- "They just follow Washington's recommendations"
You don't think there's free debate in Russia? Here's a widely-read Russian public intellectual delivering scathing critique of state monetary and financial policy
On the eve of the St Petersburg Economic Forum, the Bank of Russia made the business community happy with another reduction of the key rate by 1%. News Front asked economist Sergey Glazyev to comment on the decision.
Sergei Yurevich, what has this decision changed in the Russian economy?
Why has the press made such a fuss about it?
Because journalists who comment on economic matters, rarely understand what they are talking about. Few of them know what the key rate is…
It is the refinancing rate…
Refinancing of what? That is the main question. The rate is the benchmark for the Central Bank to provide short-term loans to commercial banks for repo transactions. These are transactions for the purchase of securities included in the Lombard list of the Central Bank with the obligation to repurchase at the same price plus the key rate. These loans are generally issued for a few days to a week. Banks need them to cover a liquidity deficit – a temporary shortage of cash to meet current obligations. These loans are not directed at the real sector of the economy where the production cycle lasts from several months to several years. The economy needs long affordable loans. Whereas the Central Bank provides short expensive money as the lender of last resort to cover short-term imbalances of supply and demand in the financial market.
Nevertheless, the whole credit system is based on the key rate.
Because that is how our banking sector is set up. Let’s start with the fact that it is a monopoly – three state-controlled banks account for more than 70% of its assets. However the state in no way manages these banks – it only rescues them time and again from crises, pumping them full of budget money and relieving their bosses of their responsibility for the efficacy of their work. Nobody gives them any kind of assignments and the senior management of these banks behaves as if these organizations belong to them. They set arbitrary interest rates and don’t concern themselves with solutions to the problems of economic development.
Indeed no-one even sets them such tasks. They exist for themselves, using unlimited access to that very system of refinancing. They take money from the Central Bank at the key rate, add their margin and offer it to borrowers. Because of their monopoly position, other banks are guided by them in their interest rate policy. This highlights the role of the key rate. The Central Bank prints money and throws it into circulation at the key rate. It thereby determines the minimum price in the money supply. After all it doesn’t cost them anything. And it can make the offer at any percentage rate. When it is necessary to stimulate business growth, the monetary authorities reduce this percentage rate.
There have been cases when the central banks of some countries offered loans at a negative interest rate – that is they rewarded commercial banks for their willingness to take money and bear the risks of its loan to businesses. Now the main issuers of international currencies, the US Federal Reserve, the European Central Bank and the Bank of England provide loans at a negative real interest rate, considered as the nominal rate minus inflation. With this they stimulate economic growth and reduce the risk of banks defaulting (bankruptcy) when they experience problems with the repayment of loans from their borrowers. When the economy is overheating – that is, it is operating at the limit of its capabilities and a further increase in business activities involves the risk of inflation – the monetary authorities raise the refinancing rate. With this they increase the efficiency requirement for loans.
And is our economy overheated?
It seems to me that the monetary authorities are overheated. I do not understand the logic of their behavior at all. One year ago they began a sustained increase in the key rate in a situation where the level of capacity utilization averaged around 60% – even less in manufacturing industries. Capacities stood idle due to the fact that businesses lacked working capital and loans for its replenishment could be taken only at a rate that exceeds the profitability of production – that is, at a loss, and on top of that with excessive collateral requirements. Raising the key rate only worsened the already difficult situation with the financial position of the manufacturing sector and was the main cause of the economic downturn. I and many other experts warned the monetary authorities repeatedly that the consequence of their policy of increasing the key rate would be a fall in output and an increase in inflation as the increase in loan costs will be passed on to the production costs and will raise prices.
This is obvious. Why did the monetary authorities not take your advice?
They don’t talk about it. The answer to your question can be found in the statement of the IMF in its address to our monetary authorities on the results of its mission in Moscow. The actions of the Central Bank in raising interest rates and allowing the ruble to float freely fully conform with the recommendations of the IMF. But the monetary authorities pay no attention to the consequences which we forecast. This is indeed strange, when you consider that raising interest rates and tightening credit conditions always reduces the money supply and there is nowhere where it doesn’t lead to a drop in production and investment.
