Statement by Elvira Nabiullina, Bank of Russia Governor, in follow-up to Board of Directors meeting 15 June 2018
The Bank of Russia today has decided to hold its key rate at 7.25% per annum.
Let me highlight the factors we considered while making this decision.
First, we have updated our inflation forecast to reflect a number of internal and external factors,
of which yesterday's proposal for tax changes is key. Although the VAT increase is planned to take place from 2019, a certain proinflationary effect from this move within this year is not ruled out, coming through changes in inflation expectations and a faster price correction. As a result, inflation will move closer to 4% by the end of 2018 – to an estimated range of 3.5-4%. It is possible that inflation will rise to 4-4.5% in the course of 2019. The effect from the tax changes is set to run its course in early 2020, when inflation is projected to return to 4%.
The impact of the other factors on consumer price movements is mixed.
We estimate that this April's weakening in the ruble on prices is moderate. We saw inflation accelerate across individual product categories which are traditionally overreliant on exchange rate fluctuations. These include, for one, outbound travel, household appliances and electronics. Viewed overall, non-food products showed a more muted reaction than expected.
Importantly, households’ reaction to the ruble weakening was mild, too: consumer behaviour remained unchanged, with no significant increase in demand for foreign currency or undermined attractiveness of ruble deposits.
The next factor is petrol prices. Petrol prices rose at markedly faster rates between April and May as oil prices climbed, excise duties were increased early this year and the ruble weakened. The rise in petrol prices proved a key contribution to accelerated price growth in non-foods. However, the reduction in fuel excise duties is expected to make a constraining impact on petrol prices.
Food price growth in May came in even below our projections. Reliance on imports and seasonality factors is declining on the back of positive developments in agricultural production (including on the back of greenhouse construction). As a result, the response of food prices to exchange rate volatility is also diminishing.
There was a certain rise in the differentiation of price growth rates across Russian regions. Inflation accelerated in large regions with the highest income levels, driven by these regions’ higher consumption of petrol, other non-foods and services related to outbound travel. Some other regions, on the contrary, saw a slowdown in inflation: I refer to the agricultural southern regions where fruit and vegetables are more affordable and the share of food in the consumer basket is larger. Having said this, inflation throughout all regions but one remains lower than 4%.
The rise in petrol prices combined with exchange rate volatility sent household and business inflation expectations higher in May, with their readings having returned to those seen between late 2017 and early 2018. As I have mentioned, a further impact on inflation expectations is poised to come from the upcoming tax changes. The duration of this effect is of crucial importance to us: that is, we must understand how soon inflation expectations will resume to decline and whether they can prove stubbornly high. This determines, among other things, the ultimate implications for inflation.
The second factor is monetary conditions. Our estimates suggest they have moved close to neutral.
As you will remember, the neutral key rate range is 6-7%. Following the developments of April and May, our estimated neutral interest rate currently appears to be closer to the upper bound.
Nevertheless, at this point in time we cannot afford the remaining one or two downward steps in the key rate, which would take us to fully neutral monetary conditions. The realised inflation risks spell the need to carry on with a slightly tight monetary policy stance. Our projections suggest that this will be sufficient so far to curb secondary proinflationary effects from the planned tax decisions.
As regards lending and the propensity to save, their performance is aligned with our expectations. Moderately growing household lending fosters a continued rise in consumer demand. Its movements are however within our estimated range, bringing no financial stability risks.
I will now proceed to speak about our medium-term outlook. It has been updated to reflect the recent fiscal policy decisions and with regard to external assumptions.
Oil prices exceeded our expectations, to the effect that we slightly upgraded their estimate for this year, from 61 to 67 dollar a barrel (annual average). At the same time, the impact of this factor is limited. It is set to be levelled off by the fiscal rule, while state regulation will neutralise its implications for domestic fuel prices.
As we expected, overall output and industrial production growth rate accelerated in the first half of 2018 after a slowdown at the end of last year. Nevertheless, Q1 GDP growth was below our expectations, this was primarily associated with the performance of construction and investment. Growth in the output of consumer goods remained stable, driven by sustainable consumer demand.
