SBERBANK CIB COMMENT: Chief economist's view – setting elusive targets

By Evgeny Gavrilenkov, Managing Director, Chief Economist, Sberbank CIB

Although inflation remains elevated in Russia, the authorities do not appear to be overly concerned. The Central Bank increased interest rates in September by 25 bps and has repeatedly promised to switch to targeting inflation at some point, but in general the government seems to be happy “targeting” relatively high inflation and sees 5-6% as a comfortable level in the years to come. We think that the country’s persistently high inflation is one of its key problems and clearly illustrates that economic policy is far from ideal. The government appears to believe that inflation is being driven largely by external factors, such as rising global energy and grain prices (to some extent this view resembles the perceived causes of the “color revolutions” that took place in some countries in recent years). Other popular views hold that Russia’s high and unstable inflation is being driven almost solely by regulated tariff hikes or currency fluctuations. In previous notes, we have consistently stressed that inflation is a much more complex phenomenon and is largely determined by a mix of domestic policies.

Inflation reached 5.7% YTD as of October 22, and stood at 0.5% already in the first three weeks of October. Annual inflation continues to rise due to base effects (m-o-m inflation was lower a year ago), and it looks as though it will remain high for some time. It is remarkable that inflation remains high in m-o-m terms and is even accelerating y-o-y while the money supply and monetary base have seen almost no growth YTD. In recent months, inflation has stayed high despite the ruble strengthening to around R31/$1, from nearly R34/$1 in May. Although this year’s grain harvest is not as good as last year’s, it is nevertheless higher than what is needed for domestic consumption, so given this and the grain reserves left over from last year, there should be no supply shock. The government has not banned grain exports, and farmers continue to sell grain abroad. We had originally anticipated that inflation would be rather low this year and next, but now we have serious
concerns that inflation may stay high next year as well, unless there are changes to macroeconomic policy.

In previous notes, we have described the deterioration in macroeconomic policy that took place in 2Q12 as the Finance Ministry absorbed liquidity from the system by running the budget with a surplus and concurrently borrowing on the local market (in net terms) in order to build up the State Reserve Fund to be better prepared for a future crisis (we think those who are less leveraged may be even better prepared for potential instability). Overnight rates have risen 150-200 bps since the start of the year, when fiscal policy was more neutral with respect to money markets.

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