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As Inflation Recedes, Central Bank Focuses on Reducing Foreign Debt

It is willing to worsen the economic contraction in order to free itself and Russian companies from foreign debt

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This post first appeared on Russia Insider


As anticipated the Central Bank at its recent meeting on Friday left interest rates at their present levels.  I attach its statement below.

The stated reason is that the recent fall in the rouble may lead to higher inflation later in the year.

<figcaption>Russia's Central Bank</figcaption>
Russia's Central Bank

All I would say about that is that that was not the pattern of 2015.  In 2015 falls in the rouble tended to lead to rises in inflation very quickly.

So far the latest fall in the rouble does not seem to have affected the inflation picture.  Economics Minister Ulyukaev has just said that its annualised level fell below 10% before the end of January - a faster fall than predicted.

By comparison inflation was running at an annualised rate of 6-8% in the first half of 2014 before oil prices and the rouble crashed, and before the government imposed its ban on food imports from the EU.  

It is now rapidly falling back to that level and is now unlikely to tip up much higher.  

Though the Central Bank says inflation may rise in the second quarter, it is actually traditional in Russia for inflation to rise that quarter, and the Central Bank predicts inflation will fall again thereafter.  Even the most pessimistic forecasts predict inflation will remain in single figures in 2016 .  

One way or another, the great inflation spike that began in 2014 is now almost over.

Unpacking the language of the Central Bank statement, it seems that what is worrying the Central Bank is less the internal dynamics of inflation this year and more worries about what may be happening to the global economy.

One point that comes across very clearly from the Central Bank’s statement is its determination to keep Russia’s trade balance in surplus.  Since oil prices have fallen it wants imports to fall even more, and is willing to embrace a longer recession to achieve that.  In the Central Bank’s own words:

……the balance of payments and the economy will have to be further adjusted to lower global prices for the key Russian exports. This will result in a more sizable GDP contraction in 2016 than forecast previously in the baseline scenario. The additional adjustment may take several quarters.”

As to why the Central Bank wants to keep the trade balance in surplus, and why it clearly also wants the government to adjust to the fall in oil prices by cutting the budget, the clue is probably provided by this sentence:

“The high debt load of Russian companies and interest rate risks for banks and their borrowers have also been factored in.”

By world standards Russian companies and banks do not have a high debt load.  On the contrary their debt load is if anything very low.

The Central Bank is however clearly concerned that with sanctions still in place the deleveraging on foreign debt that began in July 2014 should continue, and wants both a steady foreign currency income stream (thus the need to maintain a trade surplus) and a reasonably stable rouble (to make its conversion into foreign currency easier) in order to achieve it.

In other words paying off the remaining foreign debt and reducing the rate of inflation are now the overriding strategic priorities, with the objective of paying off the foreign debt accorded as big a priority as reducing inflation.  If higher interest rates causing a longer recession are the price that must be paid to achieve them, then the Central Bank will pay it.

One reason why the Central Bank is prepared to act like this is because it probably feels under no real pressure to act otherwise.

With no factory closures to speak of, no increase in unemployment, no mass bankruptcies, and with the price of goods in the shops stabilising, the Central Bank probably feels it can afford a few months more of recession in order to achieve its two targets.

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This statement was first published by the Central Bank of Russia:

On 29 January 2016, the Bank of Russia Board of Directors decided to keep its key rate at 11.00% p.a. On the backdrop of yet another oil price slump, monthly consumer price growth rates stabilised at a high level, with a higher risk of accelerated inflation. The deterioration in the global commodity markets will require a further adjustment of the Russian economy. On the strength of today’s decision, the Bank of Russia estimates annual inflation to decrease to a point below 7% as early as January 2017 so it reaches the 4% target by late 2017. Should inflation risks amplify, the Bank of Russia cannot rule out a tightening of its monetary policy.

The time period since the Bank of Russia Board meeting in December saw risks to price stability escalating. The stubborn glut of oil, the slowing Chinese economy, combined with the US Federal Reserve rate hike, have triggered a further drop in the price of crude. This, in its turn, caused the national currencies to weaken and asset prices to drop in emerging markets, affecting Russia. With more volatility in oil prices, the magnitude of variation in Russian financial asset prices and the ruble exchange rate fluctuation has increased.

The recent weakening of the ruble is putting pro-inflationary pressure and causes inflation expectations to grow, despite a slowdown in annual inflation. According to Bank of Russia estimates, the annual growth rate of consumer prices is set to drop from 12.9% for December 2015 to approximately 10% for January 2016. This slowdown in annual inflation is in line with the previous forecasts. The Bank of Russia expects consumer prices in 1Q 2016 to grow 8-9% against the same period last year. There are risks that inflation in 2Q 2016 may accelerate, caused by, among other factors, the low base effect. Thereafter, annual consumer price growth rate is set to resume its decline. This should occur on the back of, inter alia, reduced inflation expectations and the Bank of Russia’s monetary policy. According to the Bank of Russia estimate, on the strength of today’s decision, inflation is set to decrease to a point below 7% as early as January 2017 so it reaches the 4% target by late 2017. However, the risks have grown that inflation may deviate from the target in late 2017.

The key rate decision has been made in recognition of the current economic situation, with elevated risks of continued recession provoked by falling oil prices. The high debt load of Russian companies and interest rate risks for banks and their borrowers have also been factored in.

In 2016-2017, oil prices are likely to be lower than forecast previously in the baseline scenario. The floating exchange rate will partially offset the negative impact of energy prices on the economy. However, the balance of payments and the economy will have to be further adjusted to lower global prices for the key Russian exports. This will result in a more sizable GDP contraction in 2016 than forecast previously in the baseline scenario. The additional adjustment may take several quarters. The GDP growth rate will enter positive territory in 2017, but will be low.

However, should oil prices remain persistently low, this will further escalate inflation and financial stability risks and will require a more extensive adjustment of the economy to the new conditions. A continued persistence of high inflation expectations may also hamper the slowdown of consumer price growth. A well-balanced fiscal policy will be required to mitigate these risks in the medium term.


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