We have retained our GDP growth projections for 2018 onwards at 1.5-2%. This forecast has yet to factor in all the fiscal measures which were partially announced only yesterday. These need additional detailed calculations we will provide in the future. At the moment, we can see certain risks of a downward revision of 2019 GDP growth forecast, given that the VAT rise will translate into prices of goods and services, as well as consumer demand. In contrast, the forecast GDP growth from 2020 onwards may be revised upwards if the projected measures are efficiently implemented.
We have made a slight revision of the balance of payments forecast. The updated estimates suggest that the 2018 current account balance will stand at $85 billion, or 5%, of GDP against $59 billion projected in March. This mostly results from higher oil prices. That said, we can see that growth in non-commodity exports is also sustainable. Higher export proceeds are set to translate into growth of FX assets in the private sector. The new sanctions against Russia and the increased volatility in global markets are poised to bring down foreign investment in Russian companies. As a result, the negative financial account balance in the private sector will be somewhat higher in 2018 than we expected in March, totalling $30 billion.
Milder revisions were made to the 2019-2020 balance of payments forecast, with medium-term trends remaining unchanged. The current account balance will decline amid oil price adjustments but remain sustainably positive at roughly 2% of GDP in 2020. Consistently, the negative financial account balance in the private sector will shrink to $16 billion in 2019 and $12 billion in 2020 (or 1% of GDP).
Finally, some words about proinflationary risks, the balance of whichhave shifted upwards since March.
Most of the fiscal policy measures, which had been under discussion and created uncertainty, gained perspective yesterday. We will update the scope and scale of fallouts from these decisions for the economy and inflation as new, primarily expense-related, data emerge and economic agents respond to these changes.
Given that inflation will now bounce back to 4% faster than we expected, any proinflationary factors enhance the likelihood of consumer price growth outpacing the inflation target. That is, there will be no 'cushion' that we have with inflation at 2.5%. Therefore, we will be more wary in our policy.
External risks to a certain degree have also been in place since March. They are primarily associated with global financial markets and geopolitical environment. Although the past events had quite a moderate effect, we still cannot rule out a potential downfall in the future.
Furthermore, there are higher risks of trade wars, which may slow down global economic growth. All of the above may translate into the exchange rate, inflation and inflation expectations.
Other risks remain moderate.
Let me say yet again, when updating our forecast we will assess the impact of the Government-proposed measures not only on inflation, but also on economic activity. We expect that their successful completion will accelerate economic growth rates.
To conclude, I would like to celebrate the World Cup opening, an important event for Russia. According to our estimates, it will have an insignificant effect on inflation, which will be short-lived and affect only individual cities and categories of goods and services, primarily consumed by tourists. That said, such a large-scale international event will back up output growth in the second quarter, and as of year-end it may contribute up to 0.1-0.2 pp to GDP growth. We hope that the World Cup will only have a positive impact on both expectations and sentiment of both Russians and our guests.
Q&A for the Media
QUESTION from RBC:
Mrs Nabiullina, the Central Bank has repeatedly warned about the risk of skills shortages for the economy. The Government yesterday unveiled its plan to increase the retirement age. Do you think this move as announced will neutralise this risk? Has this risk run its course? Or, is there any extra action needed to avoid it? If so, what action is needed?
Yesterday’s decisions will mainly have positive implications for the labour market. There will be a rise in employment. However, the need to evade the problem of skills shortages, given the current demographic situation, spells the need to address the issue of labour productivity. We need to primarily focus on labour productivity and labour effectiveness – this is a key task.
Among other factors to consider and work on is geographical mobility. We should deliver better labour mobility so that our people can more easily change occupations and employers. This will also help us keep the current labour shortage in check.
We view current unemployment as low enough and close to equilibrium. True though, this equilibrium level is lower in some countries. It still has some room for reduction – provided that we resolve the structural constraints problem we have spoken about and come to geographical and occupational mobility.
QUESTION from RIA Novosti:
Mrs Nabiullina, according to the Bank of Russia's latest statement, it still expects a transition to neutral monetary policy to occur in 2018. Today’s Bank of Russia release gives a slightly different signal. The regulator says it is slowing the transition but gave no timeframe. Can you specify this timeframe?