You mean the stagflation which we are now experiencing – is the result of decisions taken by the monetary authorities?
And you thought it was the anti-Russian sanctions? If, after we were notified of them, the Central Bank has provided the manufacturing sector with an extension of credit, then we would have had a growth in production of import-substituting products after the introduction of our counter-sanctions against Western foodstuffs. But as loans for the increase of working capital to be used for the extension of production at domestic producers’ free production capacities could only be taken out at a high interest rate, they were forced to go the way of price increases.
We had a unique situation in world practice – a combination of devaluation of the national currency and a fall in the volume of production. Always and everywhere devaluation of the national currency automatically leads to the growth of domestic production, which becomes more price competitive with foreign imports and correspondingly displaces more costly imports and increases cheaper exports. It is this effect the President was referring to when at the Business Russia Congress he spoke about the additional opportunities that had arisen for domestic business in connection with the fall of the ruble. But few were able to take advantage of these opportunities. In conditions of low profitability it is only possible to fight off sharply increased interest rates for loans with a corresponding hike in prices – and that means at the expense of demand. Due to the insane inflation of the key rate and the deterioration of the credit conditions of manufacturing enterprises, instead of expanding production and import substitution as the government had encouraged them to, they were forced to follow a path of banal price increases and reduced production as a result of falling demand.
So in this way the monetary authorities did exactly the opposite of what the government leaders were talking about? Instead of stimulating import substitution they made it impossible and stimulated inflation?
That’s the way it turned out.
And what about targeting inflation?
That too. They announced the transition to a policy of targeting inflation and set as a reference point a decline of 5%. In reality, they achieved – as we warned – an increase by the same amount. And a slight decrease in the key rate won’t change anything. The average profitability of the manufacturing industry is three times lower than its new level. Our economy needs this latest decision of the Central Bank like a hole in the head. Money will still not enter the real sector and the refinancing of commercial banks at this rate will mostly be used for speculative purposes. The monetary authorities have driven the economy into a stagflationary trap and continue to hold it there.
Are they idiots? Or saboteurs?
No, they are just carrying out the recommendations of Washington’s financial institutions. What they call the policy of inflation targeting is really no such thing. They understand the policy of inflation targeting to mean the consolidation of all tools of monetary policy for the manipulation of the key rate in a financial system fully open to cross-border capital flows and free shaping of the exchange rate of the national currency.
If the word “targeting” is used in accordance with its meaning “goal-setting”, in accordance with the generally accepted approach to the management of systems, then the monetary powers should have monitored all the macroeconomic parameters, which are significant for the formation of inflation, such as the exchange rate, regulated tariffs and this same percentage rate and used these to reduce inflation. Moreover – not increase it but reduce it. They did the opposite and indeed got exactly the opposite of the intended result – inflation was not halved as they announced, rather it was doubled, as we had warned.
How do they explain this?
They don’t. Unless you consider of course the mantras based on the suggestion that “they did absolutely everything correctly” and that “the transition to inflation targeting implies that targeting the exchange rate of the ruble must be dropped.” But these are no more than incantations.
That is to say, there is no scientific basis to them?
There is a comparison of the monetary policies of European countries carried out on statistics from the last 100 years. The three researchers formulated the so-called impossible trinity (trilemma) that with free movement of capital it is not possible to simultaneously fix the exchange rate of the ruble and pursue an independent monetary policy. This empirical observation makes no claim of ultimate truth, which is what the IMF has made out of it.
What do you think are the objectives of the IMF?
Probably, ensuring macroeconomic stability..
Actually, the main goal of this organization, which is located in Washington, appears to be ensuring free cross-border movement of capital, which is postulated in this trilemma as a given. But if even back then the monetary authorities, with an absence of capital controls, did not manage to pursue an independent monetary policy and control the exchange rate of the national currency at the same time, then what can be said now, when the issue of global currencies is increasing exponentially. Even the slightest fluctuations in the flows of speculative capital circulating in the global market can overturn the monetary-financial system of a relatively large country. It can be proven that in modern conditions the free flow of capital makes both control of the national currency and the pursuit of an independent monetary policy impossible. The national financial and monetary market is completely dependent on foreign speculators and the conduct of an independent monetary policy is impossible.
This is also true for Russia?
