Statement by Bank of Russia Governor Elvira Nabiullina in follow-up of Board of Directors meeting on 11 December 2015
Good afternoon, dear colleagues!
Today the Bank of Russia has decided to retain the key rate at 11% p.a.
I would like to start with the current situation in the Russian and global economy and expound on the development outlook for the three years to come.
I would also like to discuss the factors underlying this decision and the attendant risks.
Firstly, the situation in the global economy and primarily in the commodity markets. The oil prices have been recently somewhere between our baseline and risk scenarios, and we can speak of the increased probability of oil prices staying below $50 per barrel.
Secondly, the dynamics of the Russian economy in Q3 turned out to be more favourable than we expected.
Thirdly, as far as consumer price growth is concerned, their dynamics failed to meet our expectations. The actual inflation runs close to the upper border of our forecast. As inflation slows in line with our forecast and provided that inflation risks recede,
The Bank of Russia will resume its key rate cuts at one of the forthcoming meetings of the Board of Directors. I would like to give more details about the main factors.
I will start with the situation in the world economy and global financial markets and their impact on the Russian economy.
External economic conditions and balance of payments
External conditions remain complicated, with persistent unfavorable trends, which became apparent last summer. First of all, this is high volatility of the world markets caused by frequent shifts in global investors’ sentiment and expectations. Such situation is linked to several sources of uncertainty. Firstly, the pace of normalization of the US Fed’s monetary policy. The review of market participants’ expectations with regard to the rise path in the Fed rate leads to reassessing the attractiveness of assets. As a result, we observe fluctuations in the world FX market, instability in the scope and directions of capital flows, and fluctuations in the stock and commodity markets.
Secondly, investors are persistently concerned about growth outlook in emerging markets, first of all China. The economic slowdown in China may have an adverse impact on the world economy, including commodity prices.
Growth rates of the world economy as a whole will remain low in the next few years. Our baseline forecast assumes that the price of oil will most likely return to the average annual level of $50 per barrel in 2016.
Nevertheless, it is more unlikely to happen and the price will stay below $50 per barrel for a longer period of time. Given the unfavorable external conditions, one can’t help noting that the Russian economy demonstrates its ability to adapt to their changes rather quickly. The balance of payments was adjusted as a whole already at the start of the year, with Q3 showing economic stabilization. The economy’s ability to adapt influenced the global investors’ sentiment: they started to look at the Russian economic prospects more positively.
Despite the persistently high volatility in the world financial and commodity markets, the risk premium for Russia has dwindled noticeably in recent months, drawing nearer to other countries with similar export structure.
In Q3 this year, we saw net private capital inflow into Russia for the first time from 2010 Q2. Amid the downturn in risk premium, some Russian companies managed to successfully place their bonds in the international markets. In recognition of this, we revised downward our net private capital outflow estimates from $70 billion (November forecast published in the Guidelines for the Single State Monetary Policy) to $58 billion as of the year-end.
Exchange rate risks related to external debt repayment decreased considerably compared to the end of the previous year and the beginning of this year.
Our business surveys show that payment profiles net of intragroup loans became more balanced. Banks and companies accumulated sizeable foreign liquid assets. Current account proceeds remain stable, and, according to our estimates, its balance will stand at $63 billion this year, which is slightly above the past year figure. In addition, we continue FX refinancing operations and will flexibly respond to the banks’ demand for FX liquidity.
Taking these into account, external debt repayments will not exert an additional pressure on the FX market in the end of the year, among other things. In spite of higher geopolitical risks and risks of persistently low oil prices, we generally see the situation with the balance of payments as rather stable one.
Economic activity and labour market
Now let me tell you about the second factor, that is the main trends in the economic activity. We believe it possible to talk about passing the most acute phase of the economic slump.
The annualised GDP fall in Q3 was less pronounced than in Q2. We estimate GDP to drop by 3.7-3.9% in 2015, which is somewhat above our 3.9-4.4% forecast.
However, it is early to talk about a positive trend. The main economic indicators give a mixed outlook. There are some signs of an upturn, but the basis is still to be formed for the economic recovery and especially for comparatively high and stable growth rates in the medium term.
The positive trends are as follows.
