Speech by Bank of Russia Governor Elvira Nabiullina at the plenary session of the State Duma on 2 December 2016

Good afternoon, esteemed colleagues, ladies and gentlemen

The Central Bank presents today the Monetary Policy Guidelines to the State Duma of the 7th convocation. On this occasion, please accept my congratulations on your election.  I look forward to our productive cooperation. We can rely on our ongoing successful interaction through the Duma’s Financial Markets Committee, the Budget and Tax Committee and the Economic Policy Committee to continue to build a constructive dialogue.

The Monetary Policy Guidelines, a cornerstone for the operation of the Central Bank, formulate our vision of economic development and policies we intent to implement to secure price and financial stability, that is, to ensure inflation is sustainably low and the financial system efficiently services the economy.

Let me begin with the current economic situation. The economy is adapting to low level of oil prices. In the third quarter, GDP decline slowed down to 0.4%, with QoQ growth edging up (0.1%) according to the Bank of Russia’s estimates.

We see the emergence of some structural shifts in the economy; these are related to import substitution and the advancement of non-commodity exports. This implies sustainable growth in several sectors including agriculture, food production, chemicals and mining. The other sectors are however still in decline; these include construction and construction materials, commercial services and the subsectors in trade, transport and logistics which are related to import of goods and services. We also see that the nascent economic rebound is likely to be uneven and it has yet to find its way into the entire economy. Growth is mainly impeded by structural constraints. We forecast the potential GDP rates to be under 1.5–2% unless structural changes in the economy are implemented.

Both Russian companies and banks now need to make lower external debt payments as the amount of their debt is dwindling. The recent stabilisation in the economy, the drop in inflation and the relatively high interest rates have combined to enhance the attractiveness of ruble assets. Dollarisation of household and corporate deposits in the banking system is declining. The ruble has been showing substantially less volatility, notably lower than oil prices, in a sign that market players have adjusted to a floating exchange rate environment. Volatility always comes with risk, and lowering volatility in the exchange rate, especially in the current context of stubbornly volatile oil prices, translates into reduced forex risks.

The overall banking system in Russia is steady. Banks reported an almost fourfold rise in annual profits on the past year, a very challenging year to the banking sector. This is a truly positive development suggesting an improvement in the banking system. Deposits this year grew at a slower pace than last year, which is natural considering the record rise of 25% seen in the past year. They are still rising by almost 4.7%, adjusted for forex fluctuations. Unfortunately, lending to the economy has so far been unsettled. In the past ten months it dropped 1.5%, adjusted for forex fluctuations; growth in some months tends to give way to decline, showing that overall lending lacks steadiness. Having said that, bank capital rose 1%, with capital adequacy ratio at a comfortable level of 12% (against the 8% minimum). This means that banks have the capital stock, estimated at 2.3 trillion rubles, to boost lending.

The Bank of Russia is making ongoing efforts to enhance regulation and supervision of the banking sector. We need to pioneer several legislative initiatives in this area, and we will subsequently meet to discuss them. In brief, we want several laws passed in the near future to enable a switchover to a differentiated model of banking regulation and a new approach to bank resolution. The first part of the proposed reform, related to banking regulation, is meant to streamline regulation of small banks so that these banks refocus on lending to small and medium enterprises (SME) and individuals. Accessibility of loans to SME is of much concern to us and calls for additional action. The second initiative, related to resolution, should add transparency to this procedure, making it more cost-effective and enabling fully restored banks to return to the market.

Let me proceed to comment on inflation.

Over the past two years, the Bank of Russia’ monetary policy stance has been moderately tight. This policy is needed to lower inflation, that is, to protect households’ savings from the negative external environment. There has been a considerable drop in inflation. Annualised growth rates of consumer prices have slowed down to 6.0% and are forecast to decline further before the year is out. You will remember that the past year saw annualised prices peak to 16.9%. We expect annual inflation to decline 2.5 times against late last year. This mark appears comparable to the low levels of inflation seen between 2011 and 2013. Yet, we saw in the past how inflation was down but then up again. Volatility of inflation is also a factor of uncertainty for business projects. Not only do we need to achieve a one-time drop in inflation, we should ensure that low inflation is the long-term basis for price stability. Hence the need to deliver on the 4% inflation target and maintain it close to this point, which would be a favourable driver of economic development.

Let me say a few words about our forecast.

The Bank of Russia is conservative in its forecast. We are deliberately committed to this approach understanding that in the highly uncertain external environment any mistakes in the policy, caused by an overly optimistic approach, may prove dangerous. This is the reason why our current monetary policy remains moderately tight. We tread carefully over key rate decisions and downgrade it only once there are fundamental, rather than short-term, enablers in place.

This year, we are more aligned with the Government’s forecast, thanks to our shared vision of such enablers. We assume that the drastic changes to the economic structure have yet to materialise, and until then the paces of growth, albeit in positive area, are set to be low. Moving forward, provided that our agenda to change the economic structure makes a difference, the paces of economic growth could and should be higher.

The pressure from structural constraints is set to continue to weigh in on the Russian economy. These constraints include the current demographic situation, an insufficiently mobile labour force and low competition, as well as quality issues with the investment climate and institutes.

Oil price fluctuations are predicted to remain a strong risk for the Russian economy, considering that diversification is still low; this is why we are also conservative in our assessments of external conditions. Our forecast assumes that global economic growth is likely to be low, while financial sanctions will still constrain the access of Russian borrowers to global markets. In light of persistently uncertain and unstable global markets, there are a few scenarios we consider.

