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Why Interest Rates Are So High in Russia

July 18, 2013 | About:

It is well known that the state of the Russian economy is heavily dependent on prices for natural resources it exports. Export of natural resources creates huge capital inflows which in turn pushes the ruble exchange rate up. When prices for oil and gas drop, the ruble goes down as well, and these drops could be very sharp.

In order to protect the economy from fluctuations in prices for natural resources the government has a so-called Stabilization Fund. There is a budget law that sets the size of this fund to be at 3.7% of GDP. The current size of the fund is $84 billion. When oil and gas prices are high fund grows, when they drop the government has money to spend to help the economy.

Not less important for business is the stability of national currency. During 2000 to 2012 the government received $2 trillion from exports of oil and gas. Compare it with just $200 billion received during 1992 to 1999. Such massive inflow of petro-dollars pushed the real ruble exchange rate to dollar 140% up. The dollar became more affordable for citizens and businesses. It became cheaper to import the goods.

A strong ruble is not good for the economy and in order to prevent such a sharp rise of the ruble, the Russian central bank once bought large amounts of dollars using printed rubles. (The large inflow of dollars has to be exchanged into rubles, and demand for rubles rises and exchange rate goes up. Therefore, the amount of rubles in the system has to increase in order to stop the national currency from rising.) But increasing the amount of rubles creates inflation, so now this policy is corrected to keep inflation from growing.

Inflation, however, still stands around 7%. The real ruble exchange rate also goes up when inflation in Russia is exceeding the inflation in the neighboring countries. Russian goods become more expensive than imports. This effect is responsible for growth of volume of imported goods and services from $40 billion in 2000 to $440 billion in 2012. Growth of imports exceeded growth of GDP by a great margin, making goods produced in Russia not competitive enough.

If spending of petro-dollars by the government is not controlled, the Russian economy gets hit twice: First imports grow and second the internal credit rates for businesses have to remain high in order to stay higher than inflation. High borrowing rates make it very hard for businesses to operate because profitability margins have to exceed borrowing cost. Many businesses borrow money today at rates of 15% and higher.

As we know, there is inverse correlation between interest rates and overall performance of the stock market. High interest rates could be responsible among other factors for sluggish growth on the Micex index. At the same time, the Russian stock market remains the most undervalued in the world. Stock market capitalization to GDP is only 35%, compared with 108% for the U.S. and 55% for China.

About the author:

I have a degree in Statistics and Computer Science from Bar Ilan unversity in Tel Aviv, Israel. After university I've spent many years in IT industry as a software developer of real time systems. In 1999 I moved to Canada where I had IT consulting business for 12 years. In March 2012 I returned to Russia after spending exactly 20 years abroad. Investing and studying finance as a hobby eventually lead me to change the career and this year I joined botique investment bank Sky Invest Securities in St. Petersburg, Russia as a partner. Sky Invest holds first place by the number of listings in North West region of Russia and second place in Russia by the number of listings in Innovation and Investment Market of Moscow Exchange. My investing philosophy is influenced by books of Peter Lynch, Benjamin Grham, John Greenblatt, George Soros and others.

Rating: 3.9/5 (8 votes)


BEL-AIR - 3 years ago    Report SPAM
If interest rates are like 8.5% or a bank cd in Russia, what has that done to the housing economy in the country?

Is a housing bubble forming, or with the higher interest rates compared to a western country not bad yet? Since with higher rates it should make stock market and also house prices and all other assets go down. with low interest rates in the west it is why our stock market is high as well as house market in Canada..

