Russia is currently facing rising inflation and a plunging currency, which has highlighted a growing disagreement between the Kremlin and the country’s central bank.

In an emergency meeting on Tuesday, the Central Bank of Russia (CBR) raised interest rates by 350 basis points to 12%. The aim was to halt the rapid depreciation of the ruble currency, which hit a 17-month low of nearly 102 to the dollar on Monday.

The decision came after President Vladimir Putin’s economic advisor, Maxim Oreshkin, claimed in an op-ed that loose monetary policy was responsible for the acceleration of inflation and the weakening currency. Oreshkin argued that the central bank had the necessary tools to address the situation.

The central bank justified its emergency rate hike by stating that it aimed to limit risks to price stability as inflationary pressure was building up. Over the past three months, price growth averaged an annualized 7.6% on a seasonally adjusted basis, with core inflation rising to 7.1% during the same period.

The central bank’s board explained that steady growth in domestic demand, surpassing the capacity to expand output, was contributing to underlying inflationary pressure. This, in turn, affected the ruble’s exchange rate dynamics through increased demand for imports.

Despite the central bank’s previous decision to halt foreign currency purchases on the domestic market until 2024 to reduce volatility, the ruble’s decline continued. Russia often sells foreign currency to offset decreases in oil and gas export revenues and buys it when running a surplus.

Prior to the Kremlin’s intervention, the Bank of Russia attributed the inflation and currency problems to the country’s shrinking balance of trade. From January to July, Russia’s current account surplus fell by over 85% year on year.

Anatoly Aksakov, chairman of the Duma Committee on Financial Markets, stated on Telegram that “the ruble exchange rate is under state control.”

The Kremlin and the Bank of Russia, having previously collaborated to mitigate the impact of economic isolation and sanctions from Western countries, now seem to have differing opinions on the causes of the currency troubles.

Analysts suggest that the government’s direct influence on the central bank’s monetary policy actions reflects the challenges faced by Russia’s economy.

Agathe Demarais, global forecasting director at the Economist Intelligence Unit, agrees with the central bank’s earlier assessment that the decline in Russia’s current account surplus is the main factor behind high inflation. Demarais attributes this to Western sanctions, which limit Russia’s hydrocarbon export revenues and increase import costs.

The ruble initially plummeted to 130 to the dollar in February 2022 following Russia’s invasion of Ukraine and subsequent Western sanctions. The central bank implemented capital controls to stabilize the currency, eventually bringing it back to a range of 50 to 60 rubles to the dollar by the summer of 2022.

The central bank has since relaxed these capital controls to support the economy as sanctions took effect. This, along with a period of low interest rates, has further contributed to the “vicious circle” for the ruble, according to Demarais.

The Economist Intelligence Unit director states that blaming the central bank has become an “easy tactic” for the Kremlin due to the lack of tangible options for improving the situation.

There have been reports that Russian authorities are considering reintroducing capital controls, such as compulsory sales of foreign currency revenues for exporters. The central bank’s rate hike only slowed down the ruble’s depreciation.

Stephanie Kennedy, economist at Julius Baer, predicts that the central bank is likely to reinforce capital controls and enforce the rule that exporters must exchange their earnings from US dollars into rubles.

Kennedy explains that the devaluation of the ruble is not caused by speculative momentum but rather by headwinds from the relative flow of exports earning foreign currency and imports requiring payment in that currency.

Although Russia’s current account surplus has declined significantly, it remains at a tolerable level and within its historical average. A cheap currency benefits Russia’s oil revenues but also increases import costs.

Julius Baer expects the ruble to be around 92 to the dollar in three months and 95 in 12 months, despite the potential reinforcement of capital controls. However, the tradeability of the ruble is low, and uncertainty about its outlook remains high.