Statement by Bank of Russia Governor Elvira Nabiullina after the Board of Directors meeting held on 14 February 2014

The Bank of Russia Board of Directors has decided today to keep the Bank of Russia key rate unchanged at 5.50% per annum, which means that the regulator will maintain its current monetary policy stance. The decision is based on the analysis of current trends in the economy and a medium-term inflation outlook, as well as the forecast of external and internal conditions. We believe that the current level of the key rate corresponds to the task of decreasing inflation rates to achieve the target of 5% by the end of the year. Meanwhile, the risks are high that this inflation target may be exceeded, mainly due to a possible growth in inflation expectations, including those related to the recent rouble’s depreciation. We will analyse ongoing developments and will be ready to tighten monetary policy, if inflation risks intensify.

The Bank of Russia has updated its baseline economic scenario, which takes into account the impact of external and internal economic factors on production activity and inflation.

External factors had a restraining effect on the Russian economy in 2013. This trend will continue in 2014 amid slack demand and the absence of growth in prices for Russian exports. Nevertheless, Russia is expected to maintain a current account surplus.

International investors’ interest in emerging market assets, including Russian financial instruments, declined noticeably in late 2013 — early 2014 for a number of reasons. First of all, growth recovery that began in the major advanced economies coincided with some slowdown in economic growth in emerging market countries. Secondly, the announcement by the US Federal Reserve that it would scale back its asset purchase programme had a strong impact on market sentiment. Therefore, global factors largely influenced capital flows. As a result, emerging market currencies, including the Russian rouble, weakened in 2013 — early 2014.

Our estimates suggest that the impact of the rouble’s depreciation on inflation remains moderate: this factor contributed 0.3-0.5 percentage points to inflation in 2013. We estimate that the decrease in rouble’s exchange rate, which occurred in January — early February 2014, may potentially contribute about 0.5 percentage points to inflation. However, the exchange rate’s full contribution to inflation will depend on exchange rate dynamics throughout the year. We believe that, aside from domestic factors associated with the growth rates of the Russian economy, the following heterogeneous factors will influence exchange rate dynamics in 2014: 1) the policy pursued by the US Federal Reserve and the European Central Bank, 2) the rates of economic growth and financial sector risks in China, 3) portfolio rebalancing by investors, and 4) the situation in world commodity markets.

Turning to domestic economy, growth in Russia decelerated in 2013. Investment dynamics made a negative contribution to GDP growth rates, in addition to the restraining effect of external demand. Consumer activity remained the main driver of economic growth but the growth rates of domestic consumer demand declined. While the unemployment rate was low, other indicators pointed to the lower intensity of workforce utilisation. In particular, part-time employment, the number of unpaid leaves and wage arrears increased. Nevertheless, the state of the labour market, along with other factors, indicates that the reasons behind slower economic growth remain structural rather than cyclical.

Taken together, these factors caused a reduction in GDP growth rates from 3.4% in 2012 to 1.3% in 2013. The actual GDP growth figures deviated from our baseline forecast of 1.8% made in the Monetary Policy Guidelines as demand restrictions were greater than we had estimated. In particular, fixed capital investment and inventories dynamics made a larger-than-expected negative contribution to GDP growth.

GDP growth rates are expected to be higher in 2014 than in 2013 and reach 1.5-1.8%. Domestic consumer demand will remain the main factor supporting economic growth but it will be restrained by moderate growth in household income and a slower increase in consumer lending. Fixed capital investment growth is also expected to recover to some extent, inter alia, due to the impact of budgetary spending. The dynamics of lending to non-financial organisations are not a factor restraining economic activity. The current baseline forecast differs from the forecast outlined in the Monetary Policy Guidelines, which can be explained by weaker 2013 results. The slightly negative output gap is expected to persist in 2014, which will have a restraining effect on inflation.

Money supply growth rates stabilised in the second half of 2013 and returned to relatively low levels in early 2014. The annual growth in the monetary aggregate M2 slowed to an estimated 12.8% as of 1 February 2014, which is just slightly above the 2012 annual growth of 11.9%, the minimum in the past four years. The current money supply growth rates conform to inflation targets in the medium term, while their decrease is a natural pre-requisite for the economy to move to lower consumer price growth levels.