Russia accounts for just 1% of the global money supply. Its financial market is relatively small. Therefore it is highly vulnerable to attacks from large international speculators. They actually manipulate it – the share of foreign speculators in the Russian financial market in the whole of the post-Soviet period ranged from 60% to 90%. It is they who are the main beneficiaries of the “free” floating exchange rate of the ruble. The profitability of speculative activity in the Russian currency market after the Central Bank let the ruble float freely last year was 30-50% per annum – and if you had access to insider information from the Bank of Russia or MICEX then it topped 100. Not surprisingly all the free money rushed into currency speculation, which along with the attack of foreign “investors” caused the collapse of the ruble.
It turns out that our monetary authorities were working for them?
While the profitability of the manufacturing industry fell to 3-5%, and investments crashed by 10%, speculators earned many billions through the destabilization of the ruble exchange rate without any risk indeed even on account of loans drawn on the Bank of Russia, which commercial banks put on the currency market. Raising the key rate could have no cooling effect for them because the profitability of the speculative operations was higher still. But for the real sector of the economy raising the key rate caused a sharp increase in the cost of credit, investments were stopped and output reduced.
Who profited the most from the free floating of the ruble?
Ask the MICEX management.
Although he is, as far as I know the chairman of the Board of Directors of MICEX, I think that the managers of the organization didn’t ask him rather they acted in the interests of their partners in the major foreign banks. After all many of them are former employees of Deutsche Bank, Morgan Stanley and other major global speculators.
But is this not market manipulation?
Yes, in the US or the EU the actions of these managers, who caused the collapse of the ruble and then its rebound semi-volatility, would have been subject to the most stringent trials and would have ended with multi-billion dollar fines and criminal penalties. For us however these managers are high professionals.
In other words, our monetary authorities are working for foreign speculators? What about the Western sanctions?
Not just foreign ones. Here as well the income of speculators grew like mushrooms sprouting up after rain after the ruble was allowed to float freely. They have superior communication and authoritative leadership with access to confidential information from the regulator. Creating “currency swings” – this latter created a real gold mine for them… By the way Western sanctions only affect loans with a term of over a month. They don’t apply to short-term loans, which are what the speculators depend on. Indeed they need loans for literally one day, often – for one hour. So the entire Western financial system is still connected to our financial market, which is still dominated by foreign speculators – they account for 90% of transactions. Despite the sanctions, American financial funds are not exiting our market, they continue to push through trillions of dollars in excessive profits on the “free” floating of the ruble.
Who is paying for all of this?
The source of income for speculators is the destabilization of the monetary market. When the ruble falls, speculators convert part of the depreciating savings of enterprises and citizens into the national currency, when it climbs then into foreign currency. This is a simple redistribution from those who earned and saved money to speculators. In addition, by destabilizing the market they sabotage the investments and business plans of bona fide economic actors, who lose their bearings and are not able to continue as planned. Investments fall, production declines, the economy stops developing. This is why in every country monetary authorities conduct an uncompromising fight against speculators.
And we think they are doing useful work…
They can be useful, if you are talking about small market fluctuations around the point of equilibrium. But if you let them manipulate the market then they transform it into a turbulent operation with unpredictable fluctuations of the exchange rate and securities with galloping inflation, making development of the economy impossible. This is exactly what is happening in our market, which any major foreign player such as Morgan Stanley or Deutsch Bank can easily destabilize. The capabilities of each of them exceed the capacity of our entire financial market.
It follows then that we should protect our financial market from such imperialist sharks?
We don’t just need to protect it, but also to regulate it purposefully. We should welcome direct foreign investment, especially when it includes the transfer of modern technology to us, but we need to protect our market from speculative attacks. All successful developing countries have used such filters, using direct and indirect methods – from banking control instruments to the taxation of speculative transactions. If we want to manage our own development then this is indispensable.
What else needs to be done?
RAS experts have long proposed a set of measures to carry out a macroeconomic policy targeted to stimulate the growth of investments and production. It involves regaining control over the proper use of credit. Then it can be dramatically increased under conditions of the specific use of credit resources for modernization and growth of production. Then instead of the current stagflation – a combination of stagnation and inflation – we would get sustainable growth and a reduction in the production costs of domestic goods, accompanied by deflation. Details can be found on mywebsite.
