With inflation in Russia now reported to have fallen to an annualised rate of just over 3.1% – well below the most optimistic forecasts of the Russian government and of the Central Bank – the Central Bank has moved to cut its key rate by 50 base points from 9% to 8.5%.
Whilst this cut is welcome, it is worth pointing out that the faster than expected fall in inflation means that real interest rates in Russia have in reality hardly changed and at roughly 5% remain by a substantial margin the highest of any G20 economy.
The Central Bank justifies its reluctance to cut its key rate further despite the faster than expected fall in inflation by claiming that inflation risks remain high
Inflation risks. Medium-term risks of inflation overshooting 4% dominate over the risk of its steady downward deviation from the target.
Fluctuations of food prices will remain the source of inflation volatility over the next six months. Food price dynamics will depend on the quality and preserved volumes of the harvest. Short-term food market factors might trigger temporary deviation of inflation (both upward and downward) from the 4%, which, however, will not persist.
Key sources of medium-term inflation risks remain unchanged. First, there are potential price fluctuations in global commodity markets. Implementation of the budget rule will reduce risks linked to oil price movements. Second, labour productivity growth may lag considerably behind the wage growth as the structural shortage of labour force aggravates. Third, inflationary pressure may stem from changes in households’ behaviour as the propensity to save becomes much lower. Fourth, inflation expectations remain highly sensitive to changing prices for individual groups of goods and services and exchange rate movements.
These factors call for moderately tight monetary conditions to be kept in place in order to anchor inflation close to the target.
The warning about “potential price fluctuations in global commodity markets” is undoubtedly what lies behind Central Bank Chair Nabiullina’s warning earlier today of a possible further fall in oil prices to $40 a barrel in 2018 unless the OPEC+ agreement on oil production cut is further extended.
The point is that historically the traded value of the rouble against other currencies has depended on the oil price, with a fall in the oil price causing the internationally traded value of the rouble to fall.
Since falls in the value of the rouble lead to higher import prices – and thus an increase in inflationary pressures within Russia itself – the Central Bank apparently sees an inflation risk in Russia because of the alleged risk of a lower oil price next year.
All I would say about that is that the Central Bank scared itself with the same thing back in 2016, when oil prices plunged to under $30 a barrel at the start of the year. In the event, the surge in inflation in Russia which the Central Bank expected failed to take place.
As to the fear that wage growth may outpace growth in productivity, as I pointed out yesterday the government expects investment to grow over the next three years at a much faster rate than wage growth, which makes the risk of wages outpacing labour productivity unlikely.
As for the risk that households’ “propensity to save becomes much lower”, there is little risk of that when real interests are as high as they are.
Whilst the Central Bank is obviously right not to throw caution to the winds, it remains my clear view that its monetary policy – what it euphemistically calls “moderately tight monetary conditions” – is much too tight. If nothing else the extent to which the Central Bank already looks likely to overshoot its 4% inflation target surely confirms this.
In Russia’s present circumstances positive interest rates and lower inflation – factors likely to encourage increased saving and therefore investment – are unquestionably needed. Real interest rates of 5% are however altogether too much, and are unnecessarily slowing Russia’s exit from recession.
I have long been puzzled by the Central Bank’s insistence on an interest rate policy that would certainly encounter strong criticism if it were practiced anywhere else. I have generally put it down to the trauma the Central Bank suffered because of the rouble crash of December 2014, when the Central Bank briefly lost control of the rouble and was further humiliated when the Finance Ministry had to come to its rescue.
It would not be surprising if memory of this event still haunts Central Bank Chair Nabiullina and her team, making them reluctant to take risks with the rouble, and causing them to keep interest rates much higher than by any objective assessment they need to be.
However I have recently begun to wonder if the true reason for the tight monetary policy is that the 4% inflation target is historic, with the Central Bank privately having a more ambitious inflation target than the 4% target it has announced.
Some months ago Alexey Kudrin, Russia’s former Finance Minister who is now advising President Putin and who is known to be close to the Central Bank’s leadership, spoke of the need to reduce inflation to an annualised rate of 2%, which is roughly inflation’s world level. The thinking behind this is presumably that a Russian inflation rate equal to the world level combined with higher investment will over time increase the Russian economy’s competitiveness relative to that of other economies.
If the Central Bank’s real inflation target is 2% rather than 4% then that might explain why real interest rates are being kept so high for so long, despite the rapid fall in inflation which is underway.