English versionCitation2021
A DEMONSRTATION OF TIGHTNESS
A DEMONSRTATION OF TIGHTNESS
Trofimov G.Yu.
At the end of July 2021, the Central Bank of Russia adopted the decision to raise the key interest rate by 100 basis points to 6.5% per annum. Such a sharp tightening of monetary policy occurred the first time since the outburst of economic crisis in Russia in 2014. The reason for the recent decision was an acceleration of the consumer price inflation: by the mid of the current year, the CPI growth rate reached 6.5% per annum and deviated significantly upwards from the inflation target of 4%. The Central Bank’s policy measure was aimed at curbing the inflationary expectations, mitigating the pro-inflationary risks and ensuring the return of current inflation to the targeted level.
The main factor of the inflation upsurge in the first half of this year was an increase of consumer demand, which was partially delayed earlier because of the pandemic. The excess aggregate demand had been accumulated due to the unrealized household expenditure items such as tourism and other forms of leisure and the precautionary savings that were formed by population under a high degree of uncertainty. As a result, the relaxation of the quarantine measures adopted by the Russian government in the second quarter of 2021 has caused a recovery of demand with the rate exceeding the potential of supply increase. The acceleration of consumer price inflation is a consequence of the widening demand-supply gap.
Another driver of the inflation acceleration is the rapid growth of global prices for agricultural and mineral commodities. In the first half of the current year, the annualized rate of food inflation in Russia reached 8%. The inflationary effect of the food prices increase is essential for Russian households due to the relatively high share of food in their consumption baskets, about one-third. This is almost twice as high as this share in high-income countries.
Besides, the inflation of world commodity and food prices brought about the increase of export sales of these commodities at the expense of supply reductions on domestic markets. The pursuit of domestic producers to maximal profits resulted in the growth of domestic prices for mineral and agricultural commodities. The state had to apply the non-monetary mechanisms of curbing food inflation, including the agreements with producers on a temporary price freeze and the selective export duties for commodities.
The import of global inflation into the Russian economy was strengthened by the expectations of the ruble devaluation, which are supported in many cases by the mechanism of the budget rule implementation. This rule forbids spending of oil and gas budget revenues under the world oil price above the base level of 40 dollars per barrel. Since the introduction of such rule in 2017, the situations, paradoxical at first glance, occur when growth of the world commodity prices weakens the ruble in nominal terms. The reason is that the import of commodity inflation is not offset by the nominal ruble appreciation that would have occurred in the absence of the budget rule, due to foreign currency purchases by the Central Bank of Russia carried out to build up the National Welfare Fund. There is no surprise that the policies of financial authorities, aimed de facto at the ruble devaluation, raise pro-inflationary risks.
Under such circumstances, the influence of pro-inflationary factors has a permanent nature and does not depend on the monetary policy measures. Nevertheless, the Central Bank had to demonstrate a resolute reaction on the inflation upsurge. The sharp policy tightening in July was aimed primarily to support the reputation of a monetary authority firmly engaged in inflation targeting. Another question is to what extent the anti-inflation policy measure adopted by the Central Bank will be effective.
By the end of the summer, the temporary pro-inflationary factors to a large degree vanished, irrespective of the Central Bank’s decision. The effect of delayed consumer demand weakened, while the world prices of agricultural commodities stabilized and began to fall. In July the world index of food prices decreased by 1.2%. The main reasons for the reversion of food prices dynamics were the upsurge of global agricultural production due to the removal of the quarantine restrictions, a high rate of vaccination in many countries and global weather conditions more favorable for harvests as compared to 2020.
The monetary policy tightening could be justified, to some extent, as a way to discourage the growth of asset bubbles. However, the rise of the key interest rate would hardly affect the real estate bubble that threatens nowadays the financial stability in Russia. The program of lax mortgage lending lunched in April 2020 by the Federal government was aimed at solving a very important social problem of the overall accessibility of dwellings, but instead it contributed to the rapid increase of dwelling prices. In the last year, the volume of new mortgage loans amounted to 4.3 trillion rubles, of which a quarter were supplied at the privileged rates. As a result, the lax mortgage program caused a boom of the real estate. The government, nevertheless, prolonged this program with insignificant corrections until July 1, 2022.
The bubble growth is reinforced by the activity of commercial banks supplying mortgage credits and seeking to continue the price rally on the market for dwellings, which brings high profits for the banking system. To attract new clients banks reduce the net interest margin and expect to compensate this by an increase of mortgage payments by households due to the dwellings price growth. The real estate bubble, most likely, will continue its growth in the current year, and the Central Bank’s decision to raise the key rate will not influence this process.
Nevertheless, the tight monetary policy will be maintained at least until the second quarter of 2022 because of inflation inertia. A further key rate increase can be adopted if the Central Bank revises its inflation target by lowering it from the rate of 4% introduced as early as in 2014 to 3%, for example. Further policy tightening may also take place if the Federal Reserve raises the base interest rate, in which case the speculative pressure on the ruble will increase.
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