The pattern of the Russian Central Bank’s inflation predictions in Russia ever since 2015 is that it regularly talks of high risks of inflation increasing. The reality instead is of inflation continuing to fall.
A few months ago the Russian Central Bank confidently predicted an inflation surge in December and January, with inflation over the course of 2018 steadily rising and eventually hitting the Central Bank’s 4% annual inflation target.
Instead there was only a minimal increase in inflation in December and in the first week of January, whilst inflation in the second week of January has fallen to zero.
The result is that instead of inflation in Russia being 4% in 2017 it was actually 2.5%, and instead of inflation rising at the turn of the year as the Central Bank expected it has now fallen further to an annualised rate of 2.2%.
The Central Bank has now grudgingly admitted that the 4% annual inflation target is unlikely to be reached in 2018, but it still expects inflation to rise to that level by mid 2019.
Meanwhile the Central Bank’s key rate continues to be 7.75%, meaning that real interest rates in Russia remain above 5% (higher than during the inflation spike in 2015), with the actual real interest rates Russian consumers must pay on credit cards and consumer loans well above 10%.
With interest rates this high, it seems to me far more likely that rather than inflation increasing over the course of 2018 and 2019, Russia may instead find itself experiencing a period of actual and even prolonged deflation this summer.
Economic commentators must resist the temptation of treating this massive and continuing inflation overshoot as ‘good news’.
Obviously lower inflation is better than higher inflation, and I mistrust the theory that zero inflation or even deflation is somehow intrinsically inimical to growth.
However when inflation is much lower than expected against a background of cripplingly high interest rates and a budget in rough balance or even surplus, it is a sign that demand is being stifled, and that economic activity is being depressed.
That this is indeed precisely what has been happening in Russia is shown by what happened to the economy last year.
After a strong start, with industrial production rising by 3.8% year on year in the second quarter, industrial growth in the second half of the year fell back again, with a shock fall of 3.5% year on year in November.
The result was that industrial growth in the year as a whole rose by just 1% over the previous year, against the Economic Ministry’s prediction of a rise of 2%. This is a lower rate of increase than in 2016, when the rate of industrial growth year on year was 1.3%.
There is more optimism about the situation this year. The Central Bank is expected to cut its key rate at the end of this month, and there are predictions that its key rate will fall by 2% this year.
As the Economics Ministry predicted, industrial growth dynamics were better in December, with industrial production higher that month than in the preceding three months. The 0.5% year on year fall in industrial output in December appears to have been almost entirely due to the fact that December 2017 had one less working day than December 2016.
Certain industries – notably the car industry – are performing strongly, suggesting that despite the continued 1.5% fall in real incomes which took place in 2017 some demand is starting to return.
Moreover the rise in oil prices which took place in the second half of 2017 will make more money available both for demand and investment, even if it is causing the rouble to strengthen more than is good, which is not surprising given that the rouble is already being supported by the very high interest rates.
Having said all this, strong and sustained growth of the sort of which the Russian economy is fully capable can only come when real interest rates fall to more realistic levels.
I have been making this point ever since 2015, and following what happened in 2017 that fact ought to be self-evident.
To reiterate, real interest rates of more than 5% (actually currently around 7-10%) are simply incompatible with sustained increases in demand and investment of the sort which are needed if the economy is to grow strongly.
This is especially so given that no support for demand is coming from the fiscal side, with the government planning to run a budget surplus this year.
Whether this fact will finally be acknowledged within the government this year remains to be seen.
What I would say is that if Russia does face sustained deflation this summer then the predicted cuts of 2% in the Central Bank’s key rate this year will be nowhere near enough.