Statement by Bank of Russia Governor Elvira Nabiullina after the Board of Directors meeting held on 12 September 2014

Good afternoon! The Bank of Russia Board of Directors has decided to keep the key rate unchanged at 8% p.a. In August, inflation accelerated, and we expect that it will stay above 7% till the end of 2014. Since the July meeting of the Board of Directors inflation risks associated with the introduction of foreign trade restrictions, the downward dynamics of the ruble exchange rate and the deterioration of external environment on the whole have materialised. Further development of the situation remains uncertain, and risks of higher inflation continue. We take into account these factors when determining the monetary policy stance. Despite the fact that in the short term inflation will exceed an annual rate of 7%, the current level of the key rate remains consistent with the goal of reducing inflation to a 4% target in the medium term without creating a risk of excessive cooling of the economy. However, under current circumstances, it is essential to prevent the persistence of inflation acceleration and higher inflation expectations. This can lead to the stabilisation of a consumer price growth rate at a higher level, and can greatly hinder their subsequent decrease. We will monitor the situation and are ready to raise the key rate, if there appears a threat to achieving the medium-term inflation target.

Today's decision is based on an updated forecast of economic development, which takes into account the impact of external and internal factors on economic activities and inflation. The forecast will be published today in the draft Guidelines for the Single State Monetary Policy.

In the second quarter of 2014, actual GDP growth exceeded our expectations. However, the forecast for the year remains at a 0.4% level because in the second half of the year the economic slowdown is expected to be stronger than the earlier forecast.

The persistent high level of uncertainty, caused inter alia by the effects of external political factors, holds back production, investment and consumer activities. Economic dynamics in Russia’s trade partners remains unstable, whereas the conditions in world commodity markets have become less favorable for domestic exporters due to a certain fall in the price of oil and other energy resources. Opportunities for economic growth are also severely limited by internal factors of a structural nature. The utilization rate of competitive production capacity remains high. It is also necessary to overcome infrastructure constraints and improve the investment climate. Productivity is growing slowly. Demographic trends cause a deficit of labor supply, which manifests itself in the reduction of the total working-age and economically active population. Under these conditions, the adaptation of the labor market proceeds through increasing the share of working pensioners (from 33% in 2007 to 39% in June 2014). The Bank of Russia monitors not only the overall unemployment rate, but also the dynamics of wages and salaries, the rate of labor resource utilization by enterprises, the number of forced leaves without pay to assess the state of the labor market. No clear trends are observed yet.

On September 8, the growth rate of consumer prices increased to 7.7%. According to Bank of Russia estimates, the contribution of foreign trade restrictions imposed in August amounted to about 0.2 percentage points. Further impact of this factor on prices will depend on the rate of import substitution and a change of external suppliers.

In the draft Guidelines for the Single State Monetary Policy, the Bank of Russia has considered three scenarios. In our baseline scenario, we project a gradual increase in the rate of growth of the Russian economy in the medium term. GDP growth in the baseline forecast will amount to 1.0% in 2015, 1.9% in 2016 and 2.3% in 2017. This forecast is based on the assumption that the geopolitical problems shall be resolved and most of the imposed sanctions shall be lifted over the next year. Normalization of the foreign policy situation, the improved expectations of economic agents and easing of financial conditions will contribute to a gradual recovery of investment activity. Investments will be also supported by the planned launch of a number of major projects, specifically infrastructure investment ones, including the project within the framework of long-term cooperation with China in the area of energy exports under the baseline scenario. Reduction of investments in fixed assets will cease in 2015, and in 2016-2017 the growth rate of investment will gradually increase.

Amid declining wage growth and slowing credit growth, a cooling in consumer demand will take place in 2015. In the future, certain acceleration of growth in aggregate labor income, lower inflation and stable dynamics of loan supply will contribute to a gradual recovery of consumer demand. As import growth is low, the contribution of net exports to GDP growth in 2015 will be close to zero. However, the gradual recovery of domestic demand will contribute to a rise of the imports growth rate in 2016-2017. As a result, against the backdrop of continued low positive export growth, the contribution of net exports to GDP growth will be somewhat negative.