And now finally we need to talk about inflation. Following the acceleration of consumer price growth in the last quarter, inflation reached 6.5% in 2013, exceeding the upper border of the target range (5-6%). The inflation surge in late 2013 was due to the growth in some food prices resulting from unfavourable harvesting conditions in the autumn of 2013 and the secondary effects of the 2012 poor harvest. Estimates show that this factor contributed 0.5 percentage points to inflation acceleration in 2013.

The Bank of Russia considers that consumer price growth acceleration in the fourth quarter of 2013 to be a temporary phenomenon. This is confirmed by lower inflation figures released in early 2014 (the CPI was estimated at 6.1% as of 10 February). At the same time, weak business activity and low aggregate demand restrained price growth. Non-food prices, as well as producer prices demonstrated slower growth rates in 2013. Core inflation did not change substantially during the second half of 2013, staying in the range of 5.5-5.6%.

Therefore, the ongoing trends in the Russian and global economies testify to the existence of pre-requisites for a gradual inflation slowdown in Russia. Aggregate demand is unlikely to exert an upward pressure on prices in 2014. The prices of goods that soared in the fourth quarter of 2013 will exhaust their influence on consumer inflation in the first half of 2014. The lower growth rates of administered prices and tariffs as compared with last year will also have a restraining effect on inflation. We estimate the contribution of the exchange rate dynamics as moderate in the baseline scenario. Our estimates show that dynamics of monetary indicators will not exert an inflationary pressure. Under the Bank of Russia’s baseline scenario, inflation will reach its target by the end of this year.

At the same time, there are significant risks of inflation exceeding the target. These risks are associated with the so-called secondary effects of the temporary increase in the prices of some goods and the rouble’s depreciation, as well as the dynamics of inflation expectations. The results of the February survey of household inflation expectations and consumer sentiments conducted by the Public Opinion Foundation do not allow at present to make an unambiguous conclusion about lower inflation expectations. If pro-inflationary factors begin to exert their influence on the prices of a wide range of goods and services and household expectations, creating risks for achieving medium-term inflation targets, we are ready to tighten monetary policy.

Today the Bank of Russia Board of Directors has also taken another decision which will enable the Bank of Russia to better achieve its monetary policy operational goal, namely, to maintain the overnight money market rate close to the Bank of Russia key rate. The Bank of Russia included fine-tuning deposit auctions into the system of its monetary policy instruments.

Fine-tuning deposit auctions are designed to manage liquidity in the money market in cases when the supply of liquidity considerably exceeds the demand for it. This instrument is functionally similar to fine-tuning REPO auctions, which are used, on the contrary, when the demand for liquidity considerably exceeds its supply.

Fine-tuning deposit auctions, like fine-tuning REPO auctions, will be held at the Bank of Russia key rate.


Media Question and Answer Session


You have noted that current credit dynamics will not evidently hamper the growth of consumer demand in the first half of the year. At the same time, the inflation target may be reached by the end of the year. Lending growth rates are expected to slow down to 20-25% in the first half of the year. Will they be correspondingly lower in the second half-year? What is your estimate?


When I said that lending dynamics was not a limiting factor for economic growth, first of all, I meant lending to non-financial organizations. It remains at the last year's level, which is approximately 12.7%. This is a fairly high rate of growth in lending to non-financial organizations. But there will be a slowdown in consumer lending. It has taken place this year, and it primarily concerns unsecured consumer loans. We plan for the growth rate to be at the 20-25% level next year, and this rate is also rather high and exceeds the growth rate of household nominal income, that is why it makes a positive contribution to economic growth.

In regard to inflation, we do not see any risks in these growth rates of consumer lending. In our opinion, this is a balanced dynamics that does not create any additional risks for financial stability.


It was suggested that a rally of the rouble, not even the rally, but its depreciation, would end before the Olympics began. The Olympics are going on, but the rouble is still losing its value. A large game was under way the last two days. It might be caused by domestic factors, and the Bank of Russia was expected to raise rates and change something.

Do you believe this depreciation will stop or will the external factors that also have a big impact continue putting on the pressure? And for how long?


The rouble exchange rate and exchange rates of the other emerging markets’ currencies are in a zone of certain volatility. They are effected by global factors, including expectations and the actions of international investors. This is one of the key factors.