And question two, please, regarding inflation. The impact on inflation of a VAT increase is estimated to be roughly one percentage point – so it means the pass-through will partially occur before the end of this year. Is there perhaps a more accurate inflation estimate for 2018? Thank you.
The very range of the neutral key rate remains unchanged – as I have mentioned. I admit though the chances of the transition to neutral monetary policy occurring before the year-end has declined. We now expect this transition to neutral monetary policy to happen next year. We do not rule out the chances of this transition occurring this year barring a new proinflationary risk materialising or an acceleration in inflation expectations – that is, if inflation expectations continue to decline despite the tax decisions and if other disinflationary factors including good crops are in play. In other words, these tailwinds can combine to help bring about the onset of neutral monetary policy before the end of the year. Having said that, the basic scenario has been updated. It assumes the transition will occur as soon as 2019.
As regards a more accurate estimate for the impact of increased VAT on inflation, we should look into the way this factor interacts with other tax system settings. We will provide this estimate in due course. Currently, the preliminary estimate for this VAT rise contribution to inflation is plus one percentage point. It is premature at this point in time to give an accurate account for its impact within this year. Global experience varies. In some cases, this impact materialises to a great extent before the decision is made; sometimes it materialises concurrently with the decision.
We will therefore watch the progress of price adjustments and analyse the trends. It is indeed too early to attempt to estimate this effect for this year and for the year next.
QUESTION from Bloomberg:
Two questions, if I may. Question one. Given that the transition to neutral monetary policy is set to happen next year, is a rise in the key rate possible until the end of this year – in recognition of proinflationary risks?
And my second question relates to capital flows in emerging markets. This month, the head of India's central bank authored a column in the Financial Times, calling on the Fed to slightly decelerate its monetary policy normalisation because of the risks it poses to emerging markets. Would you share this view? What risks to the ruble can you see this normalisation brings?
Our baseline scenario assumes no need for a rise in the Bank of Russia key rate. Nevertheless, should these factors combine to trigger a sharp strengthening in proinflationary risks; all options are on the table. This is driven by the key task on hand – to deliver inflation stabilisation at 4%.
Let me highlight one more aspect to this. In principle, a VAT increase is a one-off factor with the potential to trigger a one-off price growth effect. Yet, with inflation expectations still unanchored, it seems highly probable that we will have to deal with secondary effects and the spillovers of increased prices for goods with unchanged VAT. Therefore, if inflation expectations were anchored and if all market players proceeded from the fact that this VAT rise is nothing more than a one-off factor pushing inflation upwards only temporarily, there would be no need for any monetary policy measures. Yet, with inflation expectations remaining to be anchored, we have to soften our monetary policy stance slower than expected.
Let me reiterate: we believe the moderate tightness of monetary policy, currently in place, will be sufficient. We are ready to use other options should the need arise.
The expected monetary policy normalisation (in advanced economies) is certain to have some negative effects for emerging economies including Russia, mainly through changes in capital flow. We see this effect manifesting itself in different ways across various economies. Those with strong domestic imbalances will be the first to suffer, and will suffer most. These imbalances include debt burdens (as debt servicing will become costlier), current account deficit or any other factors investors believe to be risky. We see strong capital outflows in emerging market economies.
This process is set to affect everyone – we all realise that. Our example is the reduction in the proportion of non-resident OFZ holders. Since 1 April, this proportion fell from 34.5% to c.30%. This, together with sanctions, pushed yields higher by some 60 basis points.
This reaction has been essentially moderate so far – however, we realise this process will gain momentum, and we should be ready. Hence the need for very cautious policies and the need to maintain the existing macroeconomic buffers.
Having said that, I do not believe it makes sense to deliberately slow down monetary policy normalisation. Without such normalisation, a very prolonged period of a soft monetary policy stance poses risks to the global economy including financial stability risks, e.g. the emergence of financial bubbles. We take note of these risks – hence the need for normalisation.
I admit that we will not escape volatility surges. Yet there will be fewer such volatility surges than in 2013 – the year when the phaseout of quantitative easing was unveiled. Current global economic growth is more sustainable – in contrast to the then slow growth rates. The global economy is growing more strongly now, and hopefully we are in for no full-fledged war to stall this process.
