Russia’s Central Bank Should Set More Realistic Inflation Targets

In 2015, the Bank of Russia encountered a series of global challenges while pursuing the targets of its monetary policy. The economic situation in 2015 was characterized by the following features: Russian and Western bilateral sanctions were maintained, the prices of Russia’s basic export commodities kept falling, economic agents’ expectations for inflation remained high.

In 2015, the Bank of Russia carried out a moderately tight monetary policy aimed to cut inflation with due consideration of the slugging economy. Russia’s central bank gradually lowered the key rate from 17% in January to 11% in November 2015. On 30 January 2015, the key rate was lowered from 17 to 15% per annum, then it was cut by 1 percentage point to 14% on 13 March, slid to 12.5% on 30 April, 11.5% on 15 June and 11% on 31 July 2015. Note that it was absolutely reasonable to retain a relatively high key rate (in nominal terms) because interest rates in Russia are still low in real terms, and they are also low compared with other developing countries. Additionally, the decision to keep the key rate unchanged since August 2015 is quite rational. It appears unreasonable to lower the key rate amid high expectations for inflation, rouble depreciation risks attributed among other things to uncertainty about the dynamics of oil prices in the future, geopolitical tensions, investors’ expectations for a tighter US Fed’s monetary policy.

The Bank of Russia in late 2014 almost stopped foreign exchange market intervention, restricting itself to foreign currency purchases to replenish sovereign funds by the Federal Treasury. The central bank abandoned foreign exchange market intervention on 3 February 2015, allowing the exchange rate to be governed by private sector transactions. As a result, the rouble exchange rate at that period was driven by a balance between foreign exchange supply and demand in the corporate sector, which was influenced by oil prices, the state of global economy, geopolitical environment, as well as development parameters of the Russian economy.

The shift to a free-floating exchange rate regime amid drastically worsening external economic conditions triggered high volatility of the rouble exchange rate. The growth in exchange rate volatility on the one hand may lead to higher exposure of economic agents to foreign exchange risks, but on the other hand, this is what will curtail both speculative “games” in the foreign exchange market and growth rates of bank deposits denominated in foreign exchange.

The overall dynamics of the Russian ruble’s exchange rate against key world currencies in 2014-2015 followed the trends that are typical of the national currencies of emerging economies.

However, the depreciation rates of the Russian rouble came to be most essential, thereby reflecting the effect of geopolitical risks, as well as the strengthening of the US dollar in the global foreign exchange market and tumbling global oil prices.

Bank of Russia’s dollar-denominated loans to credit institutions came to be one of the key monetary policy measures which were introduced in late 2014 and aimed at smoothing feverish foreign exchange demand. It is repos that came to be the key instrument of foreign exchange provision. Note that foreign exchange refinancing operations through repo auctions were basically intended to avoid panic sentiments in the foreign exchange market, and this

task was accomplished in January–February 2015. In our view, the extensive use of foreign exchange repos was found to be reasonable, releasing the pressure upon the foreign exchange market.

Considering the magnitude of the exchange rate pass-through to prices, and the Russian economy’s large dependence on highly volatile global market of hydrocarbons, the central bank’s mid-term inflation target (up 4%) for 2017 appears to be unrealistic. Note that end-November 2015 inflation for the prior 12 months stood at 15% and inflation expectations increased to 15.8%. Furthermore, considering that the Bank of Russia failed, with rare exceptions, to reach the inflation targets set forth in the Guidelines for the Single State Monetary Policy, economic agents’ confidence remains low, being a headwind in accomplishing the assigned targets. In our view, the central bank should set more realistic inflation targets within a range of acceptable deviations (+/- 1 percentage point) in order to increase economic agents’ confidence and lower inflation expectations.

Finally, note that the Bank of Russia in 2015 continued working on making its monetary policy more open through regular releases of analytical reviews and statistics including information on people’s expectations for inflation, an external debt repayment schedule, etc., as well as a series of reports on economic studies of pressing matters. In our view, providing information about goals and the performance of monetary policy measures, and discussing the nature of inflation processes in Russia can help raise economic agents’ confidence in the central bank’s policy, eventually making the latter more efficient.

Alexandra Bozhechkova, Head of the Monetary Policy Department at the Gaidar Institute