The first one is the dynamics of some export-oriented industries. Among them are mining and intermediate material production (woodworking and chemical industry). In its turn, output growth in export-oriented industries boosted freight turnover, mainly pipelines and railways.
The second one is import substitution. It was primarily triggered by the trade restrictions and the ruble depreciation. The import substitution has become a key factor of output backup in agriculture and some manufacturing industries, primarily production of consumer goods (food products, household chemicals, cosmetics, and medicines) and some related industries. The import substitution contributed to improved production of investment goods. Some subsectors of machine-building and electronic equipment production saw growing output. It was driven, among other things, by the need to reduce dependence on technology imports in commodity sectors and defence industry.
At the same time, I will repeat, that positive shifts related to the import substitution or growing exports are observed only in individual market segments, certain commodity groups and product types, and do not make any sizeable contribution to the overall output dynamics so far. Investment goods production and fixed capital investments give hope that the investment slump has slowed.
However, high uncertainty in the economic outlook and slack consumer demand continue to restrict the potential for investment activity growth in the short term. Household consumption continues its downward trend at galloping pace amid falling household real income. But unemployment remains virtually unchanged, and wages are still the main channel of the labor market’s adjustment to changing environment.
However, industry sectors suffering from persistent and considerable reduction in output can accelerate labor cost cuts in the near term. This may lead to a certain increase in unemployment. However, the unemployment will still be restricted by the companies’ reluctance to lose qualified staff and by the demographic trends.
Apart from income dynamics, the consumption is also influenced by changes in households’ behavior. Households tend to save more and to borrow less amid high uncertainty.
Monetary conditions
Before moving to inflation issues I would like to talk about monetary conditions. Over last few months, they have gradually relaxed, though still staying moderately tight. The bigger portion of the positive effect of the Bank of Russia key rate’s cuts has already been utilised by the banking sector’s interest rate dynamics, therefore lending and deposit rates decreased in the second half of the year at a slower pace compared to the first six months. Corporate lending continued to demonstrate certain recovery. The growth of lending to non-financial organisations was at 9.5% year-to-December (3.3% adjusted for currency revaluation). The lending is supported by a certain revival in demand for loans driven by falling rates and by a gradual slowdown in the deterioration of the credit portfolio quality.
The implementation of the government programme aimed at increasing the capitalisation of the banking sector makes a positive contribution. Positive developments have been registered in the lending structure. Lending growth has picked up to several industries, including export-oriented and import substituting ones (for example, chemical and food industry). At the same time, banks’ requirements to borrowers and loan collateral remain rather strict. Besides, growth potential of the lending activity is held back by the high level of debt burden in the economy.
We forecast the moderate growth of credit and monetary aggregates, which will not pose considerable pro-inflationary risks triggered by money supply.
And just a few words about the ruble liquidity.
During this whole year, credit institutions’ need for the Bank of Russia’s operations to provide liquidity has been subsiding. This is explained by liquidity channelling to the banking sector via the Reserve Fund, which was used to finance budget expenditures. In this situation, money market rates fluctuated around the key rate.
This December, banks are expected to demonstrate a seasonal surge in demand for refinancing operations. This is largely caused by the seasonal elevated dynamics of cash and budget flows. In view of considerable volumes of free marketable collateral held by banks, we intend to meet their demand primarily via auction-based repos.
At the beginning of the next year, as the seasonal demand for liquidity wears out, the Bank of Russia will reduce the volume of liquidity provision at its auctions.
Inflation and inflation expectations
Let me proceed about the issue of main concern for us – the key trends in inflation dynamics.
Price growth rates in monthly terms dropped in November, seasonally adjusted. Annual inflation gradual slowdown is back, however this process is slower than we expected. This is mainly attributable to the influence exerted by the exchange rate and inflation expectations.
Monthly price growth rates, seasonally adjusted, are still at the level exceeding the comparative periods in 2012-2013. By the end of the year, inflation is expected to be close to 13%, i.e., at the upper border of our forecast.
Nevertheless, the contribution of the exchange rate to inflation is declining. Prices for different groups of commodities and services respond to the exchange rate dynamics with a different strength and speed. In particular, prices for non-food goods are the first to get affected by the exchange rate for a longer period of time. The contraction of the pass-through effect can be partially explained by a greater share of domestic products in consumption.
