Russia’s central bank kept its key rate on hold at 6% annually despite the sudden devaluation of the ruble and panic selling on the stock market.
All of the economists surveyed by Reuters ahead of the meeting expected the regulator to keep the key rate flat amid ruble turbulence provoked by the double impact of the coronavirus (COVID-19) pandemic and drop in oil prices.
The result was no surprise, but remains a remarkable result. As reported by bne IntelliNews, the Central Bank of Russia (CBR) was facing a tough choice, as it had to revise its previous course for monetary easing and support for the pro-growth spending agenda of the newly appointed government.
When the ruble crashed to below RUB80 to the dollar during the last oil shock at the end of 2014 the CBR felt compelled to make an emergency hike of a full 10pp to 17%.
This time round the central bank clearly feels that its massive $570bn in gross international reserves (GIR) including RUB10,000 trillion ($150bn) in the National Welfare Fund (NWF) is more than sufficient to defend the currency and quickly restore confidence so there is no need to hike rates.
Finance Minister Anton Siluanov said earlier this week that the oil shock combined with the coronavirus will blow a RUB2 trillion hole in the budget and result in a 0.5% contraction this year. But the NWF is sufficient to cover that revenue deficit for five years at those levels.
The CBR even had the option of cutting rates this time round to speed up the economic recovery, although that would have been a very brave thing to do. However, inflation was back to post-Soviet lows of 2.3% in February and, as bne IntelliNews reported, after crunching the numbers, the Russian government is in robust financial health. The differences in Russia’s fiscal position between 2014 and 2020 are like night and day.
Nevertheless, the devaluation of the ruble from the pre-shock RUB68 to over RUB80 in a matter of a week will clearly stoke inflation as shopkeepers scramble to adjust prices, but in 2015 the devaluation shock fed through the system surprisingly quickly (normally it can take up to six months for the inflationary effects of a big devaluation to feed through), which could have encouraged the CBR to hold off from a hike.
The ruble has shown one of the worst dynamics against the US dollar in the past two weeks, but the CBR believes the currency weakening to be a "temporary inflationary factor". The CBR admitted that a weaker ruble could have inflation "exceed the target levels [of 4%] in the current year", but believes that suppressed dynamics of domestic and external demand will curb inflationary pressure.
Inflation in 2014 was running at between 6% and 8%, rising to 11% at the end of the year, and so was a much more serious problem then. In the first half of 2015 inflation rose to between 15% and 16% and only began to fall in the second half of the year to end 2015 at 12.9%. By the end of 2016 it was 5.4%.
Starting at such a low level economists are expecting inflation to rise to around 5% in the middle of this year but fall back to around 4-4.5% by the end of 2020 – close to the CBR’s target rate of 4%.
Some analysts worry that the CBR should have hiked rates as a precaution and think it has underestimated the inflationary shock of the fall in oil prices.
“The outcome of the CBR's meeting today is very difficult to predict as there are several options on the table. Given the overall pressure, the CBR may refrain from the hike now or make a cut but we think that the regulator should make a hike given increased risks for financial stability (sharp RUB depreciation, its huge volatility and future unpredicted CPI acceleration),” said Nicolae Covrig, an economist with Raiffeisen Bank International (RBI) in Vienna. “Also, a higher rate is required to avoid switching of RUB-denominated savings into USD. If the CBR opts not to change the key rate, it will mean that the regulator rather optimistically assesses the risks of capital outflow in the global risk-off environment.”
Capital flight has been falling in the last year as Russian corporates have largely finished their deleveraging process and while the economic contraction in the second quarter of this year is likely to be significant – some economists are predicting a 14% contraction – many economists predict that the bounce-back in the third or fourth quarter will be robust. The CBR seems to take the same line: public health shocks are much less persistent than financial shocks.
The CBR indirectly commented on the expectations of a key rate hike, noting that while the ruble drop was "significant", it still sees it as a one-off factor. Monetary policy action is only appropriate for persistent factors, the CBR noted.
“The weakening of the ruble is a temporary pro-inflationary factor, and annual inflation may exceed the target (of 4%) this year under its impact. But internal and external demand will have a restrictive impact on inflation connected to a noticeable slowdown in the global economy growth and spreading uncertainty,” the regulator said in its statement.
The CBR did not revise the inflation targets, only commenting that consumer price growth was expected to moderate to the target 4% in 2021. Economic activity is expected to slow down in the coming quarters, the regulator believes, without providing specific guidance.
The government and the central bank will ensure financial stability and will support the economy. This will slow annual inflation down to 4% in 2021, the CBR said.
The falling demand is likely to be much more widespread than in 2014, when the oil producers were most affected by the fall in oil prices. This time round the whole world has also been hit by the coronavirus pandemic which will depress demand everywhere and so reduces prices and increases pressure.
The major unknown for the Russian economy for the rest of the year is how long prices will remain depressed and just how bad the spread of the coronavirus will be. Currently Russia is taking precautions, but it still only has 199 officially reported cases and only one death as of March 20. Russians have been advised to practise social distancing but Moscow is not on lockdown and public meeting places are still open.
As an extra precaution the CBR has suspended the so-called fiscal rule for a month, which means dollars that are usually sterilised and siphoned off into the NWF are available to support the currency. And on March 19 the CBR said it was accelerating a deal to sell its stake in Sberbank to the Ministry of Finance, which is also a de facto move to pump more dollars into the economy and increased the CBR’s regular allotment for the FX markets by half.