QUESTION from Interfax:
Do you expect today's decision to maintain the key rate at 7.25% alongside the potential transition to neutral policy as early as 2019 will help boost the appeal of Russian assets including for foreign investors, so we will see non-resident investors return to, among others, the OFZ market?
Please confirm that our understanding is correct: your mention of the neutral rate suggests you see no further reduction potential before the end of this year?
It is in the first place inflation that we will be able to stabilise through an unchanged key rate. It is inflation that is a key target of our interest rate policy. We also think that overall macroeconomic policy – including monetary and fiscal policy – has so far brought no stronger risks to Russia than they have to other emerging market economies.
We do take note of some foreign investors exiting our markets; however, this exit does not bring further volatility risks. As we see it, this trend is set to hold for some time. Certainly, a lot will depend on how economically attractive we become. If an investor sees economic development prospects and higher rates, while macroeconomic stability is in place, Russian assets may become more attractive.
The problem of Russian asset attractiveness is driven by factors beyond the interest rate. Investors are mindful of interest rates no less than of growth potential in this or that market. Hence the combination of factors. At any rate, our baseline forecast does not assume a strong decline in investor interest in Russian assets.
Now as regards the further reduction in the rate throughout this year. This option is open provided that the turn of events proves favourable. As I said, the transition to neutral monetary policy is not impossible within this year – although its chances look slimmer now. Should everything work out for the best, this transition is possible.
QUESTION from TASS Agency:
Do you think the pension reform will also have an impact on macro data, and how soon will this impact come? You will probably look into this somehow. Can you please enlarge on this.
There are quite a lot of macroeconomic indicators. So then, some of these indicators will be affected. They include the labour market and the potential rise in output, on the back of the shrinking risk of labour shortages. This will involve additional assessments.
As far as our remit is concerned, we forecast no strong effects in terms of implications for monetary policy – not over a short-term or mid-term horizon at least.
QUESTION from RIA Novosti:
How do you think household inflation expectations may be influenced by the pending VAT rise and growth in pensions? What will it entail?
These decisions may affect inflation expectations, pushing them upwards, and we intend to watch this. Our expectations are, having once grown, inflation expectations will resume to decline. This will ride on the performance of actual inflation. Inflation expectations tend to rise on expectations for consequences of some decisions; but the key factor is actual inflation movements and particularly movements in prices for certain goods.
Inflation expectations are primarily influenced by price movements in food products, petrol and utilities. A certain increase can indeed occur, which is a factor to consider in our decisions.
QUESTION from Stavropolskaya Pravda:
The fuel price growth problem is especially acute in Russia’s southern regions, with higher fuel prices having sent the costs of the sowing campaign higher. We therefore face the risk of rising prices for agricultural products. How large is the share of domestically produced agricultural products in food inflation? What repercussions do you expect the higher costs of new crops will have?
This is truly an important question we have just discussed. Petrol prices are an important driver for inflation expectations, but certainly not only for inflation expectations – but for inflation itself. We have pointed out that we are committed to our estimates that suggest increased petrol prices will contribute a further 0.2–0.4 percentage points to inflation.
What are key channels of this inflationary impact? First of all, these are petrol sales. The second one is growing corporate costs. And the third one is special, it was raised in the discussion. This is about a rise in agricultural product prices driven by higher operating costs. Yet, given the solid proportion of fuel and lubricants in the cost of several agricultural products (it varies across product types) ranging from, for example, 3% to 10% for cereals and legumes, this rise is estimated to push product costs 1–2% higher.
We hope that the recent excise duty reduction decisions, as well as antimonopoly regulation decisions will help put these prices in check, but some effect will be inescapable.
The share of domestic production in retail food sales is already large enough. We can indeed say import substitution has succeeded. Domestic agricultural production is estimated to account for 75%. Higher prices and higher costs of these products are indeed meaningful. We hope however that this growth in costs and prices will be limited timewise and scalewise.
QUESTION from Reuters:
We see bonds declining – the market has viewed your statements as excessively harsh. Can you please comment on the conditions which will lead to a rise in the key rate, and what are the odds this review may occur? If this occurs, will it precede the transition to neutral monetary policy?
