Failure to cut interests rates in Russia ‘ridiculous’, says Economics Ministry

Russia experienced zero inflation in August and in the first week of September, with suggestions that there might actually be weeks of deflation in September as there were in July and August. 

The annualised rate of inflation in Russia has now fallen to 6.9%, and is continuing to fall rapidly.  The underlying rate of inflation is probably around 5.5% or possibly even less.

There is a traditional pick-up in inflation at the end of the year, but even the Russian Central Bank is now admitting that inflation expectations in Russia are now abating. 

“InFom August public opinion poll launched on the Bank of Russia request showed a substantial decline in people’s inflation expectations with wealth prospect assessments turned out to be ultimately optimistic over the last year.

Respondents expressed much lower concern about prices for those goods and services that used to be given heightened attention: meat and poultry, fish and seafood, cheese and sausages, milk and dairy products, medication and drugs, fruits and vegetables. This is in line with actual inflation dynamics.

Respondents also seem to be more optimistic in terms of the changes in their material standing both over the last year and for the next 12 months. Nevertheless, in August they still preferred to do the saving since they believe the current time is unfavourable for big purchases including buying on credit.

Assessments of macroeconomic development in general changed for the better. Respondents expect the growth of production and reduction of unemployment and corruption in 2017.”

Both the Russian Central Bank and the Economics Ministry are predicting growth in August after the brief dip in July which the Economics Ministry attributes to seasonal factors.  The PMI manufacturers’ index for August after a brief dip in July has also turned positive, also pointing to growth. 

All this allowed Putin to say at the G20 summit in Hangzhou that the Russian economy has stabilised and that industrial output in Russia is growing, though slowly.

All economic forecasters, including the Central Bank and the Economics Ministry, are however predicting only slow growth for the remainder of this year and next year.

The reason for this is not the legendary “structural factors” of which we hear so much about.  I attended a seminar at SPIEF 2016 in June attended by Kudrin, Central Bank Chair Nabiullina and Finance Minister Siluanov.  Though the seminar was supposed to discuss “structural factors” and what to do about them, as is invariably the case when this subject comes up, Kudrin, Nabiullina and Siluanov struggled to say what they were.

The reason growth for the remainder of this year and next year will continue to be low is because monetary and fiscal policy continue to be so tight.  Interest rates at their current level of 10.5% may now be roughly twice the level of inflation, which is the reason why investment and real incomes continue to fall and why – in the words of the Central Bank – the population

“…..still preferred to do the saving since they believe the current time is unfavourable for big purchases including buying on credit.”

Since the government in the midst of a recession, with monetary policy extremely tight and despite a sharp fall in the oil price, refuses to run a large federal budget deficit (the current federal budget deficit is just 3.3% of GDP), it is not surprising that there is a lack of growth.  In order for growth not just to return but to become stronger, interest rates will have to go sharply lower.

The point is fully understood by the Economics Ministry whose head, Economics Minister Alexey Ulyukaev, was notably absent from the panel I attended at SPIEF 2016, and who has said that in light of the low growth rate and the sharp fall in inflation a failure by the Central Bank to cut interest rates this September would be “ridiculous”.

Ulyukaev is obviously right, and in light of the Central Bank’s admission that inflation expectations are abating I expect the Central Bank to cut interest rates again this month.  However in view of the Central Bank’s overriding focus on its anti-inflation strategy, and its single-minded determination to bring inflation down to an annualised rate of just 4% by the second half of next year, I expect the interest rate cut this September to be no more than 0.5%, bringing the Central Bank’s rate down to a still very high 10%.