The banker’s dilemma

How Elvira Nabiullina and her team have tried to save Russia’s economy amid war and sanctions

In the aftermath of Moscow’s February 2022 invasion of Ukraine, experts warned that Western sanctions might tank the ruble, threaten the Russian state’s capacity to pay public employees, and cripple the national economy. So far, however, the financial system is holding out. Russia has avoided a run on its banks, and the ruble now trades for more dollars and euros than at any time since 2015. This relative stability is largely the result of the policies pursued by Elvira Nabiullina, the chairwoman of Russia’s Central Bank, which now operates in wartime conditions. Meduza examines how Nabiullina and her deputies have managed Western sanctions, and what moral dilemmas the Central Bank’s leadership faces while the Kremlin wages a full-scale war against Ukraine.

Warning: there’s a potential conflict of interest here. Margarita Lyutova, who coauthored this report, worked as an editor from December 2018 to April 2021 at Econs.online, a website managed by staff at Russia’s Central Bank that publishes economic and financial research. (Econs.online’s content does not reflect the Bank of Russia’s official position.) In preparing this article, Lyutova did not communicate with her former colleagues. The text below is an English-language summary of a Russian-language story first published on June 27, 2022.

Between 1998 and 2003, Ksenia Yudaeva and Konstantin Sonin were colleagues, first at the Russian-European Center for Economic Policy and then at the Center for Economic and Financial Research and Development. After Russia invaded Ukraine in February 2022, Sonin (now a professor at the University of Chicago) reached out to Yudaeva (who today serves as the first deputy governor of the Central Bank). Fearing data insecurity on Facebook and Telegram, she asked him to install Signal.

When they finally connected using the encrypted instant messenger, Sonin warned Yudaeva that staying with Russia’s Central Bank is tantamount to supporting the invasion of Ukraine. The bank’s currency-transaction controls (later softened gradually but not lifted entirely) and other wartime interventions exist only to further Russia’s military campaign, not to help ordinary people, Sonin argued. “They’re working for the war,” he told her, comparing the bank’s staff to Hjalmar Schacht, who served as president of the Reichsbank in Adolf Hitler’s government.

“Here in the Central Bank, there’s a lot of interest in Schacht,” Yudaeva confided in Sonin (he told Meduza). But she refused to quit her job, insisting that either her resignation or the resignation of Chairwoman Elvira Nabiullina would mean the appointment of Sergey Glazyev, who’s proposed price freezes on consumer goods and a fixed dollar exchange rate. It would be a disaster for the national economy and a nightmare for millions of ordinary Russians, she explained. (Yudaeva redirected Meduza’s questions to the Central Bank’s press service, which ignored our inquiries.)

Sonin says he deleted Signal immediately after this conversation with Yudaeva. “I never want to speak to her again for the rest of my life. Not under any circumstances,” he told Meduza.

Moral dilemmas for professional people

Working at Russia’s Central Bank has never been simple in political terms. “There’s this funny paradox where liberals have always considered the bank’s leadership to be too conservative, while conservatives think it’s too liberal,” a source at the Central Bank told Meduza.

Since the early days of Russia’s full-scale invasion of Ukraine, rumors have circulated about Central Bank senior staff itching to quit their jobs. On March 23, Bloomberg reported that Chairwoman Nabiullina tried to resign, “only to be told by the president to stay.”

Five sources who previously worked at the bank and another three people still employed there told Meduza that they don’t believe Bloomberg’s story. One person who used to work at the Central Bank told Meduza that it’s foolish to think Nabiullina’s exit would pressure the Kremlin to change course in Ukraine, but less competent leadership at the bank would undoubtedly “fuck over” the wellbeing of millions of Russians. In fact, on the very first day of the war, Nabiullina reportedly told her subordinates that they needed to limit resignations as much as possible and work together “to save everyone.” Her top deputy, Ksenia Yudaeva, expressed the same sentiment.

