Speech by Elvira Nabiullina, Bank of Russia Governor, at Russian Government’s Meeting on 25 September 2014

Dear Dmitry Anatolyevich, dear colleagues, good afternoon!

Today, we offer for your consideration draft Guidelines for the Single State Monetary Policy in 2015 and for 2016 and 2017, prepared on the basis of analysis of the current economic situation and forecasts of its development. We have considered three scenarios for economic development.

The baseline scenario is built on the following assumptions:

  • a gradual recovery of global economic growth and a moderate downward trend in oil prices;
  • lower geopolitical risks and the gradual lifting of sanctions and retaliatory foreign trade restrictions;
  • no increase in a tax burden and no substantial changes in tariff policy parameters are assumed.

Under this scenario, an improvement in the expectations of entrepreneurs and investors, inflation deceleration and an easing of financial conditions will contribute to the restoration of both investment and consumer activities.

Although the development of the Russian economy amid existing structural constraints will remain inertial, in our opinion, and a significant change in structural trends will require more than one year, nevertheless the growth of investments will be promoted first of all by the implementation of infrastructure projects, including the co-operation with China in the field of energy exports. A decline in fixed asset investment is estimated to cease in 2015, and in 2016-2017 the growth rate of investment will gradually increase. An important factor in the implementation of this scenario and in the future achievement of higher rates of economic growth in general is the creation of conditions for a large-scale increase in private investment.

In 2015, a slowdown in consumer spending against the background of declining wage growth and a saturated consumer loan market will continue. In 2016-2017, we expect a gradual recovery.

The baseline scenario expects a reduction of inflation to 4.5%-5.0% in 2015, and 3.7%-4.2% in 2016-2017. GDP growth rate will rise from 0.4% in 2014 to 1.0% in 2015, 1.9% in 2016 and 2.3% in 2017. Money supply growth will accelerate. The growth rate of lending to the economy will remain at a level comparable to 2014. We expect a reduction in the current account surplus to $15 billion in 2017 and a progressive decrease in a private capital outflow.

This scenario assumes a gradual easing of monetary policy as inflation expectations will stabilize and subsequently decline in 2015. The more pronounced a downward trend in inflation and inflation expectations will be, the softer the monetary policy may become. However, a significant upward deviation of inflation and inflation expectations from the predicted path will be a basis for policy tightening, or keeping the current policy stance for a longer term.

Both under the baseline and other scenarios, we will continue using special refinancing programs to stimulate certain segments of the credit market, the development of which is constrained by structural factors, primarily the financing of investment projects, project financing. The Bank of Russia will monitor the implementation of these programs on an ongoing basis and, if necessary, adjust their parameters. In this area, we expect the Government to decide on selection rules for such investment projects. Our baseline scenario in its key assumptions is very close to the baseline scenario of the Ministry of Economic Development.

Alternative variants II and III are based on more negative assumptions.

Variant II assumes a longer effect of foreign trade restrictions, as well as an increase in a tax burden on the economy, which will lead to a larger outflow of private capital. A change in the exchange rate of the ruble will partially offset a negative influence of the external environment by supporting the economic activity through an increase in net exports, but at the same time it will lead to a higher inflationary pressure. Under these conditions, inflation will exceed the targets in 2015-2016.

In this case, the reduction of inflation will take a longer period than in the baseline scenario. Inflation is expected to reach 6.0%-6.5% in 2015, 4.5%-5.0% in 2016 and 4.0%-4.5% in 2017. The GDP growth rate will be slightly lower than that assumed under the baseline scenario: 0.9% in 2015, 1.5% in 2016 and 1.9% in 2017.

If this scenario materializes, the Bank of Russia will focus on the maintenance of financial stability and will be ready to use additional tools, including unconventional ones.

Variant III in addition to the second variant assumes a more pronounced decline in oil prices, to $87 in 2017. In this case, we expect a more significant slowdown of the economy.

The monetary policy will be pursued in such a way as to contain inflation but to prevent an excessive cooling of the economy. Under the third scenario, particular attention will also be paid to financial stability, measures aimed at preventing a lower confidence in the national financial system and the domestic currency. A wide range of tools, as well as international reserves will be used to eliminate the risks of financial instability.

The Bank of Russia is developing an additional, fourth stress scenario, which assumes a sharper and a more significant drop in oil prices in the forecast horizon. We are considering the inclusion of this scenario in the document at the next stage of finalizing the draft Guidelines.

As previously planned, the Bank of Russia intends to complete a long-term transition to inflation targeting. Why don’t we postpone this decision?

In our opinion, it is timely right now, because this regime creates conditions for reducing long-term interest rates and stimulating investment growth. In the event of pursuing a consistent policy of inflation deceleration, temporary negative factors will impact the rates on short-term rather than long-term loans and this will promote investment lending, which is so much necessary for the economy.

Thus, the meaning of inflation targeting is not just a mechanical reduction of inflation to the target, but the creation of predictable financial conditions.

Dmitry Anatolyevich, you’ve already spoken about this. Judging by polls, inflation remains not only the number one problem for the population, but becomes more and more acute. For 71% of the population it is the most disturbing problem. High inflation erodes their salaries and pensions, devalues their savings.

Last year, the Guidelines for the Single State Monetary Policy set the inflation target of 5.0% for 2014, 4.5% for 2015 and 4.0% for 2016.

Inflation influenced mainly by external and unforeseen factors has substantially accelerated, and it is obvious that the target of 5.0% set for 2014 cannot be achieved. Inflation is expected to exceed 7.5%. Nevertheless, we do not offer to change the targets set for 2015 and 2016, despite the fact that there are risks of a failure to reach them. We should not adjust the target to the fact, but explain why it has not been achieved, in which period of time and what are the factors that will return inflation to a normal path. We believe that the normal target for our economy is 4.0% and suggest making this a permanent target for the medium term.

