Russia’s consumer price inflation has dropped below 5% for the first time since the fall of the Soviet Union more than a quarter of a century ago. Inflation was 4.6% y/y in February, according to Rosstat, down from 5% in January and in line with the Bloomberg consensus for the month.
The result will please the government as Russia is well on track to hit the Central Bank of Russia (CBR) target of getting to 4% inflation, maybe as soon as the end of this year.
In broad terms, the 4% inflation target is the cornerstone of the government’s plan to reenergise the Russian economy. Once inflation gets down to the sort of levels of a “normal” country, the authorities are hoping this will kickstart borrowing, investment and spending as the cost of money will be low enough for long-term planning.
The first time Russia’s inflation fell into single digits was at the start of 2006, and that led the Kremlin to launch a $1 trillion investment plan focused on infrastructure. However, that plan was abandoned very quickly as the economy was plunged into crisis by the start of the Great Recession. Now those plans are back, but in a scaled-down version due to the lower price of oil.
The immediate benefit of low inflation is that it remains the thing Russian consumers are most concerned about. Falling inflation also increases real wages, which turned positive in the second half of last year. More importantly it will help real disposable income (inflation-adjusted income left after food and utilities are subtracted) to move into the black. Despite a spike of 8.1% in real disposable income in January due to a one-off pension payment, this number has been negative for several years and will almost certainly be negative in April too, depressing retail sales which are continuing to contract. However, the successful fight against inflation means all categories of income should turn positive this year, bolstering consumption that will return as an economic growth driver.
Low inflation will also help to promote bank loans, which have been very depressed as the cost of money is too high. Here, a rate cut by the CBR would be a big help, but despite another good result this month the CBR is unlikely to cut rates at its next meeting on March 15, or indeed any time in the first half of this year, as it is fully focused on driving down inflation to 4% as fast as possible.
Taken all together this probably means that Russia’s economy will continue to muddle through for the first half of this year, but green shoots of a long-term sustainable recovery should start appearing after the summer.
As for the details, Russia is still in a deflationary phase. Food inflation has been a big problem, but a bumper harvest in 2016 and another good harvest expected this year mean that food prices have fallen dramatically. An end to European agricultural sanctions would make the biggest change in this category, but that remains unlikely this year.
Food inflation decreased from 4.2% in January to 3.7% y/y, excluding fruit and vegetables, which fell a bit less from 5.7% to 5.4% y/y, mainly as these products remain largely imported.
Non-food inflation was down from 6.3% to 5.4%, while services inflation edged down by 0.1pp, from 4.4% to 4.3% y/y.
“These inflation dynamics are encouraging and likely reflect a pass-through effect from strong RUB dynamics between December and January. However, we don’t believe this low inflation print gives the CBR sufficient freedom to cut the key rate at the March meeting, as the regulator is likely concerned about sticky inflation expectation dynamics. The recent figures show that the decline in inflation expectations stalled in February and the level remains elevated,” VTB Capital said in a note.