The Putin administration has given near carte blanche to Nabiullina and her team to manage Russia’s monetary policy, UCLA Economics Professor Oleg Itskhoki told Meduza. But it’s not just the president who holds Nabiullina in high regard — even economists who are among the Kremlin’s most outspoken critics acknowledge her achievements at the Central Bank.

“This is a crew that did a lot of good things, professionally speaking, after 2014,” Economics Professor Sergei Guriev told Meduza, referring to the monetary policies adopted in response to international sanctions against Russia for the annexation of Crimea.

Two sources at the Central Bank told Meduza that 2014 tested the banking system that Nabiullina and Yudaeva built, and the system passed the test.

Following the annexation of Crimea, Russia’s banking system withstood the blow of sanctions, foreign investors didn’t lose interest in Russian securities, and the Central Bank learned to communicate better with the market. “They successfully fought rising prices, and the bank became the main driver of professional economic discussions in Russia,” says Konstantin Sonin (adding that this feat was “flushed down the toilet” with the invasion of Ukraine).

“They really became extremely professional, focusing on very serious analytical work and maximizing all international experience,” Ruben Enikolopov, an economics professor at Barcelona’s Pompeu Fabra University, told Meduza.

A fundamentally different monetary policy

In September 2018, despite Russia’s growing isolation from the West, Elvira Nabiullina attended an International Monetary Fund conference in Washington, DC, where she delivered a lecture on what she described as the Russian Central Bank’s main accomplishment in recent years: transitioning to a policy of inflation targeting.

This new monetary approach (common among more developed economies) meant shifting the Central Bank’s focus from managing the ruble exchange rate to pursuing an explicit inflation rate (4 percent), achieved by altering Russia’s key rate (the interest rate at which banks can borrow when they fall short of their required reserves, which determines the cost of credit for borrowers and influences the supply of money and credit in the economy).

Nabiullina’s push for inflation targeting followed more than a decade of interventions by the Central Bank to shore up the ruble. Because it is impossible in an open market economy to manage both the exchange rate and inflation, a stronger currency sometimes decreased inflation in Russia, but it still fluctuated around 10 percent annually. Studies show that this level of oscillation over several years inevitably hurts a national economy because it impedes individuals’ financial planning and businesses’ investment decisions.

As part of the campaign to reorient Russia’s monetary policy, Ksenia Yudaeva built an entire research division at the Central Bank, says one of her colleagues, in order to shift the institution’s policymaking to a basis of scientific evidence and mathematical models. “This was her dream, and she achieved it,” the source told Meduza.

And then the invasion happened.

A painful rescue

The rigorous adoption of scientific decision-making under Nabiullina and Yudaeva gave Russia’s Central Bank more opportunities to adapt to the extraordinary conditions of international sanctions, says Ruben Enikolopov. “They saved the banking system. I mean, they simply saved it!” he told Meduza.

This rescue hasn’t been without its costs, however. On February 28, 2022, the Central Bank raised its key rate to an unprecedented 20 percent per annum, effectively halting all lending in the country. The goal of this radical measure was to prevent a run on the nation’s banks. So far, it’s worked. In a telephone blitz, Nabiullina’s top managers convinced Russia’s banks to raise interest rates on savings deposits just as drastically as the key rate, preventing widespread panic.

Simultaneously, in another anti-crisis policy that hurt Russians even more directly, the Central Bank limited the movement of capital, restricting the export of foreign currency, banning its transfer to foreign accounts, and suspending cash withdrawals from individuals’ own foreign currency deposits. Export businesses, meanwhile, have been forced since the start of the war to exchange 80 percent of their earnings for rubles. Russia’s biggest exporters are commodities giants, but the new requirement has also weighed on smaller enterprises that need dollars and euros to buy raw materials and equipment abroad or pay off foreign currency debts.

These currency controls are “both stylistically and strategically” antithetical to the Central Bank’s policies in recent years, says Enikolopov. “But I have no idea what else they could have done in the current situation,” he told Meduza.

