To cut or not to cut? That is the question facing governor of the Central Bank of Russia (CBR) Elvira Nabiullina on June 10 at the regular policy meeting.
Analysts are divided 50/50 over whether she will leave the policy overnight rate at a painfully high 11% in order to maintain the fight against inflation, or chop some 0.5% off the rate to accelerate the return to economic growth widely expected for the second half of this year.
This will be one of the most closely watched CBR meetings for a long time, as what she decides to do will say a lot about liberal reformist plans for fixing Russia Inc.
Russia’s economy contracted by -0.7% y/y in April, a better result than the -4.9% it was contracting at the start of the year. In the normal course of things the regulator would cut rates to put economic growth back in the black a bit sooner. Moreover, as inflation came in at 0% m/m in May, driven by the seasonal copious agricultural production from the ubiquitous dachas, there is room for a cut. However, what is at issue this year is the need to create a new growth model for Russia.
Russia has just launched its third big structural reform drive, “Plan K”, led by former finance minister Alexey Kudrin, which will attempt to switch the growth driver from consumption to investment. Russia has exhausted all its “catch up” growth and the main driver in the last few years has been consumption. But following the devaluation of the ruble in December 2014 and the collapse of oil prices, real incomes have been falling and boosting them again will only stoke inflation. The plan now seems to be, according to Kudrin’s public comments, to hold income gains to a modest level and encourage investment to get the economy moving again.
To do that Russia badly needs lower interest rates. Nabiullina hiked interest rates to 17% in December 2014 to halt the collapse of the ruble and then followed through with five rate cuts since, but with the reappearance of inflation the CBR ended the easing cycle earlier this year.
While inflation has been tamed – the rate of annualized inflation has been 7.3% y/y for the last three months – it is still not low enough to allow the CBR to cut interest rates to the point where investment and borrowing will restart. Investment needs to be growing by more than 20% a year and currently it is negative as the companies that could borrow from the banks won’t borrow at these rates and the banks won’t lend to the companies that want to borrow at these prices.
What a rate cut or not at this meeting will show is to what extent the CBR is coordinating its policy with Kudrin. Instead of looking to boost the slowly recovering economy in the short-term, if Nabiullina holds off then that means she is attempting to drive inflation down to her stated target of 4% as fast as possible. This is the cornerstone of creating a new investment-based growth model for Russia that could start to function at the end of this year, or the start of next.
In any case the situation in the economy is slightly improving, if not particularly fast. Russia's w/w consumer price index posted 0% in the week ending June 6, down from almost eight weeks of 0.1% w/w, according to the weekly report by the RosStat statistics agency. The m/m inflation figure, respectively, did not take off as of June 6 and remained at 0%.
Annual price growth looks to be on the way to meet the central bank's target of 6% by the end of 2016. However, base and seasonal factors could push the annual inflation up from the current 7.3% in June-July, which would encourage the forward-looking CBR to keep the key interest rate unchanged.
Room to cut
However, despite the moderation of inflationary dynamics, there is still no certainty among the analysts that the CBR will resume the long-delayed monetary easing cycle at this CBR meeting. But if Nabiullina wants to cut there is room.
“It now appears m-o-m inflation may slow in June, even from the relatively low levels in the spring (around 0.4% on average). There is a chance that this month's m-o-m reading will match the 0.2% record low of June 2015,” Sberbank CIB, which accurately predicted the m/m rate in the previous three months, commented on June 9.
The data breakdown for the first week of June suggests that inflation in some food categories was strongly offset by 1% deflation in fruits and vegetables. Favourable inflationary dynamics in the food segment are expected to continue in the fall as Russia might be headed for a record-high grain harvest.
Inflationary dynamics are the main indicator watched ahead of the central bank meeting on June 10, as curbing annual consumer price growth to 6% by the end of 2016 and 4% in 2017 is the main policy goal of the regulator.
Recent surveys by Reuters and RBC show that the consensus is almost evenly split between the CBR making its first change since August 2015 or reducing the current 11% by a cut of 0.5pp. Externally, the chance that the US Fed will raise rates in July might keep the CBR cautious of resuming monetary easing. Domestically, the upwards revision of first-quarter income data and other positive signals on the consumer demand side could pose inflationary risks.
In addition, fiscal risks identified by the central bank as the main potential contagion for the economy remain largely unaddressed, with Reserve Fund spending by the government translating into a liquidity influx and additional inflationary pressure.
The main pressure to ease the rate for the CBR is to support the economic recovery, but the situation is much less critical now compared to the beginning of the year. The positive surprise in the GDP and income data for the first quarter of 2016 had the domestic and international consensus shift to expecting output growth figures in positive territory by the end of 2016 even without a monetary push.