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May 14, 2015 Eastern Europe and the Caucasus bne IntelliNews Daily 9 Russia's inflation target becomes a mirage
Ben Aris in Moscow
In 2007, the Central Bank of Russia (CBR) made a definitive change in the way it works: it formally dropped attempts to manage the exchange rate and focused entirely on inflation targeting. Today, in the aftermath of last year's ruble crisis, the bank has in effect been forced to abandon inflation targeting.
Russia suffered hyperinflation in the 1990s (technically defined as inflation above 50% a year) and inflation remains a highly emotive issue. For most of last year inflation was put at the top of the lists of regular Russians' worries, ahead of the conflict in Ukraine, although since the start of this year the economy has overtaken it, as real wages began to fall for the first time in more than a decade and unemployment started to tick upwards.
However, the CBR lost control of the situ- ation in December last year when the ruble crashed on the back of tumbling oil prices and the regulator was forced to hike rates by 6.5% to 17% in one day. The commercial cost of capital rocketed to a growth killing 20%- 25%. Since then the CBR has had one task: get interest rates down as fast as possible as the economy has simply ground to a halt and will stay stopped until interest rates are back into single digits. The CBR surprised analysts with a 2% cut in January, a 1% cut in March and most recently a 1.5% cut on April 30, bringing the minimum repo rate to a better, but still high, 12.5%.
The first question the rush to cut rates raises (and the banks would like to go even faster) is: won't slashing rates send infla- tion shooting back up?
In a statement accompanying the last rate cut the CBR said inflation was running
at 16.5% as of April 27 and was expected to fall to below 8% in 12 months' time and to 4% in 2017.
Economists such as Alfa Bank's Natalia Orlova and Sberbank's Evgeny Gavrilenkov have said that upward pressure on inflation caused by the 50% devaluation of the ruble in December has worked its way through the system faster than expected; the spike in inflation caused by a sharp devaluation usually takes about six months to work its way through an economy, but in Russia's case inflation is thought to have peaked in March instead of April or May. That gives the CBR some wiggle room for faster-than- usual rate cuts. The rate cut was further
monetary policy decisions ie. the cause of the current inflation is something that the CBR has no control over.
The upshot of all this upheaval is that the CBR's inflation-targeting policy has gone out the window as it administers a string of cardio-vascular rate cut shocks in an attempt to revive Russia's moribund economy.
"The main reason given by the central bank for the [April interest rate] cut was 'lower inflation risks and persistent risks of considerable economy cooling', which rein- forces the direction of the monetary policy taken after the CBR's U-turn in January 2015," said Danske Bank in a note. "Since
by the majority of analysts: the effects of exchange rate depreciation and the import ban will evaporate soon," said Alfa Bank's Orlova in a note. "However, CBR expecta- tions of single-digit inflation by January 2016 are optimistic, in our view, as year-to- date inflation had already hit 7.5% by the end of the first quarter of 2015 and would have to stay at 0.3% month-on-month for the rest of the year to meet that target. We, on the contrary, expect inflation at 11% for the full year."
Orlova also pours cold water on the CBR's target of 4% inflation in 2017. The market consensus is for inflation of 7% in 2016 and 6% in 2017.
Part of the problem is Russia's election cycle will end up boosting inflation. Usually inflation is brought down partly by slowing nominal wage growth, but Russia goes to the polls to elect a new Duma in 2016 and to (presumably) reaffirm President Vladimir Putin in his job in 2018, and in the past the government has dramatically hiked both public wages and pensions in the run-up to elections. This time round the Kremlin will have to spend heavily to keep the rul- ing party of power United Russia in office; it barely cleared the 50% threshold in parlia- mentary polls in 2011 and has been loosing support steadily since then.
Splashing money about in the public sec- tor might stem that slide, since about half of Russia's population is directly or indirectly dependent on state wage spending, while state social spending accounts for 20% of household incomes, according to Alfa Bank. This will give all give another boost to infla- tion, burying the central bank's target and its pretence of targeting.
planned hub at the Greek border (Turkey will take about 14bn cm/y), from which EU customers can help build and own the line's extension into Europe, Gazprom says. The Greek government has been actively courting Russia in hope of receiving bil- lions of dollars of advance payment for its role in extending Turkish Stream into the EU. However, the US is putting pressure on Greece to concentrate on the completion of TAP rather than Turkish Stream following a May 8 visit to Athens by Amos Hochstein, US special envoy for energy affairs.
“The CBR is seriously taking into account economic developments rather than purely targeting inflation”
supported by a rally in the ruble vs the dollar and a partial recovery of oil prices.
Secondly, the governor of the CBR Elvira Nabiullina believes inflation pressure is mainly coming from factors such as soar- ing food prices (the price of cabbage has tripled) - which are the result of agricul- tural sanctions imposed by the Kremlin last year on EU and US goods - rather than
then, the central bank is seriously tak- ing into account economic developments rather than purely targeting inflation."
However, independent economists are worried and think that inflation is going to be harder to defeat than the CBR is predicting.
"That the current inflation spike to 16.9% year-on-year is transitory is a view shared
sian gas export strategy is a direct result of issues that Gazprom and the Kremlin have seen emerging in Europe over the past decade,” says James Henderson of the Oxford Institute for Energy Studies. “Its suggestion of a Turkey-Greece hub seems to be a concession that new delivery points are an option, potentially at the border of Europe rather than at the borders of con- suming countries.”
The new line – which will fully comply with EU laws, the Russian side emphasises – will deliver an estimated 49bn cm/y to a
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Turkey takes centre stage in energy battle
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The fight between the West and Russia over energy supplies is increasingly centring on one country that is itself struggling to de- fine its place in Europe: Turkey.
On May 8, EBRD President Suma Chakra- barti said during a visit to Baku that the multilateral lender will extend a syndicated loan for Azerbaijan's biggest gas project, the second phase of the Shah Deniz project, which will produce 16bn cubic metres cm of gas a year (cm/y) from 2019-2020, with 10bn cm earmarked for Europe and 6bn cm for Turkey. The gas will be transported from Azerbaijan to Turkey via Georgia through the South Caucasus Pipeline (SCP) and planned Trans-Anatolian Natural Gas Pipe- line (TANAP). From the Turkey-Greece bor- der the gas will be sent to Europe via the planned Trans Adriatic Pipeline (TAP).
The size and terms of the loan have yet to be decided, Chakrabarti said. However, analysts say the move is a measure of the project’s importance to the EU as an alter-
native gas supplier as Europe tries to re- duce its reliance on Russian energy.
At the same time, Russia is pressing ahead with its Turkey-centred gas pipeline, the so-called Turkish Stream. On May 7, Gazprom CEO Alexei Miller said after talks with Turkish government officials in Ankara that the first consignments of Russian gas would flow through Turkish Stream by the end of 2016.
Turkish Stream was dreamed up by the Russians in response to the EU’s objec- tions to its proposed South Stream pipe- line, which would have sent 63bn cm/y of Russian gas into Europe up through Southeast Europe. The EU’s strict rules over third-party access to pipelines under its Third Energy Package and its stricter stance over Gazprom’s alleged abuse of its dominant market position in Emerging Europe has, say analysts, set in motion a major policy shift at Gazprom in the way it exports gas to Europe. “This shift in Rus-
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