Second. We should take into account the state of the Russian economy as well. We realize that higher economic growth rates in the medium-term perspective may lead to the appreciation of the rouble.

We have diverse and multidirectional factors affecting the exchange rate. The combination of these factors will determine rouble fluctuations.

I think the Olympics are too much to be discussed, though the Olympics have the least impact on the rouble exchange rate. Much less than the other factors that we have talked about.

That is why we pursue exchange rate policy that was announced earlier according to established rules, mitigating short-term fluctuations. We are going to continue this policy, increasing the flexibility of the exchange-rate regime, so that by the end of the year we can move towards an inflation-targeting regime.

I would like to repeat once more that our main objective is to reduce inflation. Therefore, we adhere to this policy.

Now let’s talk about the possibility of increasing rates. Actually, some countries have raised interest rates, in particular, emerging market countries have done it to curb the depreciation of their currencies.

It should be mentioned that these are countries lacking sufficient foreign exchange reserves. It is difficult to assess the efficiency of this policy. It will take some time. But it is important to realize what influenced the exchange rates of these countries apart from interest-rate decisions.

When we speak about the possibility of tightening monetary policy, we do not mean we should use it for reducing exchange rate fluctuations. We will switch over to tightening monetary policy if inflation risks materialize. These risks exist.

In our view, it is premature to raise rates because these risks have not materialized yet. At the same time, we realize that an interest-rate decision should be balanced and take into account effects on economic growth. As the national economy is experiencing rather sluggish growth, higher rates may suppress economic growth.

Therefore, we deem it necessary to follow the situation and will make this sort of decision in the event there is an increased risk of inflation and its target is exceeded.


A question concerns the Kazakhstani tenge. There is much talk about it. Will the devaluation in Kazakhstan impact the Russian rouble? And are the currencies of other emerging markets, including the Russian rouble and Ukrainian grivna expected to depreciate?


We believe that the depreciation of the tenge will not effect the exchange rate of the rouble. But it may have a slight impact on the trade between our countries, although the turnover for the Russian economy is not very large, unfortunately. We hope that the trade relations will develop within the Customs Union.

Exchange rate fluctuations are observed in other emerging market countries. We will monitor it.


The Bank of Russia does not intend to abandon plans for moving to a floating exchange rate. But tell me what fluctuations are expected on the market in this environment during the year? I do not mean the specific year of 2015. What range of the rouble movements is possible on the whole?


The range may vary. And I say again that the Bank of Russia is not going to shift deadlines and reschedule the transition to the inflation-targeting regime. But the inflation-targeting regime in itself does not mean a total refusal from currency interventions. We have decided that currency interventions will be carried out if we see any threats to financial stability.

How will these currency interventions be carried out? Many countries that have adopted the inflation-targeting regime do not abandon currency interventions. And in fact, there are two ways of conducting them: ad hoc, when a situation occurs, a decision is made to carry out currency interventions out of necessity, or they are conducted according to specific rules.

We discussed this problem at the Bank of Russia. We deem it expedient to establish some rules specifying terms and conditions of carrying out these interventions to maintain financial stability. They should be clear and predictable for economic agents and households.

The allowed depth and fluctuation or movement of the currency depends upon the fact if this movement constitutes a threat to financial stability. Therefore, we will make a decision on this assumption.

In my opinion, it is not so bad. And we already see positive dynamics as compared with many cases in previous years, when households and enterprises strongly reacted to exchange rate fluctuations and made large purchases of foreign currency, in particular. This reaction still exists, but much weaker than it was before, because if you live and work in the rouble economy, your incomes and expenses are, correspondingly, denominated in roubles.

I'm talking about citizens and businesses. Inflation is much more important for them.

Therefore, we believe that by moving to inflation targeting, we will remove such risks, including the risk of sharp exchange rate fluctuations.

In addition, businesses can hedge exchange rate fluctuations, using some market instruments. The latter should be developed and are already being developed. It permits these risks to be removed.


You said that if you increased rates, it would not be for the sake of supporting the rouble, but for reducing inflation.

Are there any other instruments that the Bank of Russia may use on the foreign exchange market? In particular, is it possible to set currency swap limits and increase currency swap rates, because many analytics say that some banks put pressure on the rouble with the help of these instruments?


