Comments by Central Bank Chair Elvira Nabiullina confirm Russia will maintain tight monetary policy as it seeks to rein in inflation and to move from an economic model based on consumption towards one focused on investment, manufacturing and export.
With annualised inflation in Russia falling to 6.9% at the end of August, and with Russia reporting zero inflation in the first weeks of September, the strong indications are that the Russian Central Bank is preparing to cut interest rates by 0.5% to 10% at its next meeting on Friday 16th September 2016.
The Central Bank has indicated that it intends for the time being to keep its key rate 3% above the annualised rate of inflation. Since the annualised rate of inflation is now roughly 7%, following the logic of the Central Bank’s own policy that should mean a cut in interest rates on Friday to 10%
Central Bank Chair Nabiullina calls interest rates of 10% against an annualised inflation rate of inflation of 6.9% and an underlying rate of inflation which may be as low as 5.5% a “moderately tight monetary policy”.
In reality this “moderately tight monetary policy” is leaving Russia with by far the highest real interest rates of any major economy in the world. To be clear, such a “moderately tight monetary policy” were it attempted in any Western economy or in China, would cause an extremely severe recession, one far more severe than the one Russia has just been through.
The reason Russia has managed to avoid such a severe recession is not because the high real interest rates are not for real. It is because its debt levels are so much lower than in the West and in China that it can live with interest rates they would find unendurable. As it is these very high real interest rates are depressing economic growth, which is why the Central Bank, in the absence of any softening of policy, forecasts that growth in the medium term will remain low.
Nabiullina on Friday at an economic conference in Sochi provided an explanation for her policy. She made it clear that she has no intention of softening her policy. Rather she intends to keep interest rates 3% above inflation for the indefinite future in order to purge the Russian economy of its long running inflation problem, one which extends back to the 1960s (though it was masked during the Soviet period by the Soviet practice of fixing prices), and which caused Russia to experience double-digit inflation continuously throughout the 1990s and 2000s, with a sustained fall in inflation to single figures only taking place since roughly 2010.
Nabiullina has made it clear that this is all part of a long term policy of moving the Russian economy away from a model based on consumption towards one centred on investment and manufacturing. The Central Bank explained its thinking back in November 2015 in the Guidelines it published to explain its monetary policy
“Interest rates on long-term contracts always imply inflation expectations. The Bank of Russia proceeds from the fact that as the inflation and inflation expectations decline, long term rates on loans will go down boosting the economic growth. Amid low inflation expectations long-term rates will persistently develop at the low level. It is an important advantage of the inflation targeting, under which the Bank of Russia implements the monetary policy.”
In the same Guidelines the Central Bank also made clear that it sees low inflation as the means of achieving long-term stability for the rouble
“……ensuring the stability of the national currency does not mean fixing its exchange rate against other currencies at a specific level, but rather achieving stability by maintaining the purchasing power of the ruble, i.e. by ensuring price stability.”
This is a policy framework which would be immediately familiar to the Bundesbank, from whom it appears to have been copied. The idea is that the combination of low inflation, low long term rates of interest, and positive real interest rates, will encourage long term saving and investment, increasing over time productivity and growth.
Until that comes the Central Bank is prepared to accept a trade-off of lower growth because of the tight monetary policy to reduce inflation in the short term. This is the policy framework that I heard Kudrin and Nabiullina discuss at SPIEF.
A further aspect of the policy is that in order to increase competitiveness and hold down imports the current policy also seeks to bear down on consumption by keeping the budget out of deficit. Russia in fact already runs a very tight budget, with the country’s federal budget deficit as it exits recession no more than 2.9% of GDP in the first 8 months of the year – a fact which points to a budget surplus once the economy achieves sustained growth.
Somewhat to my surprise Kudrin justified the policy of keeping the budget out of deficit by conjuring up the so-called “crowding out” hypothesis whereby the need to fund the budget deficit supposedly “crowds out” funding for private investment.
It would be more true to say that keeping the budget balanced or in surplus tends to limit consumption and that this can result over time in trade and balance of payments’ surpluses. Again that is the policy followed in Germany and is the reason for the very large trade and balance of payments surpluses there. Once again it seems that Kudrin and Nabiullina want to copy it.
In other words, by raising investment and limiting consumption they want to make Russia an exporter of finished goods rather than, or as well as, an exporter of commodities.
That incidentally point to an important fact about the current fall in real incomes in Russia which has happened since the start of the recession, and which is still underway, and which critics of the government speak so often about.
As Kudrin and Nabiullina both know it is the product of super-tight monetary and fiscal policies they are both insisting on, and is moreover an intended consequence of those policies. In other words it is being deliberately engineered as part of a programme of moving the Russian economy away from an economic model based on consumption towards one based on investment, manufacturing and export.
Again the parallels with Germany, which also squeezes real incomes in order to limit consumption and gain competitiveness, are very striking. Given the implications this has for most Russians, it is no wonder that Kudrin and Nabiullina are unpopular.
All of this of course was accompanied both at SPIEF and in Nabiullina’s latest comments at Sochi by much talk of various incremental reforms to improve the business climate, which took up most of the time during the presentation at SPIEF which I attended.
As Kudrin and Nabiullina of course both know, these reforms have actually been underway in Russia for some time, and have resulted in a sharp improvement in Russia’s World Bank Ease of Doing Business rankings.
From time to time the reality of this improvement is questioned. However there is no reason to think it is not taking place. Anecdotal evidence on the contrary suggests it is. German Gref, a supporter of Kudrin and Nabiullina who is Sberbank’s CEO, recently told Putin that it actually is taking place, and as the CEO of Russia’s biggest bank he is arguably in the best position to know. In a meeting on 4th August 2016 to discuss the support Sberbank is providing to small businesses, he said the following
“As far as small businesses go, there are two aspects here. First, they need rapid and high quality lending. Second, there is everything related to assisting small businesses to resolve all the remaining problems such as convenient practice for keeping accounts, banking accounting and so on.
We have made great progress in this area and, starting in September this year, a new law will come into effect making it possible to open accounts, make transfers, register changes to company charters and so on online.
Essentially, small businesses will not have to visit state agencies in person anymore. This programme, which we are implementing together with the tax service, is a big step forward in general.
I think that the environment that we will have in place by the end of 2016, when all of the legal amendments take effect, will mean that Russia will be offering one of the most interesting and technologically convenient environments for small businesses.”
(bold italics added)
To those who assume that Kudrin and Nabiullina are free market fundamentalists, I would say that the word “market” was barely mentioned during their entire SPIEF presentation, just as it barely appears in the Central Bank’s Guidelines document.
On the contrary – and as I have heard Kudrin say before – Kudrin seems to favour elements of industrial planning, as well as state involvement in developing infrastructure, even as he criticises excessive government interference in private business activity. I doubt there is any Russian official who believes – as do some people in the US and in Britain – that the market is infallible and can be left alone to take care of itself.
Like it or not this is Russia’s economic policy. I know that some people don’t like it. I also know that there is an alternative plan being proposed by the Stolypin Group which takes an altogether more Keynesian approach by seeking to expand the economy through higher deficit spending. Whilst this alternative plan seems to have some supporters in the Economics Ministry, and though Putin has agreed to look at it, it was absolutely clear to me at SPIEF that it is the current policy that Putin favours and which has his backing, and which has the overall support of the government.
I don’t expect it to change and Nabiullina’s comments on Friday all but confirm as much.
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