In the baseline scenario, we expect a reduction of inflation to 4.5%-5.0% in 2015, and 3.7%-4.2% in 2016 and 2017. The conditions for a gradual slowdown in consumer price growth will be provided by the current moderately tight stance of the monetary policy. The gradual exhaustion of the impact on prices from the imposed trade restrictions, low aggregate demand and the stabilisation of the exchange rate dynamics will also contribute to lower inflation. Money supply dynamics also provides for a slower growth of consumer prices in the medium term.

However, the risks of inflation deviating from the target in the medium term remain. In particular, they relate to continued uncertainty, exchange rate dynamics, possible changes in the tax and tariff policy, as well as a corresponding increase in inflation expectations.

These risks have been considered in two alternative scenarios that are presented in the draft Guidelines for the Single State Monetary Policy. The second scenario assumes the continued sanctions and an introduction of a sales tax that will mean with a high probability a longer horizon for achieving the medium-term inflation target. Under this scenario, the inflation will stand at 6%-6.5% in 2015, 4.5%-5% in 2016 and 4%-4.5% in 2017. The third scenario includes in addition a pronounced decline in oil prices, which, according to our estimates, could lead to a further slowdown of economic growth.

When implementing any of these scenarios the stance of monetary policy and the path of inflation reduction will be determined by the Bank of Russia with account of risks to price stability and the prospects for economic growth. Along with that, amid increased uncertainty of future economic development, the Bank of Russia is ready to promptly respond to the situation and to use non-standard solutions in the event of threats to financial stability.

According to the draft Guidelines for the Single State Monetary Policy, to achieve the monetary policy objective of ensuring price stability stipulated by law, the Bank of Russia is completing, as previously planned, a long-term transition to inflation targeting.

The transition to inflation targeting proceeds in a difficult environment for the Russian economy. Geopolitical events have had a significant impact on the Russian financial market, the banking sector and the economy as a whole. The main challenge for the monetary policy has been an acceleration of inflation occurring against the background of an economic slowdown, capital outflow and increased volatility in various segments of the financial market.

In such a situation, there are calls to abandon inflation targeting or to postpone the transition to it. Indeed, the situation is now difficult and there is high uncertainty of future developments. However, this is not a reason to abandon long-term strategic objectives. The Bank of Russia pursues a flexible policy and is ready to quickly respond to emerging challenges. It should be noted that the Bank of Russia's intention to complete the transition by 2015 is not just a blind adherence to some doctrine or earlier announced plans, it is a conscious and balanced decision that meets the challenges of the current situation.

One shall not underestimate the negative effects of high inflation and the scale of inflation risks. If inflation gets "stuck" at a high level or will continue accelerating, it will complicate not only its reduction in the future, but also the transfer of the economy to a path of sustainable growth. High inflation increases the uncertainty of economic conditions which adversely impact the planning of production and investment activities. High inflation means the lack of incentives for long-term savings and, as a consequence, the deficit of long-term financial resources in the economy, high interest rates on deposits and loans. Therefore, it is the high inflation that underlies the low monetization of the economy and the unavailability of long-term credit.

Inflation reduces the welfare of households: the purchasing power of income is going down, savings get devalued. High inflation, judging by polls and applications to the Bank of Russia, remains one of the most acute problems for the population. At the moment when external conditions for the Russian economy deteriorate it is even more important to create a favorable domestic environment. Therefore, maintaining the purchasing power of the national currency – a fall in inflation and its stabilization at a low level - is a top priority for us as the most important condition for ensuring a balanced and sustainable economic growth.

In addition, the stability of the national currency is a requirement for raising its credibility, including the broader use of the ruble in foreign trade settlements.

The Bank of Russia considers it reasonable to set the inflation target of 4% for the medium term and to maintain it in the foreseeable future. This medium-term inflation target allows, on the one hand, fixing inflation expectations at a low level and creates a favorable environment for long-term savings and investments. On the other hand, at this level of headline inflation, the growing prices of some product groups will not lead to a steady decline in prices of other goods.

