst told Sputnik.

Commenting on the Russian Central Bank's decision yesterday to raise the base interest rate, Michael Schroeder stated that "it is a desperate effort but it will not work."

He expects Russian interest rates to decrease in coming weeks when the failure of the Central Bank's intervention becomes obvious. "If the interest stayed that high for a longer time period it would severely hurt the Russian economy," the expert concluded.

On Tuesday, the ruble was trading at 80 rubles to the dollar and 100 to the euro on the currency exchange market, losing 20 to 26 percent during the day on the trading floor.

Drahokoupil, who is also co-author of the book series "Transition Economies: Political Economy in Russia, Eastern Europe, and Central Asia," believes that the seriousness of the situation seems to call for more unconventional measures such as capital and currency controls.

Drahokoupil sees the low price of oil as the main cause of the drastic fall in the value of the ruble.

"The broader context is the unfortunate reliance of the economy on oil exports," the ETUI analyst said, noting that while EU and US sanctions were not the main cause, they provided an additional blow to the embattled ruble and their significance should not be underestimated. He expects a pretty bad 2015 for the Russian economy, the extent of which depends heavily on the price of oil.

"Some sort of a geopolitical deal with the European Union and the United States would be also extremely helpful," Drahokoupil said adding that he is afraid that "the economic crisis may be an incentive for Putin to play hard on the geopolitical front."

Michael Schroeder saw yet another reason for the ruble crisis in the huge capital flight Russia has witnessed this year, motivated by a desire to avoid even more severe capital losses. The Central Bank of Russia has predicted that capital flight will reach $130 billion this year, compared to $63 billion last year.

Despite the current financial difficulties, Russia still has enough resources to achieve its economic goals, Russian Prime Minister Dmitry Medvedev said Wednesday, speaking at a meeting with the senior government finance and economics officials, heads of the Central Bank and management of Russia's major steel and energy companies. The Russian Prime Minister underlined that the ruble today is undervalued and its exchange rate on the trading floor does not reflect the actual situation in the economy.