We expect a sharp deceleration of the annual inflation up to 7.5-8% in 2016 Q1. One of the underlying reasons will be the base effect.
We believe the process of adjustment to foreign trade restrictions Russia imposed against Turkey will have a tiny impact on inflation in general – it will be within 0.2-0.4 percentage points in the next few months.
Relatively tough monetary conditions and poor consumer demand dynamics will be those key factors that will slow down the annual price growth up to 5.5-6.5% at the end of 2016. We need to reduce inflation expectations of the population and producers to achieve a steady inflation slowdown.
The ideas of future inflation alongside the interest rates have a significant effect on decision-making in the economy. This includes decisions of households as regards the ways to spend their income – should they spend more or make bigger savings – and decisions of the business community on investments, wage changes and so on.
Currently, inflation expectations of the population and producers are still pretty high. Last November saw a small growth in inflation expectations of households. People are sensitive to accelerated price growth on individual products especially on daily consumption products even when this is caused by short-term factors. We can understand them.
However, following the downturn in actual inflation indicators and their reaching a principally lower level, there should also be a drastic change in expectation dynamics. A risk for our inflation forecast is that such drastic change will take time or it will not be that recognisable, and inflation expectations will remain elevated for a longer time span.
With due regard to higher inflation risks and the persistent economic slowdown risks, we took a decision today to set the key rate at 11% per annum.
I want to stress once again, that the Bank of Russia will resume cutting the key rate at one of the forthcoming meetings of its Board of Directors as inflation slows down according to the forecast and provided that inflation risks weaken.
I would like to remind that we expect the annual inflation to be at 7,5 – 8% in 2016 Q1 and lower than 10% in January 2016.
Mid-term prospects: key points
And, finally, let me say a few words on our mid-term forecast, to be published in the Monetary Policy Report released today.
We consider three scenarios for the development of the situation. The external climate prerequisites and the forecast for macroeconomic fundamentals thereunder remain basically unchanged from those contained in our Guidelines for the Single State Monetary Policy. Our baseline scenario suggests that the oil price in the next three years will linger at about $50.
We also include the optimistic scenario of a more rapid oil price recovery. This recovery is in line with the forecasts of many international organisations, analysts and market participants. Furthermore, we consider the risk scenario whereunder the oil price falls below $40.
The recent oil price developments suggest that this scenario has become more relevant.
The baseline scenario suggests that in 2016 we will see the economy continue to adapt to the new conditions, change its structure, while resources will flow to more productive sectors. Under our estimates, GDP for the year will contract, but not as much as for this year, by 0.5-1%. In the second half of 2016, a reversal trend in the stocks is projected. We forecast that the investment downturn will gradually stop.In 2017, investment and production activity are expected to recover, primarily in the sectors with an import substitution potential or those capable to compete in foreign markets. GDP growth rates in 2017, as our estimates suggest, will enter the positive territory.
We expect that in some time consumption will begin to grow as incomes show improvement on the back of economic revival. With regard to the balance of payments, the current account balance in 2016-2017 will be quite stable at about $50-60 billion. Net exports are set to make a positive contribution to GDP. The amounts of foreign debt payment will gradually decrease. Such repayment of external liabilities will decline at a rate faster than the growth in demand for foreign assets. This will drive capital outflow reduction to about $50-60 billion in 2016-2017.
Given the level of export earnings and the level of foreign assets accumulated, we foresee no need for the Bank of Russia to expand its FX refinancing programme.
The outcome will be different if the risk scenario materializes. The GDP drop can be at about 2-3% in 2016. Higher inflationary pressure mainly driven by the exchange rate will necessitate a tighter monetary policy, that is higher key rate values than implied by the baseline scenario.
If lengthy, further deterioration in the external climate will require additional adjustment of the balance of payments and the economy as a whole. Should the need arise, we will be ready to use all the tools available, including FX market transactions, to ensure financial stability is maintained.
We believe it is possible to ensure not only stable operation of the financial markets and the banking sector, but also contraction of inflation to the target of 4% in 2017, so it settles around this level in the future. The strengthening of positive trends in the structure of economic activity, their proliferation to a wider range of goods and services are key to economic recovery and a return to sustainable economic growth, regardless of global markets.
To enable the advancement of these trends, it is crucial to create a predictable economic environment for our citizens and business, with price stability as its integral part.