Setting the medium-term target at a relatively low level (by Russian standards) does not mean that we will strive to reduce inflation at all costs, which many are scared of. Bank of Russia plans to cut inflation to the target gradually so as to prevent excessive risks to economic growth.

Under this strategy, the Bank of Russia regularly makes decisions on the key rate based on an assessment of the economic situation and a forecast of its development. In doing so, the Bank of Russia assesses the impact of possible medium term measures, which is very important in implementing the monetary policy, which affects prices and rates only indirectly and with a certain lag. Moreover, this approach presumes a high degree of flexibility. The Bank of Russia does not respond to the acceleration or deceleration of inflation, if it is caused by seasonal factors or fluctuations of prices of certain goods and services and in the medium term inflation is expected to return to the target. Measures shall be taken only if these factors apply to a wide range of prices, leading to higher inflation expectations, and a threat of inflation deviation from the target in the medium term.

The inflation targeting strategy is in line with market principles. The Bank of Russia does not directly intervene in market pricing using administrative methods, it affects inflation indirectly, through the interest rate channel. We need to ensure that the signal given by the Bank of Russia – the key rate level – is transmitted via the money market to the economy as accurately as possible. The Bank of Russia has already managed to substantially limit the interest rate fluctuations in the short-term segment of the money market. The transition to a floating exchange rate regime is the necessary prerequisite for the efficient steering of interest rates. The flexible exchange rate allows the economy to better adapt to changing global markets. However, the floating and flexible exchange rate does not mean its strong volatility. In the future, lower inflation will provide for increased confidence in the national currency and achievement of the exchange rate stability.

It is also very important to note that inflation targeting is, in essence, an open-door policy. The Bank of Russia has been consistently increasing the transparency of its monetary policy. Understanding monetary policy, its objectives and methods of achieving them is the basis for building confidence in the Bank of Russia, which is important for keeping inflation at a stable and low level. The Bank of Russia is ready to discuss monetary policy issues with businessmen, economists and analysts, representatives of the scientific community, to interact with the Government and other public authorities.

of the interrelation between targets, forecasts and actual inflation indicators is of great importance. The principle of inflation targeting is not changing the target but explaining the reasons for deviations from it, as well as policy path and instruments that will allow reaching the target.

Last year, the Guidelines for the Single State Monetary Policy, which were discussed with the Government and the State Duma, set the inflation targets of 4.5% for 2015 and 4.0% for 2016. As a result of increased risks, including those of non-monetary nature, there is a high probability of inflation deviation from the targets for the respective years. Inflation is estimated to reach the medium-term target within 2-3 years, which is considered to be a normal period for the return of inflation to the target path in world practice. At the same time, the change of targets is fraught with changing expectations and is equivalent to the continuous change of the rules of the game that can undermine the public trust and understanding of the ongoing policy of the monetary authorities. Therefore, the Bank of Russia proposes keeping unchanged the previously agreed targets, explaining at the same time in its information and analytical materials the reasons for deviations from the targets, their nature, the actions taken and the expected period of returning to the target path.

In connection with the decreased rate of economic growth, current discussion focuses on the possibility of applying monetary policy measures for its stimulation. According to Bank of Russia estimates, the present slowdown of the Russian economy is largely caused by structural factors: demographic problems, technological lag, underdeveloped infrastructure, as well as other institutional factors which the monetary policy is unable to influence. In addition, it is not so much the level of loans rates as uncertain economic conditions that restrain investment and consumer activity. In this environment, it is unlikely that a decrease in loans rates will create a stimulus to companies to make long-term investments and modernize production capacity. Thus, all kinds of attempts to stimulate economic growth by reducing rates only accelerate inflation. In this case, the threat of high inflation at persistent low rates of economic growth will become more real. Moreover, one cannot not exclude the possibility of bubbles forming in some markets, when lower rates will lead to an unjustified increase of the debt burden on certain social groups and business segments.

Thus, only consistent monetary policy aimed at a gradual reduction of inflation will provide for sustainable economic growth and the higher living standards of Russian citizens.

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