Our baseline scenario assumes that with oil prices remaining at $40 a barrel the paces of Russian economic advance are set to grow gradually but will remain low within 1% for the next year and between 1.5% and 2% in the next two years. We plan to deliver on our inflation target of 4% by the end of next year.

The currently positive current account balance is forecast to shrink gradually, driven by low paces of export growth as a result of several factors including the price environment; at the same time, imports are set to rebound slightly, in tandem with domestic demand. Capital outflows are set to remain at a level which is relatively low at around $25 billion. We expect this year’s capital outflows to remain at a point below $20 billion.

In addition to a baseline scenario, our Guidelines include, as is customary, a risk scenario and a scenario where oil prices grow.

Let me begin with the risk scenario, which is calculated assuming that the price of oil is $25 a barrel. In this scenario, GDP decline would continue into 2017 and 2018, however, this decline would be minor. It is not before 2018 that inflation would reach the target of 4%. The Central Bank would still have the entire toolkit to maintain price and financial stability even if the negative scenario should materialise. Let me emphasise that we consider the likelihood of this scenario to be low.

In the scenario of rising oil prices, they would climb to $55 a barrel in 2019. In this scenario, the economy would begin to recover sooner. However, the subsequent rates of economic growth will only marginally beat those in the baseline scenario, considering that growth constraints are domestic in nature and not external (oil prices). Our calculations indicate that even if oil prices grew after 2019, the paces of economic growth would settle within 1–1.5%. I would also like to emphasise that rising oil prices would be no remedy for the domestic problems of our economy, creating only an illusion of a swift return of prosperity. This is why we call this scenario ‘optimistic’. If we change nothing and carry on building our national wealth by exporting hydrocarbons, with wages outpacing labour productivity, as before, and no technological upgrades, then this seemingly more comfortable scenario for us to weather the storm is likely to translate into stagnation, coupled with low growth and a deepening gap with advanced economies.

Let me elaborate on the workings of our monetary policy in the conditions I have described.

Our policy priority will be low inflation. The recent polls show that inflation is invariably the most essential problem for our people. High inflation erodes household incomes, bringing about uncertainty for businesses and hindering investment. Low inflation is not an option; rather, it is the groundwork for economic growth. At the same time, we realise that low inflation in itself does not lead to stronger economic growth. This is a prerequisite, but not a self-sufficient prerequisite for economic growth.

Our monetary policy will be moderately tight for the next year and a half. The current key rate is 10%, with the next downgrade unlikely to come before the first or the second quarter next year.

Our moderately tight monetary policy currently means that we will take action to ensure that interest rates in the economy are slightly above inflation, that is, effective rates are set to remain positive. Our understanding is that interest rates at this level help economic growth rather than impede it.

There is a common misconception that a rate cut would quickly ignite growth, as loans would be cheaper to companies, while relatively high borrowing costs are becoming an obstacle for business activity.

The question is which will work better: positive effective rates coupled with low inflation or low interest rates with the inevitably high inflation they entail?

The question is also, what happens if we switch to loose monetary policy at this juncture? The stimulative effect from lower rates will only be short-lived. In the current context, reduced rates will make dollar assets more attractive and spur dollarisation with the ensuing weakening of the ruble. This will in its turn accelerate inflation and trigger a reverse trend in interest rates. Unjustified rate reduction would also come with a growing corporate debt, and this burden in some sectors is already high enough. Ultimately, a short-lived growth period would give way to a still deeper recession.

Here is why we think that positive effective interest rates will make a difference.

Positive effective rates in the economy imply the need for business to optimise costs instead of shifting them to households through price hikes.

Naturally, lending conditions will be better for more cost-efficient and competitive projects, that is, to companies which would lay the groundwork for sustainable economic growth.

This is not to say that there will be no reduction in interest rates for businesses. Businesses will enjoy lower rates but these rates would need to follow the pattern of inflation. We at the Bank of Russia believe that the reverse situation is unacceptable as rates reduced prematurely would trigger, sooner or later, a surge in inflation. In this development, it is our citizens that will have to bear the burden of low rates for businesses. The business effect in this case would also be short-lived and illusory.

There is no simple recipe to put the Russian economy on course for quick economic growth. Having said that, this does not imply that we would need to accept a 1.5-2% growth cap – we can and we should deliver faster growth.

The Russian economy is in need of a predictable business environment and a set of measures to lower uncertainty and bring about structural change. The Central Bank contributes to a more predictable environment by sustaining price stability, financial stability and banking sector stability.

An advanced and healthy banking sector, coupled with a similar financial market, is key to effective transformation of savings into investment. This is the current focus of the Bank of Russia’s policies, in its capacity as a megaregulator responsible for, among other things, a healthy financial system.

We are very much aware that some tools beyond monetary policy could and should be used to lower inflation. What we also need is a balanced budget. The rates of natural monopolies should be indexed by an amount lower than inflation. This is an important consideration as the costs of services provided by natural monopolies are an impactful cost factor. Last but not least, we need a truly competitive environment when products, better in quality and lower in price, meet no barriers as they enter the market. These non-monetary factors would combine to bring about a faster decline in inflation.

We are fully aware that it will be quite some time before all problems accumulated over the preceding years in the Russian economy have been solved. Our action agenda includes a programme to change the current economic structure, reduce our reliance on commodity exports, as well as the efforts to upgrade production facilities and increase labour productivity. We recognise that this will not happen overnight.

We have a long journey ahead of us. As we address all these problems, the coming three years will be critical to creating the entire environment for private investment, to accelerating economic growth. This is where the Central Bank will contribute, by reducing inflation, sustaining financial stability and improving financial sector efficiency.

Thank you very much for your time.

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