As a result of these restrictions, Nabiullina and her team shielded Russia’s banks from high demand for foreign currency, and the higher key rate helped curb inflation. When imports dipped and export earnings held, the Central Bank allowed the ruble to appreciate, which reduced price rises and made it possible to lower interest rates, explains Oleg Vyugin, who worked with Nabiullina for more than two decades.

None of these measures, however, are enough to save the Russian economy in the long run. As Elvira Nabiullina puts it, the nation’s hopes lie in “structural transformation.”

“Structural transformation”

In her urgent appeal to Central Bank staff a week after the invasion began, Nabiullina instituted an informal but nevertheless strict ban on any talk about politics. At this year’s St. Petersburg Economic Forum, she said nothing about the war. When Ksenia Yudaeva spoke at the Yasin International Academic Conference in April, she addressed international sanctions but didn’t mention why they’ve been imposed.

For all this caution, the Central Bank has actually written quite openly about the meaning of “structural transformation.” This spring, for example, Yudaeva’s research and forecasts department released a report on Russia’s alarming economic trends. Econs.online published an excerpt from this study (with a disclaimer that his views don’t represent the Central Bank’s official position) in a column by Head of Research Alexander Morozov.

In that article, Morozov warned, “The structural transformation of the Russian economy in the face of sustained external restrictions will come with technological regression across multiple industries.” Within a few years, Russia will begin to experience “reverse industrialization” as “less advanced technologies” begin to drive industrial development, leading to less modern, more expensive products and less efficient, environmentally dirtier production.

For the Russian people

Three insider sources told Meduza that fewer than 50 people have resigned from Russia’s Central Bank since the start of the February invasion — a remarkably small number, given that the bank employs almost 50,000 people. The lack of turnover, however, doesn’t mean everyone is at peace with their work. Three employees told Meduza that the constant criticism they face on social media for keeping their jobs makes them feel like “Reichsbank employees.”

Some resent being called collaborators. One source with close ties to the Central Bank told Meduza, “You could say the same thing about everyone who’s still working for the public — building, healing, teaching. [Anybody] who’s trying not to lose it in a government that’s gone crazy, who’s at least trying to improve something in people’s wrecked lives.”

Economist Ruben Enikolopov says employees face a tough moral dilemma: Should they sabotage the economy by leaving the Central Bank in the hope that it shortens or softens the war in Ukraine, if it means jeopardizing the welfare of more than 145 million Russians?

UCLA Professor Oleg Itskhoki says his friends at Russia’s Central Bank compare themselves to air-defense officers guarding the country against missile attacks. Should these soldiers also abandon their posts to make the war more painful for Russians? (For his part, Itskhoki says he would have quit the Central Bank more than a decade ago “when it became clear in what direction the Russian state was headed.”)

Even without mass resignations, Western sanctions mean a potentially crippling “brain drain” for Russia’s Central Bank. Elvira Nabiullina and Ksenia Yudaeva modeled their work not just on international standards but also on international cooperation. Since the February invasion of Ukraine, the bank has lost access to experts and analytical resources abroad. Before the war, Yudaeva’s research department relied on constant dataflows exchanged internationally. Today, it runs on Russian expertise alone.

An independent regulator, for now

Russia’s Constitution establishes the Central Bank as an independent state agency charged with safeguarding the economy and monetary system from politicians who might benefit in the short term from printing more money when the treasury runs out of cash.

In recent years, despite the upheaval of war and international sanctions, President Putin has remained committed to this independence. Last December, for example, he said at a press conference that he shields the bank from critics on a daily basis. “I know how unhappy the real sector of the economy is with the raised interest rates, but we could end up like Turkey if it isn’t done,” Putin reasoned.

Economists like Ruben Enikolopov and Oleg Itskhoki doubt the bank’s independence will last much longer. Once export revenues begin to slip and the federal budget loses those injections, the Kremlin will likely ask the Central Bank to plug the gaps, says Enikolopov. Itskhoki thinks this could happen before the year’s end.