It is also important to emphasize that the Bank of Russia does not intend to reduce inflation in the short term and at any cost, which many are afraid of. This will occur gradually over 2-3 years. Naturally, we will take into account and we are taking into account the state of the Russian economy and its development prospects.

When making decisions, we always consider the features of inflation dynamics in Russia, namely the fact of a significant contribution made by non-monetary factors. Therefore, the Bank of Russia thinks it is very important to restrict tariffs and tax innovations and inflation targeting has been also chosen because of the flexible character of this strategy. This regime allows temporary deviations of inflation from the target under the impact of short-term non-monetary factors.

Keeping inflation at the target at every instant is impossible, so we specify the most likely range, within which inflation fluctuations can occur under the influence of unforeseen factors, it is estimated at 1.5 percentage points on each side in accordance with the Guidelines.

The inflation rate of 4.0% in the medium-term is estimated as realistic without creating risks of a material cooling of the economy. Let me remind you that before inflation accelerated sharply in 2014 under the influence of unforeseen external factors, it was already close to 6.0%.

Most central banks that target inflation have medium-term objectives. The inflation target in developed countries is about 2.0%, and in emerging markets it tends to be higher, about 3.0%-4.5%. Under inflation targeting, interest rates are the main channel of the impact of Bank of Russia's policies on the economy and price growth.

We strive to avoid spikes in money market rates, and for this reason, in contrast, for example, to the period before 2009, when the exchange rate was under stricter control, interest rate fluctuations have become smaller.

The transition to a floating exchange rate regime is the necessary prerequisite for the efficient steering of interest rates. However, the floating exchange rate does not imply that the Bank of Russia completely abandons its operations in the foreign exchange market. The purpose of these operations will change, we will conduct them to ensure financial stability.

In connection with a lower rate of economic growth, the issue that is now being actively discussed is the use of monetary policy measures for its stimulation. According to a Bank of Russia estimate, a growth deceleration is largely caused by structural factors. Monetary policy cannot eliminate the impact of these factors. We cannot continue growing extensively any longer, growth can only be provided by increased productivity and efficiency. Unemployment rate staying near historically low levels and other indirect measures are indicative of this. For example, the share of part-time workers remains low, while the average rate of labor utilization is quite high.

For the time being, the growth of the economic activity is not accompanied by a corresponding increase in productivity growth rates. They remain below the pre-crisis level, so we need to remove some bottlenecks in the labor market, and to increase production and territorial mobility.

Now let’s talk on the link between monetary policy and the availability of loans. Interest rates on loans are actually high, especially for investment purposes. There are few long-term loans. However, we should be aware of the fact that lower interest rates on loans can only partially be achieved through monetary policy and require an integrated approach that includes a number of structural changes, especially in the real sector of the economy.

What can be achieved by monetary policy measures and what are we planning to do? First of all, to cut inflation. Rates will be falling to the extent of inflation deceleration.

As a rule, inflation sets the lower level of rates on loans, because it sets the lower level of rates on deposits. If we want commercial banks not only to allocate money issued by the Central Bank of the Russian Federation, but to be market institutions and financial intermediaries (which is the essence of banking), we cannot ignore this. Households and businesses will not bring their savings to banks, if the interest rate does not even cover inflation.

However, realizing that there is a chicken and egg problem and we cannot launch an investment process without cheap long money and long money will not appear without economic growth, the Bank of Russia developed non-standard tools to provide liquidity to banks: regular three-month auctions (they were introduced a year ago), annual auctions, refinancing for a year and a half at fixed rates. In spring, we approved a three-year instrument for investment projects at the key rate minus one percentage point. We are taking efforts to reduce the dependence on international rating agencies.

What is the Bank of Russia unable to do? The Central Bank of the Russian Federation is unable to directly steer bank rates. It may not force banks to issue cheap loans to borrowers if there are high risks of default, because funds should be ultimately returned to depositors. We need a set of measures that will allow the economy to offer for bank financing high-efficiency projects with a low risk of default on loans.

What is the outcome of an attempt to stimulate lending through the easiest way, through reduction of the Bank of Russia key rate? Even if commercial banks receive funds from the Bank of Russia at 4%-6%, it is unlikely that they will extend loans to companies with a high debt burden, and unclear prospects for their sales of products. If there are no well-structured investment projects, the share of investment loans will not increase, but the possibility of speculations against the ruble on account of borrowings will rise. The issued loans will flow to the foreign exchange market, and will support the outflow of capital and inflation. If this process grows in scale and creates risks of dollarization of deposits and preference to cash, the Central Bank of the Russian Federation will be forced to spend international reserves and raise interest rates. Well-intentioned measures will just lead to the deterioration of the situation.

Thus, the majority of those who propose to ease monetary policy cannot do without the necessary introduction of foreign exchange restrictions, which will be extremely negatively met by investors, who will look for ways to circumvent them. In our opinion, the introduction of foreign exchange restrictions is an inexpedient way.

In conclusion, I would emphasize once again that in accordance with law, the Bank of Russia provides for sustainable economic growth through maintaining price stability, which helps to preserve the purchasing power of the national currency, lower economic uncertainty and encourage long-term savings and investments. This is the approach we are laying into the draft Guidelines for the Single State Monetary Policy, which will now be open for further discussion. We will make amendments to them, including those resulting from the today's meeting.

Thank you for attention!

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