We have not considered this instrument. We think that if we make a decision, it would be better to raise the key rate. Undoubtedly, there is some real inconsistency. On the one hand, we conduct interventions and sell currency, on the other hand, and we provide refinancing, when buying it. But it is the inconsistency of the transitional period. We are not going to solve it by artificial methods. We will solve it gradually as we pass to inflation targeting and increase the flexibility of the exchange-rate regime.


Is the introduction of new "fine-tuning" instruments, namely additional deposits, and a decrease in the value of loans against non-marketable assets at the February auction connected with a tendency to limit a rouble liquidity flow to the foreign exchange market? Or are there any other reasons?


As far as deposit auctions are concerned, we introduced them to supplement our set of instruments that have impact on interest rates.

We have a respective liquidity provision instrument, such as repo auctions. When there is liquidity shortage, it may be used pointwise. It is not a standing facility, but a "fine-tuning" instrument that is applied depending on the liquidity situation.

The same instrument is necessary for the absorption of liquidity in cases of its unforeseen surplus.

This does not effect the exchange rate in any way. It is just to complete our set of instruments.

Now, let's give an eye to refinancing against non-market assets. We reduced the value of funds provided at these auctions from 500 billion to 200 billion based an analysis of liquidity demand. It is absolutely normal. No other measures were taken. We have an established procedure specifying analysis and forecasts for liquidity requirements and the application of various instruments. We have been developing this instrument and we will continue to do it, because we make market collateral available for the inter-bank market in such a manner. These auctions of refinancing against non-market assets do not create excess liquidity in any way.

When we hold an auction for providing liquidity against non-market collateral, we simultaneously make a decision on reducing liquidity provision using repos. Therefore, there is no excess due to these operations, just as a special decrease in liquidity does not occur if we reduce the value of funds provided. All is based on demand assessment.


The Bank of Russia is being criticized for pursuing the policy of banking sector rehabilitation simultaneously with the transfer to inflation targeting.

How could you comment this? Do you think that these processes can be rebalanced if they do lead to the destabilization of the financial system, as your critics allege?


Surely, I do not agree with this. I believe these tasks may be solved simultaneously: to rehabilitate the banking system and transfer to the inflation-targeting regime. Incidentally, the rehabilitation of the banking system and increased confidence that reliable and stable banks operate in a banking sector will create more confidence in the interbank market. When we say that the interbank market is undeveloped, this is not only a matter of collateral shortage, but low confidence between banks.

Stricter supervision and higher confidence in banks’ health will have a positive effect, to my mind.

Let's proceed to inflation targeting and a possible inconsistency. Usually matters of liquidity provision and bank liquidity shortage are discussed. It seems to me that we can and do balance these tasks. Liquidity provision to the banking sector is a key task of financial and banking stability. I believe it is a jointly solvable task.


The Bank of Russia notes that it may tighten its monetary policy if inflation substantially shifts from the target. Does this shift equal to 1.5 percentage point from the target?


We proceed from the fact that inflation will gradually decrease during the year. In the first half of the year, it will be range between 5.8% and 6.1% and at the end of the year it will drop to 5.0%. I have already mentioned the factors that would influence these dynamics. One of the factors that we cannot evaluate in full is how recent depreciation of the rouble exchange rate and its future movements will impact inflation expectations and goods prices. And it is medium-term inflation and not a short-term spurt in inflation that is of importance to us. When we transfer to inflation targeting, we should ensure a steady decline in inflation.

As far as the transfer effect is concerned, it has decreased. The factor that has reduced the transfer is growing competition on the domestic market, though it is insufficient, including competition from imported goods. It also concerns consumer goods.

Then we will examine what channels and goods such effect will be transmitted through, as imports account for 44% of retail trade turnover on the whole, foodstuff imports for about 35% and non-food imports more than 50%. We will be looking into this effect depending on internal competition.

In addition, we import not only from countries where currencies appreciate, but also from countries where their currencies depreciate as quickly as the rouble does or even faster. However, the competitiveness of imports from these countries will not necessarily rise.

All these effects should be examined and measured (I have not mentioned all of them) in order to realize whether this inflation risk materializes.

But I would like to emphasize once more that to make a decision on a rate hike in advance is also incorrect, given the dynamics and growth rates of the national economy.