If the federal government lacks the revenues to cover its expenses, it has three basic options: withdraw funds from the National Wealth Fund, borrow domestically, or cut spending. In 2022, Russia’s Finance Ministry expects to run a deficit of at least 1.6 trillion rubles (currently almost $25.2 billion). In April, Finance Minister Anton Siluanov warned that the government would need to pull money from the National Wealth Fund. Two months later, he said he wasn’t ruling out issuing new government bonds on the domestic market before the end of the year. (Russia’s total domestic debt is currently 16.6 trillion rubles — $251.2 billion.)

In a televised interview, eight years ago, Elvira Nabiullina admitted to journalist Vladimir Pozner that the government has the capacity to pressure her in tough economic times. In such a situation, Nabiullina said, she would not resist but would convince herself that the decisions she makes “are needed for the economy and financial sector to develop appropriately.”

If asked to patch the growing holes in the federal government’s budget, Russia’s Central Bank could respond in multiple ways. The bank could insist on a lower key interest rate, which would raise inflation, reduce public debt, and make it easier for the state to pay back what it’s borrowed. More radically, the bank could even buy the Finance Ministry’s federal bonds, effectively lending money directly to the state.

Ruben Enikolopov says it’s irrelevant how the Central Bank ultimately “caves” under pressure; what matters is the fact that the bank’s core purpose shifts from fighting inflation to plugging deficits, the moment this happens. “The entire population will suffer from rising prices in order to replenish the budget, and we know where that money is going,” Enikolopov told Meduza. “At that point, the argument about [the welfare of] 145 million Russians goes out the window.”

For the time being, thanks to oil and gas income, the Russian government is actually working with a surplus. In the first five months of 2022, federal budget revenues exceeded expenditures by almost 1.5 trillion rubles ($23.6 billion). This number is deceptive, however. The federal budget in April alone was in deficit, and the government’s dependence on oil and gas revenues rises as revenues from non-hydrocarbon industries collapse. (In the past year, oil and gas money went from 36 percent of federal budget revenues to 63 percent.) The growing reliance on such exports means restrictions imposed by Russia’s biggest fuel importers in Europe will hurt even more.

In recent public statements, Nabiullina has indicated that she’s already thinking about this scenario. In a speech on June 10, she warned that the ruble’s value could tumble in the event that Russia’s export earnings dive, accelerating inflation. Back in April, Central Bank Head of Research Alexander Morozov acknowledged that a strong ruble won’t last.

The Central Bank hasn’t been asked yet to intervene directly to rescue the federal budget, but unhappiness about the current exchange rates exists. A stronger currency is less profitable for exporters, which means less revenue for the government. In mid-June, First Deputy Prime Minister Andrey Belousov stated that the ruble is currently “over-strengthened.” A more comfortable exchange rate “for our industry,” he explained, would be 70–80 rubles to the dollar. (At the time of this writing, $1 traded for 63.2 rubles.) A vocal advocate for state interventions in the market and long considered one of Elvira Nabiullina’s political opponents, Belousov said a discussion is now underway “both at the expert level and in government structures” about reverting Russia’s monetary policy from inflation targeting to exchange-rate management.

In the past, when these debates became public, Vladimir Putin rejected such proposals and supported the Central Bank’s chief. On March 18, just a few weeks after he ordered the full-scale invasion of Ukraine, Russia’s president stood by Nabiullina again, urging the State Duma to reappoint her to another five-year term. A month later, when lawmakers voted on the matter, she kept her job.

Story by Svetlana Reiter and Margarita Lyutova. English-language summary by Kevin Rothrock.

Photos: Dmitry Dukhanin / Kommersant, Emin Jafarov / Kommersant, Alexey Nikolsky / TASS, Dmitry Azarov / Kommersant, Ruslan Shamukov / TASS, Gleb Shchelkunov / Kommersant, and Evgeny Razumny / Vedomosti / TASS