Get the latest updates as we post them — right on your browser

. Last Updated: 07/27/2016

Don't Let Fiscal Policy Slip Further

The Central Bank's decision Monday to tighten monetary policy is the clearest sign so far that the uncertainty on world and Russian financial markets could start to have an impact on the real economy.

Apart from burning a few high-flying stockbrokers, the crash on Russia's stock market had been more a curiosity than a serious economic threat.

But faced with heavy selling pressure on the ruble as foreign investors withdraw funds from emerging markets like Russia, the Central Bank this week hiked its refinancing rate and Lombard rates, key indicators of interest rates for the rest of the economy. It also increased the level of reserves that banks must keep to cover their hard-currency holdings.

Both moves are technical, but they could have significant flow-on effects for the Russian economy, especially the prospects for urgently needed investment.

Markets reacted immediately to the Central Bank's tightening of the money supply by hiking interest rates on government treasury bills.

This is an unfortunate retrograde step because the government has spent the past year trying with some success to lower interest rates. With annualized rates as high as 200 percent last year, investment was strangled and funds were sucked away into the market for government paper.

With rates down to under 20 percent last month, signs were emerging that Russian banks were changing their policies and moving out of T-bills into commercial loans into the private economy. Now they will have to think again.

The government and the Central Bank must be aware of the threat high interest rates can pose to hopes of economic growth in 1998, but at the moment there is little choice.

Raising rates is the only quick way to encourage foreign investors who are exiting Russia because of a general distrust of emerging markets to keep their money here.

The real message in all this concerns not so much the Central Bank's monetary policy as the fiscal policy carried out by the government and the State Duma.

Relying excessively on tight monetary policy to manipulate the economy is dangerous because it stifles investment.

Instead, Russia should be ensuring that the budget is tight and investment is not crowded out by government borrowing to finance the deficit.

The government has already made concessions to the Duma on the 1998 budget, which will increase government spending and strain its ability to meet revenue targets. Markets could react harshly if fiscal policy is allowed to slip any further.