Ms Nabiullina, have I got right that the Bank of Russia has reviewed its baseline forecast that is given in the Guidelines for the Single State Monetary Policy? If so, what other indicators have been reviewed? Is the GDP growth of 1.5%-1.8% already a revised and reduced forecast?


Yes, it is a reduced forecast, and the decrease is based on last year dynamics that were much weaker than we predicted.


And what about capital outflow?


It is the most difficult task to forecast capital outflow, which we assumed to decrease in 2014. We hope that this forecast comes true. We do not have reasons to review it so far. Too little time has passed - one month, a month and a half. And unfortunately, this indicator is quite indefinite.


A question to clarify "fine-tuning" instruments related to deposits.

As I have got, it is not closely connected with the exchange rate. Nothing special happens with demand for credit either. Have I got right that that excess liquidity emerged when large banks and major players on the market faced some unplanned inflow of liquidity amid repairing the banking sector?


You are talking about a situation that might arise now. But we are discussing the instrument that will be used in any situation where by virtue of some circumstances this unpredictable excess liquidity may emerge, including excess liquidity in individual banks. It may emerge due to uneven provision of resources by the budget system. You know that allocation is uneven there.

When we see this deviation or a large excess, we will make a decision on holding this auction based on specific data. The decision will be taken on the date when the auction will be held, that is to say, it is a response to an absolutely short-term situation.


Please tell me, has the Bank of Russia ever measured rouble volatility? If yes, what is the volatility forecast for 2014?


Volatility forecast does not exist. We do not manage the exchange rate. We mitigate short-term fluctuations when they arise.


The law on the representative offices of foreign banks is already adopted. The top managers of these offices are to submit their CVs to the Bank of Russia. Will this boost investment? Or what is this measure taken for?


I may answer this question, though today we are discussing monetary policy issues. This decision is taken to provide a registration system convenient for banks and their representative offices. It is done for the regulator to know what representative offices of which banks we have, what type of people they are, and to provide transparency. Higher transparency always increase investment potential.


Talking about inflation risks you said that you allowed the possibility of raising interest rates if the former materialized, but analysts still expect the rates to be reduced in the fourth quarter.

To what extent may the rate reduction scenario realized taking account of inflation risks you spoke about? Is there any economy slowdown target the achievement of which makes you think about rate reduction? Thank you.


We make decisions on rates based on an analysis and forecast, not only a short-term, but also medium-term forecast of many indicators, first of all, inflation. Second, we take into consideration economic growth, unemployment, use of production capacity, and risks impacting these factors.

It is always a balanced decision. Mindful of the above, we think that inflation risks have materialized much more. That is why we stated that monetary policy tightening was possible. At the moment, we do not see a high probability of monetary policy easing. Everything will depend on how the situation will develop and the balance of different trends will be formed, both in the real economy, and in terms of inflation. I am not able to give any specific forecast for the year.


Recently the Bank of Russia has decided that the key rate is a 1-week repo rate, not the refinancing rate. We will be getting closer to it. This decision was aimed at improving Bank of Russia interest-rate setting mechanisms. Are there any estimates that determine if these mechanisms work better and to what extent? Or it is possibly to make only long-term estimates, isn’t it?

And the second question. On September 1, a provision of the Bank of Russia Law came into force stipulating, among Bank of Russia objectives, maintenance or promotion of economic growth. For the present, we see only the review of the economic growth forecast. Do you consider this objective nominal? If you consider it real, in what time period may the Bank of Russia make an impact on economic growth, even if an indirect one? Thank you.


Really, the improvement of the Bank of Russia system of instruments was aimed at making the so-called transmission mechanism, including the effect on money market rates, more efficient.

It is probably too early to make final conclusions. But we already see some positive moments. As far as the refinancing rate you mentioned is concerned, it was always used as a reference for the money market, as liquidity was not available at this rate. The refinancing rate was mentioned in laws, documents, and agreements when government support instruments were fixed to it.

Now, the refinancing rate seems to be a real reference rate. As far as a transfer to a 1-week repo is concerned, banks are moving to this mechanism successfully enough, i.e., managing their liquidity and balances. For the two weeks this mechanism has been in place, we have not had any need in "fine-tuning" operations. For this reason, we regard the movement as positive. We hope that it will continue to be positive.

