Where does the Russian economy go from here? It will be a question of politics, both in Western capitals where sanctions may soon be toughened even further following Theresa May’s recent Skripal revelations, and in Moscow where the Putin administration will be forced to choose between growth and stability.

IMPACT

The rouble’s new decline: Turkey redux? Russian monetary policy is partially to blame for recent declines in the rouble. Amid a global capital flight from emerging markets, the Russian central bank has held interest rates fast at 7.25%, unwilling to move away from the looser policy of recent years.

There are growing calls to increase interest rates to shore up the value of the rouble, but this would come at the cost of jeopardizing Russia’s growth targets. The Russian economy has finally returned to limited growth after years of contraction. The country is now averaging about 2.2% annual growth, a considerable uptick from the dismal average of 0.7% over the past decade. The rouble’s new plunge comes right on the heels of President Putin’s successful reelection campaign, where he promised to reduce unemployment and produce an economic ‘breakthrough,’ returning Russia to the days of 4%+ GDP growth.

Consumer debt is another problem for the Putin administration. Russian consumers have steadily become more leveraged over the past decade, and lending has outpaced wage growth by a wide margin. Over the first half of 2018 alone, consumer credit grew nearly five times faster than real disposable income. Many of these loans are unsecured and are being used to maintain living standards amid recession. An interest rate hike could be expected to increase the servicing burden of ordinary Russians, worsening the country’s already moribund consumer spending. In extremis, a tighter monetary policy would represent a systemic risk to the Russian banking system in the form of unsecured, non-performing loans.

The overall situation is broadly comparable to Turkey under President Erdogan, the self-declared “enemy of interest rates,” who has kept a loose monetary policy despite a halving of the Turkish lira’s value this year. An interest rate hike represents a risk to many of President Putin’s goals for the term ahead. It’s the last thing he wants. But should the rouble continue its recent plunge, he’ll likely find that he doesn’t have much choice in the matter.

It’s worth mentioning that, again similar to Turkey, the independence of Russia’s central bank is somewhat of a question mark. Governor Elvira Nabiullina is believed to have been granted a high degree of independence following her successful handling of the 2014 crisis, but like any other high-level Russian official, she serves at the pleasure of the president. Putin has the power to lean on monetary policy; it’s just a question of whether he decides to do so.

Sanctions outlook in the West will be decisive in rouble’s fate. New sanctions from the United States have added to Moscow’s economic misery. The sanctions were announced at the end of August; they ended certain arms sales, financing mechanism, and the availability of US credit. Their immediate impact was to send the rouble careening toward its present lows. Yet it wasn’t so much the (admittedly limited) scope of the sanctions that was the difference-maker, but the message they sent to investors and the Russian government.

That message was: it’s unlikely that President Trump will be able to implement his long desired reset with the Russians.

Now that Theresa May has revealed the identity of the Skripal attackers as two individuals from Russia’s military intelligence unit (also known as GRU), we can expect additional US sanctions against Russia. US lawmakers have already begun discussing a new round of sanctions, and early indications point to new restrictions on individual oligarchs and/or Russian sovereign debt issuance. There has consistently been broad, bipartisan support for increased sanctions in the US Congress, whether over Russian election meddling, its activities in the Syrian civil warand Ukraine, or more recently the Skripal attack. We can expect something new to come of this; however, the sanctions could come to be watered down or haphazardly implemented by the executive, as has generally been the case so far.

New sanctions on sovereign debt issuance could be expected to have a major short-term impact on the value of the rouble due to the messaging (sanctions are here to stay) and the uncertain effects, particularly with regards to global markets. Those who believe that such sanctions would have a manageable effect point to Russia’s low foreign debt needs (only 13% of GDP) and the relatively few US buyers of the debt. Others, including the US Treasury Department in its recent report, maintain that sovereign debt sanctions would have damaging spillover effects in the global economy.

The UK is also pushing for the EU to impose new sanctions against Russia over the Skripal poisonings, but its pleas will likely be falling on deaf ears. For one, new sanctions would require a unanimous vote from EU member governments, which is unlikely to be forthcoming. Two, the preexisting sanction regime, which has been in place since the 2014 annexation of Crimea, is already contentious enough with certain members. These sanctions were recently extended in July and will now remain in place until January 2019.