As I have said, this is not impossible. We cannot see this rise as highly probable though. Our baseline and most likely scenario does not assume a key rate hike –vice versa, it suggests a slightly slower downward revision. In other words, we admit the potential transition to a neutral rate will occur, but it will occur over a longer horizon, that is, through the end of next year.
Incidentally, our position has always been that, should all proinflationary risks materialise, we will change our monetary policy stance to stave off any sustainable upward deviation of inflation. A number of impactful inflationary factors (I will not be enumerating them) could combine to force us into taking this action. Let me say once again: this course of events falls outside of our baseline scenario.
QUESTION from RIA Novosti:
Today you have unveiled the new oil price forecast per your baseline scenario. I would like to ask you if updates have also been made in risk and optimistic scenarios which assumed 65 dollars a barrel.
Not really – we are optimistic in general so we left oil prices in the risk scenario unchanged [in the alternative scenario which assumes $69 a barrel as a constant oil price in 2018]. So in fact current, constant, oil prices have been factored in.
QUESTION from Bloomberg:
Before this policy Board meeting, economists were almost equally divided as to what the Bank of Russia’s action would be. This has never been the case since probably last year. Just curious, were the Board members divided in a similar way? Considering your prediction for a real discussion to take place at the Board meeting before deciding on the key rate, was there much debate as to the key rate itself and the message the Central Bank wants to put across?
Market expectations had indeed been equally divided until yesterday. Following yesterday’s announcements, we saw a shift in the opposite direction in many analysts’ opinions. Our discussions over the key rate have continued over the whole week into today. We are engaged in lively discussions with the representatives of regions. This time we updated the forecast and looked into a number of options considering the case for rate reduction: inflation remains fairly low; the market reaction to rather strong external shocks, which unfolded between March and April, was moderate. This is a sign of financial markets’ resilience to these types of shocks. We indeed looked into various options, but the decision was eventually made in the light of the recent announcements [of the Government proposals].
As to how directors vote, we undisclose this information.
QUESTION from Altayskaya Pravda:
The Bank of Russia says that it keeps inflation in check through its monetary policy tools. Some people say however low inflation is not the results of Bank of Russia actions but is rather a result of reduced purchasing power of the population. We in the Altai Region see inflation a way below the Russia average. Our region is in the lowest wage group – so I wonder if this is what is driving our low inflation?
The Altai Region sees inflation growing at the average national of 2.4%. Meanwhile, real income there is somewhat less than the Russia average. The Russia average is 3.8%, relative to 3.1% for the region; no matter how you interpret these data, they point to growth in real incomes.
It is not true that a drop in incomes was the price we had to pay for lower inflation. Incomes were declining on the back of declining economic growth and its descent into negative territory, driven by, among other things, oil price collapse. Oil price is a key economic growth driver.
We are convinced that lowering inflation helps us support real incomes of the population. This inflation trend enables us to prevent the danger of inflation eroding nominal incomes. And lowering inflation rate maintains purchasing power of wages, which is what we are seeing in practice.
There can be another factor. The region is specific in its fairly long advanced agricultural sector, it is especially notable for the production of buckwheat. Thanks to this level of agricultural sector development, inflation could be reduced as long as it is brought about, in addition to the action to check excessive demand, by growing supply. Each time we improve supply, we reduce inflation.
QUESTION from Interfax:
We know that the Government has discussed various tax options in recent years, and Prime Minister Medvedev announced yesterday that the option of changing personal income tax together with other one-off measures was being considered. Ultimately though, it was the decision to raise VAT from 18% to 20% that has been made.
Do you think this decision will do the least damage in terms of proinflationary risks for the country? Were there any other options – the options to increase other taxes – which would have fewer consequences for inflation?
The efficiency of tax measures is estimated not only from the point of view of proinflationary risks, but also in terms of the overall impact on the economy and consumption, and other factors. Therefore, an overall impact should be looked into when comparing various options.
