Abandonment of the Exchange Rate Band is a Logical Step by the Central Bank of Russia

Fr om 2015, the Central Bank of Russia intends to switch over completely to the inflation targeting regime, abandon the exchange rate band and ensure free floating of the ruble. Abandonment of the exchange rate band is a logical stage in a switch-over to inflation targeting.

The upper limit of the exchange rate band is meant to prevent excessive weakening of the national currency so that the import would not become too expensive, however, foreign exchange interventions in such a case will squeeze the ruble supply in the economy which situation may result in liquidity problems in the banking sector (wh ere the liquidity is rather low even now) and, as a consequence, to limited lending to the real sector.

With the exchange rate of the national currency supported by means of ruble interventions at the level which does not go beyond the lower limit, it is possible to prevent the ruble’s excessive appreciation which may have an adverse effect on the competitive edge of domestic producers.  In the short-term prospect, the effect of ruble interventions can be smoothed by means of sterilization, however, in the long-term prospect there will be a macroeconomic dichotomy:  it is impossible to manage simultaneously both the money supply (the rate of inflation is implied as well) and the foreign exchange rate.

Consistent implementation of the inflation targeting policy permits to ensure low and, more importantly, expected growth rates of prices, which factor is crucially important to economic planning. In particular, with sustained low growth rates of inflation the banking sector can rely on “long” money, while business planning is carried out with smaller risks.

At the same time, in the commodity-based economy inflation targeting creates additional macroeconomic risks: if monetary authorities actually stick to the principles declared and oil prices fluctuate a great deal, the exchange rate will be subjected to severe fluctuations. In such a case, the Central Bank of Russia will probably have to make interventions on the foreign exchange market and maintain the balance between the policy aimed at smoothing foreign exchange fluctuations and that of inflation targeting in order to preserve confidence in the monetary policy and devalue the very idea of management of growth in prices in the economy.

А.Yu. Knobel, PhD (Economics),  Head of the Foreign Trade Department