Let's go over to economic growth and objectives. Actually, one of monetary policy objectives is promotion of economic growth. In our opinion, we help meet the challenge by reducing inflation. Economic growth can be boosted by solving structural problems, first of all increasing investment, and improving an investment climate. Inflation reduction is just one of the key elements of the investment climate and macroeconomic stability that help investors make long-term forecasts.

We consider it as our main task and contribution to economic growth.


Early in the week, the new head of the US Federal Reserve reported on monetary policy for the first time. Have you studied her report and ever seen anything that may influence Bank of Russia activities?


In general, I scrutinize the statements made by the heads of major central banks, as their policies impact global economic processes and processes that occur in the Russian economy, since we are an open country. But our situation is quite different. The origin of our problems and imbalances is absolutely different compared to the United State of America. Nevertheless, I study their resolutions. We assess their possible impact on the Russian money and FX market.


And what are the conclusions?


The conclusions are spoken in Bank of Russia interest-rate decisions, the grounds for decision-making and will be made in the Monetary Policy Report. It is a large report that is to be published on Tuesday. We gave a detailed description of the situation development, its qualitative assessment and our short-term and medium-term forecasts. It is the basis for our decision-making. The Report describes main results and trends that are of importance in decision-making.


One more question about the rouble, if you allow me.

Tell me please, has the rouble, according to a Bank of Russia estimate, reached its balanced value?


Fair, unfair, overvalued, undervalued, sort-term, long-term…

In terms of the current account, the rouble is somewhat undervalued, to my mind, but the factors that I have mentioned before will surely exert an impact on the exchange rate movement. It is the situation on global financial markets, the Fed's and the Eurosystem’s policy of quantitative easing that is of great importance, as well as the terms and depth of portfolio adjustment by investors. We should follow developments in China and, of course, in Russia, namely economic growth rates and the dynamics of the current account and exports and imports. All these factors will have an effect on the exchange rate.

These are the main points for a brief reply.


I would like to return to the devaluation in the ex-Soviet space and ask aren’t you afraid that rouble movements may trigger a cycle of competitive devaluations in the ex-Soviet space and damage integration processes? In your opinion, how stable is the situation when the rouble is in a free float while the currencies of trading and integration partners are generally fixed?


I do not see a great risk in such competitive devaluation or currency wars. In fact, the development of mutual trade is impacted by a large number of factors, and not only by the exchange rate. The member countries of the Customs Union have different tax systems, this is one of the main factors. Consequently, creating a level playing field for competition in every respect is a task for the Customs Union development.

So, I do not see any large risks in terms of currency competition.


Are you discussing different regimes?


Indeed, we have different regimes. But we discuss at quarterly meetings with our colleagues from the National Bank of Belarus and National Bank of Kazakhstan the situation and forecasts in order to mitigate negative effects that might appear due to different policies. But each country has its own rate of transition to the optimal foreign exchange regime.

We do not have a harmonized exchange rate policy yet. It is a task of a longer term, and different level of integration.


Taking into account the fact that the Bank of Russia supports the rouble to a little degree, all the time reducing the level of support, but still supports it, and this attracts speculators to the market, is there any possibility of the rouble free float to remove this imbalance by 2015?

Thank you.


I have already spoken about these inconsistencies and a certain imbalance. There are some allegations that the Bank of Russia has exited the FX market, but come back. I hope that those who know our rules of exchange rate policy, do realize that we acted strictly in accordance with the rules and depending on where the rate was within the band and whether it reached the upper border.

These rules are changing due to the move to inflation targeting and higher flexibility of exchange-rate setting. Every change is accompanied with a press release. These changes are done gradually.

We do not consider it necessary to make them as one-time action, as we have promised to gradually move to the floating exchange rate this year. So, we are moving to it. In my opinion, it is more important that the foreign exchange policy is predictable, consistent and transparent. One should not change the rules based on how much the situation changed.

These rules were actually developed several years ago. I am sure that the authors of the rules understood that the fluctuations which we observed, might happen. The rules are able to work efficiently with such fluctuations and we, in my opinion, now observe this.

Statement by Bank of Russia Governor Elvira Nabiullina after the Board of Directors meeting held on 14 February 2014