June 24, 2019

Russian Macro: Healthy Rate Cut

BY Alexander Kudrin, Evgeny Gavrilenkov

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( 8 mins)

Rosstat reported that the major economic indicators in May 2019 were not as good as in April, but that was largely expected as there were fewer working days this year in May than in 2018. The fact that the non-oil-andgas budget revenues were some 15% higher this May than in May 2018 somehow indicates that the economy is far from stagnating. Nevertheless, the rate of economic growth does not look impressive either.

Lower interest rates may somehow support the economic growth and the recent 25 bps key rate cut should be just a small step likely to be followed by more rate cuts, because inflation keeps coming down much faster than the CBR anticipated three or four months ago. It became clear of late that inflation will fall well below 5% y-o-y by the end of June and keeping rate at 7.75% was unreasonable. Inflation may fall to around 4.5-4.6% y-o-y by September.

  • Focusing only on the y-o-y inflation for monetary policy set up may be insufficient if inflation is volatile. Looking at the y-o-y inflation alone is kind of a backward-looking practice. It is worth looking at some other measures of the “current” inflation, such as its annualized 3M or 6M moving average levels, which would be more forward-looking indicators. The latter measure may fall to 2.2-2.4% in August-September.
  • The decelerating current inflation amid a relatively unimpressive economic growth generally means that the nominal income across the economy and the assets of economic agents (such as bank assets) are not going to increase as fast as during the periods of higher inflation.
  • In such an environment, obligations taken by economic agents previously may look relatively more expensive. Hence more rate cuts should be expected in order to avoid accumulation of additional distortions in the economy.
  • One such distortion, mentioned in one of the previous reports by GKEM Analytica, was the opportunity for banks to get deposits from Minfin and invest in CBR bonds, which was a risk-free opportunity to generate cash due to interest rates difference.
  • More rate cuts may reduce this spread and encourage banks to turn to the real economy.

Rosstat reported that the major economic indicators in May 2019 were not as good as in April, but that was largely expected as there were fewer working days this year in May than in 2018, namely 18 versus 20, which makes a big difference in those segments of the economy which do not operate on a 24/7 basis. Industry in May expanded by a mere 0.9% which brought the 5M19 tally only to 2.4% y-o-y, as manufacturing (sensitive to the number of working days) was down by 1% y-o-y in May. Manufacturing was up by 1.6% y-o-y in 5m19, which was better than 1.3% y-o-y in 1Q19. Mining (less sensitive to the number of working days) was up by 2.8% y-o-y in May and 4.3% y-o-y in 5M19. It makes little sense to focus too much on seasonally and calendar adjusted numbers for May as they may change significantly in the future, because they will be very sensitive to observations which will be published for June and July.

Construction growth remained near zero level due to the unprecedented revision of the 2018 statistics (but still positive). Due to the base effects and rather uneven 2018 monthly data construction is heading toward a 2% growth this year, and possibly even higher as confirmed by the data on production of major construction materials.

Agriculture was up 1% y-o-y in May, and as it cannot be ruled out that this year grain harvest may be either close to historical record seen in 2017 (and possibly even exceed it), this sector can make a rather strong contribution to GDP growth, possibly expanding by several percent. Indeed, the grain harvest is expected to be much higher this year than in 2018.

Following relatively weak May statistics in the aforementioned sectors that produce goods, the output in the transportation sector was up just by slightly more than 1.0% y-o-y with prospects to accelerate in 2Q19. Retail trade expanded in May by a mere 1.4% y-o-y (1.7% in 5M19) with prospects of a bit stronger growth in June as the m-o-m inflation is likely not to exceed 0.2% this month (it reached 0.5% in June 2018). Given the aforementioned observations, the overall economic performance does not look that bad, though it is not great either as even some 2.0% growth this year would not impress anyone. Meanwhile, the fact that the non-oil-and-gas budget revenues were around 15% higher this May than in May 2018 somehow indicates that the economy is far from stagnating.

GKEM Analytica mentioned in previous reports that lower interest rates may somehow support economic growth and that the recent 25 bps key rate cut should be just a small step likely to be followed by more rate cuts, because inflation keeps coming down much faster than the CBR anticipated three or four months ago and will fall well below 5% y-o-y by the end of June. Hence, keeping rate at 7.75% was unreasonable. Inflation may fall to around 4.5-4.6% y-o-y by September.

Meanwhile, focusing only on the y-o-y inflation for monetary policy set up may be insufficient if inflation is volatile. Looking at the y-o-y inflation alone is kind of a backward-looking practice. As was seen in Russia’s case, the y-o-y inflation accelerated in mid-2018 due to the developments that had occurred some time before. As inflation started to decelerate since February – March 2019 it is also worth looking at some other measures of the “current” inflation, such as its annualized 3M or 6M moving average levels, which would be more forward-looking indicators. The chart below shows that even though the 6M MA annualized inflation is obviously more volatile than the y-o-y inflation, but during the chosen period (since 2017, i.e. when the Finance Ministry resumed buying FX in line with the fiscal rule) both measures of inflation remained well below the key rate. In 2019, the gap between the key rate and inflation narrowed, which can be treated as some kind of loosening of the interest rate policy. However, this gap still remained quite visible – particularly in the case of the y-oy inflation. Given that the y-o-y inflation started to pick up in 2Q18 as the m-o-m inflation accelerated, while in recent months it was the m-o-m inflation that decelerated fast, it is not surprising that in the months to come the annualized 6M moving average is expected to fall much faster than the y-o-y inflation.

Russian Macro: Healthy Rate Cut 1





The decelerating current inflation amid a relatively unimpressive economic growth generally means that the nominal income across the economy and the assets of economic agents (such as bank assets) are not going to increase as fast as during the periods of higher inflation. In such an environment, obligations taken by economic agents previously may look relatively more expensive. Hence more rate cuts should be expected in order to avoid accumulation of additional distortions in the economy.

One such distortion, mentioned in one of the previous reports by GKEM Analytica (“Walking with hurdles”), was the opportunity for banks to get deposits from Minfin and invest in CBR bonds. The agency currently holds over R12 trln of spare cash, the bulk of which is stored outside the banking system, i.e. on treasury accounts, but some part of this cash (around R1.3 trln) is deposited by Minfin in banks at a rate below the money market rate, such as RUONIA. The interest paid by the CBR is equal to the key rate. As since 2017 amid Minfin’s interventions on the FX market RUONIA fell below the key rate (in 2019 it was on average 25 bps below the latter as the chart below shows) it was a risk-free cash-generating transaction for banks.

Russian Macro: Healthy Rate Cut 2

 This chart also illustrates that in the days that followed the recent key rate cut RUONIA also changed, but not significantly as it is more determined by Minfin’s actions, but not by the CBR. Given that the volumes of rubles spent on daily FX purchases are not going to change much, RUONIA may also remain close to current levels. Also, now that the key rate is lower, it is likely that the spread between the interest on CBR bonds and the interest banks have to pay on Minfin’s deposits should narrow. This will make the aforementioned activity of pumping money from Minfin to CBR and back less interesting for banks, leaving some chances that banks will be more interested in lending money to the real economy at a bit lower cost. Therefore, if more rate cuts are to follow, then the economic situation in the country may slightly improve in 2H19.

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