Russia’s Monetary Policy: Priorities to be Reconsidered Amid Decelerating Inflation, Slow Growth

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( 8 mins read )

As in early October the w-o-w inflation did not move to a positive territory for another week and remained at zero, it became almost certain that inflation is going to get closer to 3.0% rather than to 4.0% this year, i. e. it will be well below the CBR target. It cannot be ruled out that inflation could also stay around 3.0% next year. Hence the question, what the CBR will do with its key rate if it happens to be the case.

Russia’s 7% key rate looks unnecessarily high in this environment as it keeps OFZ yields elevated – around 6.4-6.5% for the paper with shortest maturity, around 7% for ten-year OFZ and closer to 8% in the very long end of the curve, which looks too much for a twin-surplus economy. Respectively, borrowing costs are even higher for other borrowers such as consumers and corporations.

Slowing inflation, a lack of economic growth, high costs of borrowing and unnecessary spending of budget funds on debt servicing combined with global easing may encourage the CBR not to simply continue series of key rate cuts, but to reconsider the “foundations” of its monetary policy sooner rather than later.

  • As a general disinflationary trend in Russia will continue in 2020 the CBR will be forced to reconsider not only the concept of the “neutral rate”, as it has already promised, but the inflation target as well, as it cannot be ruled out that Russia may end up even with inflation below 3% in 2020.
  •  It would be reasonable for the CBR to deliver 50 bps cuts this year, however the regulator might refrain from action in December when liquidity is traditionally abundant due to a budgetary spending spree, while delivering a 50 bps cut would be too “unusual” for the cautious regulator (a 25 bps cut can be expected in October).
  •  In January 2020 the y-o-y inflation may already fall below 3.0% due to a base effect and a 50 bps cut may be expected in 2020 at the next scheduled BoD meeting (in case it delivers only a 25 bps cut by the end of this year). Having a less volatile and low inflation next year, more rate cuts and the key rate around 5% would set a better environment for economic growth.

As in early October the w-o-w inflation did not move to a positive territory for another week and remained at zero, it became almost certain that inflation is going to get closer to 3.0% rather than to 4.0% this year, i. e. it will be well below the CBR target and the regulator’s recent forecast released in the minutes of the CBR September 6 BoD meeting. A month ago the CBR decided to cut the key rate by 25 bps and trim its annual inflation forecast by 20 bps, i. e. down from 4.2-4.7% to 4.0-4.5%, which makes little difference, especially given the fact that inflation was not expected to accelerate in September and its YTD measure reached just 2.3% as of October 7. It looks highly unlikely that cumulative inflation could reach 1.7-2.0% in the remaining twelve weeks of the year in order to hit the CBR 4.0-4.5% annual forecast range.

One of the previous GKEM Analytica reports released this summer suggested that inflation in Russia could fall below 3.5% by year end and it now looks as though it could fall even to 3.1-3.3%. It cannot be ruled out that inflation could also stay around 3.0% next year. Hence the question, what the CBR will do with its key rate if it happens to be the case. GKEM Analytica mentioned in its previous report that cutting the key rate by at least 150 bp would look reasonable in the environment of slowing global economy and expectations of more stimulus from some of the most globally powerful central banks.

Indeed, Russia’s 7% key rate looks unnecessarily high in this environment as it keeps OFZ yields elevated – around 6.4-6.5% for the paper with shortest maturity, around 7% for a ten-year OFZ and closer to 8% in the very long end of the curve. This looks too high, especially for a twin-surplus economy. Respectively, borrowing costs are even higher for other borrowers such as consumers and corporations.

Meanwhile, the government plans to spend around R820 bln from the federal budget on debt servicing in 2019 and it has already spent over R470 bln on that in 8M19. Whether the government which runs a surplus budget really needs to borrow on the market in line with the fiscal rule and continue building up its costly debt remains a “conceptual” question without a clear answer. This debt does not look so high relative to GDP, however, debt servicing this year is supposed to exceeded the federal budget spending on healthcare (around R739 bln to be allocated in 2018) and is nearly comparable with the annual spending on education (around R900 bln for 2019). Of course, education, culture, and healthcare also get some funding from the local budgets, but not all regions in Russia are as rich as Moscow or the Tyumen Region.

Overall, it looks as though slowing inflation, a lack of economic growth, high costs of borrowing and unnecessary spending of budget funds on debt servicing combined with global easing may encourage the CBR not to simply continue series of key rate cuts, but to reconsider the “foundations” of its monetary policy sooner rather than later.

The chart below (on the left) illustrates that Russia’s inflation has generally subsided since 2009 as the trend line shows, albeit not evenly. The year 2015 is a striking example of how inflation went out of control due to a combination of several factors such as extra-soft monetary policy in 2014, sanctions and falling oil price. Since then, monetary policy turned much tighter and despite more sanctions and an even lower oil price in 2016 (below $30/bbl in 1Q16) inflation decelerated to single digits and eventually became less volatile in recent years. In the aftermath of those shocks the CBR announced that it targets inflation to reach 4% while later, namely during the September 6, 2017 BoD meeting, this 4% level was proclaimed as a kind of a “permanent target” in a sense that inflation was supposed not to simply be brought down to this level, but allowed only to drift sideways going forward (with some fluctuations). The chart on the right shows that in fact the CBR was able to succeed and inflation has indeed fluctuated around the 4% target since 2017.

Russia’s Monetary Policy: Priorities to be Reconsidered Amid Decelerating Inflation, Slow Growth 1

Some important questions stem from these charts. Is the CBR really happy with rather wide fluctuations of the y-o-y inflation seen in recent years near the chosen target? Does the CBR want the general disinflation trend to stop, so that the future dotted inflation trend line is supposed to become flat and equal to 4%? Would not it make sense for the CBR to reconsider its inflation target and reduce it, say, to 3%? Indeed, if the y-o-y inflation will organically fluctuate around 3.0% or 3.5% next year and not cross the 4% benchmark, will the CBR try to bring inflation higher? What will be the purpose of doing so and what will it do in order to stick to the aforementioned “permanent target”? Meanwhile, the economic rationale to have chosen the 4% level as a “permanent” target is still not clear enough – having a GDP growth about 1-2% and a 4% inflation does not seem to be a comfortable growth trajectory.

It looks as though the CBR will eventually be forced to answer those questions and eventually reconsider some of the basic principles of its policy. In the previous report GKEM Analytica mentioned that smaller surpluses expected next year (the current account and the budget) will limit the scope of Minfin’s interventions on the money and currency markets, implying smaller liquidity injections into the system and relatively higher borrowing costs on the interbank market. To some extent it is already happening as the gap between RUONIA and the key rate has gradually become not as negative in recent weeks as in the early year when the oil price was higher and MInfin’s daily FX purchases were larger.

In this environment a general disinflationary trend in Russia will continue and the CBR will be forced to reconsider not only the concept of the “neutral rate”, as it has already promised, but the inflation target as well, as it cannot be ruled out that Russia may end up with inflation below 3% in 2020.

It would be reasonable for the CBR to deliver 50 bps cuts this year, however the regulator might refrain from action in December when liquidity is traditionally abundant due to a budgetary spending spree, while delivering a 50 bps cut would be too “unusual” for the cautious regulator (a 25 bps cut is likely in October). However, as in January 2020 the y-o-y inflation may already fall below 3.0% (due to a base effect given that in January 2019 the m-o-m inflation accelerated to 1.0%) a 50 bps cut may be expected in 2020 at the next scheduled BoD meeting. Overall, having a less volatile inflation around 3% next year, more rate cuts and the key rate around 5% would set a better environment for economic growth.

Data provider: Cbonds

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