Yet I heard that house prices in Moscow are some of the highest in the world, so this should not be the case if interest rates are so high in Russia, do you have any comments on this?
Investex premium member - 3 years ago
Good question. Moscow real estate prices are indeed some of the highest in the world. Unfortunately the development of Russia is very assymetric, Moscow literally has 90% of Russian wealth concentrated in one city, it has more billioners that any other city in the world according to some research. Presence of large amount of peoploe with lots of money in one city drives up real estate up. It had its buble which peaked in 2008 when CAP rates were around 3-4% and prices still haven't reached pre 2008 levels. I live in St. Petersburg which is the second largest city in Russia but its population is one third of Moscow. Here real estate costs half of Moscow and resturant bills are half of their Moscow equivalents as well. CAP rates in St. Petersburg are around 6% for residental and around 10% or even higher for commercial real estate. With such high mortgage rates another buble isn't possible. Previous buble was caused by specifics of Russian economy and specifics of mentality of Russian people. With high oil prices enormous amount of money was coming into the country and then getting redistributed throughout economy from rich down to everybody else. Because people still remembered very well 3000% inflation in the 90s and default of 1998 everybody poored lots of money in real estate which in the minds of typical Russian is the only safe investment. Most of the Moscow real estate at the time was owned by speculators. Today we have much lower levels of mortgage debt compared to Europe or US/Canada, but overall amount of unsecured debt has peaked and right now approaching dangerous levels. People are not buying real estate so much but just borrow to consume. Banks are making record profits and there is lots of money accumulated but not enough opportunities for investment so capital leaves Russsia. This is quite unfortunate.
Investex premium member - 3 years ago
As far as stock market goes, there are really good companies but too few of them. Gov-t is working to changed laws, I hope that from next year IFRS reporting will be obligatory for all public companies. I also hope that laws will be changed to improve quanitity and quality of information disclosure for public companies. Corporate goverance also needs to improve. If we don't do that we don't have a chance for brighter future.
BEL-AIR - 3 years ago    Report SPAM
Thank you for that useful info.... Amazing it is 15% to borrow money for businesses.

What is the interest rates to borrow money to buy a house?

How about a car?

I know taxes are now a flat 13% now in Russia which is amazing, I heard they wanted to lower it even more like to 10% but the 2009 recession prevented that, what would the tax rate be for investing in stocks for a Russian living in Russia, is it still 13% or half of that for capital gains?

Thank you for your time and article and whats happening in your country.

Investex premium member - 3 years ago
Sberbank is offering mortgages at 14.5% right now. For cars 13.5% - 16% in rubles, 10-13% in dollars or euro. If taxes were 13% Russian economy would go into stratosphere. 13% is only part of taxes in addition to this around 20% from salary will go into obligatory gov-t pension plan. So the total tax rate is around 33% and its flat ! From your stocks related profits you would pay 13% only and 9% from dividents.

The tax system has no logic and it causes massive illegal tax avasion schemes by employers because in Russia employer is responsible for paying taxes. Regular citizens are not trusted by the gov-t to pay their own taxes.

Investex premium member - 3 years ago
its a trick for a business to stay profitable with such high taxes and such high borrowing rates if everything is done legally. The gov-t is basically forcing employers to take risks and avoid paying all taxes by lowering legal salary and giving illegal part of salary in envelopes.
BEL-AIR - 3 years ago    Report SPAM
You been a real education....

Must be tough to buy a house with such high interest rates.....

I thought that the you were lucky in Russia since you only had a flat 13% tax rate, I did not know about the other 20% for Government pension, so it is not what I thought at all. This flat tax of 13% it starts on the first dollar you make or are the lower incomes exempt like that first $5,000 or something.

So taxes are really not less than in the west like I thought.

Yes with the interest rates that high it would be very hard to make it if you had a small business.

Thank you for letting us know about the markets and business climate is like in Russia, I had my eye on your etf RSX, If it went a little cheaper I wanted to buy a little also your energy stocks are getting really cheap as well, thank for giving us a small glimpse why the stocks are cheaper in Russia.

I made alot of money on your MTL, in 2006 to 2007, but got out in aug 2008 just before the collapse, looks like it is really suffering with low steel prices and a huge amount of debt, happy I got out when I did...

Thank for all the great info.
Investex premium member - 3 years ago
13% and 20% is genral rule regardless of your salary, this is why I call this system stupid.
Tom1985 - 3 years ago    Report SPAM
A very interesting piece of writing Ilia. Very good! I have a question probably a bit out of the topic. Can we consider Russia as large open economy? Has it power to affect global market like US does?
Investex premium member - 3 years ago

Hi Tom, sorry I just saw your comment. Of course Russia is large economy which is lets say "becoming open" after it joined WTO last year. Russian GDP is the size of Canadian for example and by 2020 Russia is going to be the largest economy in Europe. Hopefully Putin will be gone by then and we are going to have a president much more popular on the west and hopefully better overall image of the country. Right now Russia is loosing information war by all accounts. Which is sad.

Gvegys - 8 months ago    Report SPAM

I have a small question. If Central bank buys large amounts of dollars using printed rubles, how come demand for rubles rises? Shouldn't it be vice a versa?

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