The head of the Central Bank on the reasons for the increase in the key rate and the possible consequences for the Russian economy
Russia needs a tighter monetary policy than expected as the imbalance in the economy worsens. This was stated by the head of the Bank of Russia, Elvira Nabiullina, explaining why the Central Bank immediately raised the key rate to 9.5% per annum. This is the highest value since spring 2017 and the eighth consecutive increase in the rate. Why it was impossible to postpone this decision and what consequences to expect — read the details in the material of Realnoe Vremya.
Growing economic overheating
It is already customary to determine the trends in the work of the Central Bank by the brooches on the suits in which Elvira Nabiullina goes out to communicate with the press. This time, the non-verbal symbol was a pin in the shape of a scale, probably suggesting that the Bank of Russia is trying to balance the economy.
“Today we have decided to raise the policy rate by 100 basis points to 9.5% per annum. It is based on a major revision of the vision of the economic situation and its prospects. Contrary to our expectations, there has been no change in inflation dynamics so far. In addition, its stable components have even strengthened. The main reason is a growing imbalance in the economy. Tighter monetary policy is needed than we previously thought,” the central bank chief said.
According to her, high inflation cancels economic growth, threatens people’s real incomes and savings, and reduces people’s living standards. Nabiullina called high inflation an indicator of an overheated economy, resulting from an imbalance between supply and demand:
“We now expect inflation to return to the 4% target only by the middle of next year. We are seeing an increase in consumer and business activity. The net profit of Russian companies is almost twice as high as before the pandemic. Unemployment updated the historic low. These are impressive results, if not for one “but”. High inflation. The observed growth rates of the economy under current conditions are mistakenly considered stable or balanced. High inflation is an indicator of growing economic overheating. If steps are not taken to put the economy back on a balanced growth path, its overheating will intensify and lead to rising inflation and a subsequent slowing of the economy, leading to a recession.
Right now, in his view, it is necessary to direct forces to fight against excess demand, which is overheating the economy, due to excess demand, not from consumption, but from rising prices. This explains the key rate hike cycle. At the same time, at present, according to the Central Bank, GDP is expected to grow at a steady pace.
“According to our forecast, taking into account the policy, the GDP will increase by 2 to 3% this year. Next year, growth will be 1.5-2.5%. By the end of the forecast horizon, it will come back to 2-3%, which we consider a steady pace,” Nabiullina pointed out.
“If it hadn’t been for the rate hike, inflation could rise well over 10%”
According to Nabiullina, last year prices doubled the inflation target and annual inflation rose again in January. Temporary pro-inflationary factors on the supply side proved longer and international logistics continue to be a bottleneck for many imported goods for the past two years. Restrictions on outbound travel drive up the price of domestic tourism.
“The temporary factors gave the effect of stable factors, which considerably affected the inflation expectations of the population and businesses. A view has emerged that raising the policy rate does nothing to curb price growth. In fact, if we hadn’t started raising the rate in the spring of last year, inflation today would have been well over double digits. Our rate prevented this. The actual pressure from pro-inflationary factors turned out to be much greater than one might have expected.
The peak of inflation was exceeded in October
Taking into account the impact of all factors, the inflation forecast this year has been raised to 5-6%. The Central Bank expects inflation to return to 4% by mid-2023. Currently, it is not yet necessary to speak of a slowdown in inflation:
“We have passed the peak of inflation, it was in October. If we talk about annual indicators that take into account price growth over the past 12 months, then we are currently at the maximum value. So far there has been no reversal so we can say that there is a trend towards lower inflation. We expect a slowdown by the end of the first quarter, in the second quarter. But we can talk about the trend later, when we see that it is stable. Our economy recovered quite quickly. The recession that plagued the pandemic was quickly overcome. To avoid overheating, the economy must grow at a rate close to its potential. But it continued to grow at a rate well above potential.
To reduce inflation, we must go to the regime of tight monetary conditions, the boss of the Central Bank is convinced. There should be higher savings rates on deposits so people understand that these rates will not be swallowed up:
“We will increase deposit rates. Then the excess demand will turn into additional savings, which will expand the possibilities for long-term financing, lending to the corporate sector, and then inflation will slow and return to our target.
Today, inflation is more than twice off target. The increase in the key rate is a mechanism that has repercussions over time. The effect of it, according to the expectations of the Central Bank, will manifest itself at the end of this year and the beginning of the next.
How much mortgage will become more expensive
The Central Bank records a rise in mortgage rates but notes that they have increased less than the principal. And the mortgage itself is growing at a high rate. The pace of development of mortgage lending is also not balanced, it should be less so. Preferential programs, according to the boss of the Central Bank, must be targeted. In 2021, mortgages increased by 27 percentage points. An increase in the policy rate will contribute to a reduction in the cost of housing and its availability.
“The main thing is the availability of housing for people. This is influenced by both the cost of credit and housing prices. The cost of long-term borrowing is more influenced not by the policy rate, but by the yield on long-term bonds. Our policy is linked to the rise in the cost of current money in the short term,” added the head of the Central Bank.
Nabiullina emphasizes that mortgage loans with or without down payment pose particularly serious risks for the economy:
“A mortgage with no down payment isn’t that bad, it’s extremely bad. The ability to save for a down payment is an indicator of a person’s ability to repay a loan. These loans are less than one percent. But even a low down payment can create problems. Our system of macro-prudential provisions is put in place to discourage banks from issuing loans with a low down payment.
Central bank against cryptocurrencies
The Bank of Russia sees a threat in the expansion and development of the cryptocurrency market both for the well-being of citizens and for financial stability in general. According to Nabiullina, the involvement of citizens in this market should be reduced, which contradicts the recently published concept of the Ministry of Finance:
“We see the risks of the easy possibility of using cryptocurrencies for illegal operations. The concept of the Ministry of Finance speaks of some advantages of the legalization of cryptocurrencies. This argument confuses us, we will discuss it. Even more embarrassing, the concept of the Ministry of Finance does not yet respond to the risks that we point out. The approaches proposed by the government do not allow us to compensate for the risks we see and create new threats. »
The risks of legalizing cryptocurrencies in the country, according to her, are significant. Currently, the tools that will help stop these risks have not been developed:
“I’m going to give an example with a home loan in foreign currency, it’s on everyone’s lips. People took out a foreign currency mortgage, it all seemed attractive to them, not understanding the risks they were taking. And when all this happened, the question arose: why didn’t all this become forbidden? These problems had to be solved by the government and the Central Bank. Then the scale was much smaller than with cryptocurrencies. Another problem with cryptocurrencies, it is important for the Central Bank. We have been fighting illegal operations for many years. But cryptocurrency, by its nature, will open a new large-scale channel for such operations. Along with illegal operations, the conditions for tax evasion will be created throughout the economy.