Each option had certainly its respective proinflationary effects. The strongest proinflationary effect would come from the introduction of sales tax. As for personal income tax, it is a measure of the least proinflationary effect. Let me reiterate; this is a limited view of regulatory innovations, other aspects beyond proinflationary effect should also be considered. In our opinion, the inflationary effect from the VAT increase from 18% to 20% (as I have said, 1 percentage point is a preliminary estimate) is rather moderate in the context of current inflation and the current monetary policy stance. As we see it, this measure allows us to deliver on our inflation target of approximately 4 per cent over the medium term. We see no major proinflationary risks beyond our control.
QUESTION from Vedomosti:
Two questions, if I may.
Question one. You told us that the Government measures have been implemented. You said that they were set to reduce GDP growth rates in 2019 somewhat, and thereafter they would increase its growth potential. Are there any preliminary estimates as to how high they can increase GDP growth potential?
And question two, please. Speaking at the International Financial Congress, you urged banks to expand lending to, beyond traditionally growing economic sectors and enterprises (specifically, oil and gas) but also to new sectors and new enterprises. You said then that this is indispensable for acceleration of GDP growth to 4% – which is higher than the potential growth rate.
Do you view current monetary and credit conditions as favourable for this lending at this moment in time?
As regards the impact of fiscal policy on growth rates, I will reconfirm that it takes time to make an accurate calculation of this impact. A lot will ride on how quickly the positive effect of higher spending on account of higher taxes will manifest itself. Taxes are not raised for nothing: they are raised to secure the development of infrastructure, human capital, healthcare and education. These are certainly underlying economic growth drivers.
We all understand however that some lags are possible here. Taxes will rise in 2019, while some demand for investment and other goods can occur in 2020, but the overall effect of investment programmes will be stretched in time. And we will need to make estimates to understand how this effect will materialise.
The big plus is that these measures, once effectively implemented, will enable us to raise the bar for potential economic growth rates. These rates are currently estimated at 1.5–2% – very low growth rates for our economy.
We surely need to grow quicker – therefore, we assume that if we deliver these measures and succeed in spending efficiency, alongside other structural measures beyond fiscal policy, we will be able to accomplish a rise in these potential growth rates. We will make calculations and unveil them as we have more clarity but in any case before a new forecasting cycle.
As regards lending to the economy, consumer credit is indeed recovering faster that lending to non-financial organisations. In simpler terms, I refer to household and corporate lending.
Household lending is rising at a double-digit speed; as I have said, there are no risks from the financial stability standpoint. Yet from an economic growth perspective it would be much better if the structure of lending gradually evolved towards an increased share of lending to the real sector.
Household lending also creates additional demand both for domestically manufactured products and imports. Corporate lending could be controversial from the standpoint of its effect on economic growth: in the case of lending to non-performing projects or in the case of property redistribution lending could fail to bring benefits to the economy.
It is important therefore that banks have incentives to lend to the real sector of the economy. This is not to say these incentives should rest on some administrative measures – it is risk reduction that is key. Why are banks lending less to businesses? The answer is, they are seeing more risks here than in household lending. This is especially true of mortgage lending with its highly disciplined consumers servicing their debt and a very small share of troubled loans.
We therefore propose incentive-based regulation, joining forces with the Government to develop these measures – to make sure banks are truly interested in project finance.
In response to your question whether the tight monetary policy stance is an issue here, the answer is no. Our assessments show that current monetary conditions are already close to neutral. They have no constraining effect on lending expansion.
QUESTION (OTV TV channel, Chelyabinsk):
When do you think will families be able to take mortgage loans with the rate of 7%?
Well, mortgage rates are declining anyway. They are 9.57%, recent data suggest. This is certainly above the target of 7-8%. We expect that as inflation declines, mortgage rates will decline, too. This is a gradual process, there is no need for any sudden movements here. Importantly, a phased approach is key, as we will make sure there are no bubbles in the mortgage market. For all its high growth rates the current state of the mortgage market involves no problems with excessive debt burdens or the like.
While we recognise that even these lower mortgage rates are still inaccessible to a considerable part of our population, let me point out the effective state-backed mortgage programme we have (mainly targeting families with two or three children) where the interest rate is 6%.
Having said this, our strategy is, through the policy of reducing inflation and interest rates, to make mortgage lending more even more available and reduce its rates to about 7–8%.