It’s that simple?
It is not simple at all. The launch of the proposed financial arrangements for investment growth and production involves a transition to a qualitatively more complex system of management of development of the economy, including strategic and indicative planning, a stringent system of accountability for the effective use of credit resources in the same state-owned banks, which together with the Central Bank should operate as a system of development institutions. And in order to access long-term, cheap credit resources private businesses must take responsibility for achieving the goals of development of production under which these resources are provided by the state.
And this isn’t a return to a planned economy?
If so, then Japan, China, India and Brazil all have planned economies. And even in Western Europe there was also a planned economy before the introduction of the Euro – money was printed by the national banks according to demand from the manufacturing enterprises, as confirmed by their business plans, the implementation of which was monitored by commercial banks. They took the risks of lending to their clients and refinanced with the national banks using promissory notes. It was this mechanism of monetary emission for the commitments of the manufacturing enterprises rather than the infamous Marshal Plan which ensured the recovery of the economies of Germany and France after the war.
But in order for it to work effectively the national banks of these countries were monitoring the creditworthiness of all businesses, the promissory notes of which were taken to secure the refinancing of commercial banks. These then monitored the efficiency of the use of the credits made available to them, including their intended purpose. The national government was responsible for the development of the economy, defining priorities, shaping indicative plans and implementing specific programs. That is what created the European aviation industry, nuclear energy and transport infrastructure. Only very naïve people who are very distant from the real economy can believe in the automaticity and optimality of the free market. It exists only in textbooks for students of the lowest courses.
Apparently for our monetary authorities it is necessary to organise a course of instruction for advanced students…
As long as they learn from the IMF they will probably never manage to progress to an advanced course. For the Washington consensus is characterized by market fundamentalism, which for many years has served as a condition for granting loans to underdeveloped African countries. They were given money on the condition that they do nothing except protect the property rights of foreign capital and to ensure its free entry, exit and circulation on the national market. And instead of they themselves planning their economic development, foreign corporations did this, building the economic structure according to their own needs and extracting excessive profits with the exploitation of their natural resources and cheap labor. And the monetary authorities regulated the key rate in the naïve belief that this could affect something.
So the Bank of Russia did the right thing when it lowered the key rate?
That’s not the point. The key rate is the benchmark for short-term credits to replenish liquidity. Along with the mechanism of current balancing of the financial market a system should be in place to target loans to support the growth and expansion of manufacturing enterprises with differentiated rates and terms and conditions of credit depending on the nature of the activities.
For example, loans to MIC companies with defense contracts should be refinanced at a zero rate, as they are fully secured by the budget. Loans to construction companies with mortgages should be refinanced at a rate of 1%, as they are secured by the savings and income of citizens. Credit rates for agro-industrial and processing industry companies should not exceed the average profitability of manufactured products, as in the opposite case they would either not be reimbursed or it would entail an increase in prices. And so on, but in all cases the commercial banks must monitor their borrowers in respect of the proper use of the loans granted according to the schemes of targeted refinancing. And you can let speculators take out loans at the key rate – the profitability of their operations taking into account the risks allow them to do this. In such a system the key rate would not be determined by the lower but by the higher value of the interest for the loan.
What stops us launching this mechanism for the financing of economic growth?
First of all the naïve faith of the monetary authorities in the recommendations of the IMF. It is engendered not only by lack of knowledge and competence but also by unwillingness to take responsibility, including for the proper use of the money issued. The main weak point of the proposed mechanism of targeted multi-channel financing is corruption. If it is not eradicated the specific loans will not result in growth of production but in currency speculation and capital flight. This, by the way, is what is happening now with the main flow of credits, allocated by the Central Bank under the existing scheme of refinancing of commercial banks at the key rate. So, it’s not that simple. But we just don’t have another option of financial support for economic growth today. Waiting until people accumulate money won’t work as they already owe the banks more than they can pay. Western banks no longer provide loans because of the sanctions. Of course you could hand over the development of our economy to eastern banks – for example the Chinese ones. But then they will plan the development of our economy for us, while the Central Bank plays with the key rate, naively believing that they are targeting inflation.