The Bank of Russia has raised the key rate to 18% and announced that it will consider increasing it even further at its upcoming meetings. Invest Foresight discussed the options and possibilities for the future key rate path with Nikita Maslennikov, Director of Economics and Finance at the Institute of Modern Development.
– What steps do you expect the Central Bank to take at its September 13 meeting? Will the key rate be hiked again? Will it remain at the same level? Lowering it is definitely not an option, this much is clear.
– I would like to believe that the rate will remain at the current level of 18%. According to the Summary of the Key Rate Discussion, the Central Bank considered two options.
The first one was to raise the key rate to 20% and keep the signal about further key rate action ‘neutral’. The other was to raise it to 18%, but give a signal about a key rate increase, which may be considered at one of the next meetings. In bankers’ jargon, this means it might be hiked again at one of the next three CBR meetings.
This is essentially why currently the probability of further hike is 50/50.
– The Central Bank explains the key rate rise with the economy being overheated and attempts to fight inflation. First, let’s talk about overheating. What kind of beast is it?
– Overheated economy is an actual term meaning that the economic growth rate has been steadily, or for several quarters, above the potential product output. And this is exactly what we are experiencing.
– Is this a serious problem?
– Yes, it is, because in addition to being a deviating upward trajectory of the domestic product macrodynamics, it also means high inflation. It is the root cause of why the inflation rate was accelerating during the first half of the year.
Naturally, all these factors contribute to significant disparities in industry dynamics. While it’s true that the entire sector has slowed down, the extent varies – some sectors have decelerated more than others. The real risk of overheating lies in the fact that once it’s overcome, the economy could slip into stagflation. In this scenario, growth rates drop sharply, by roughly half, while inflation remains persistently high, staying above the target level.
– How can stagflation be overcome?
– To begin with, it’s important to note that emerging from stagflation can take years. Historically, the only sure way to break out of an overheated economy has been through a deep recession.
However, such a scenario is undesirable given our social, defense, and other commitments.
This is why we need to gradually and systematically ease the overheating. Recognizing that growth will slow significantly next year, the Central Bank projects an increase of just 0.5% to 1.5%, while the median forecast from analysts is no higher than 2%.
Next year, will expect to remain at about the same level – yet, the official inflation rate is likely to decrease to 5-5.5%. And next we need to take efforts to build the mechanism for stimulating private investments.
– Why is this necessary?
– These investments are required to secure the growth in the coming years until 2030. Developing the mechanism is the regulator’s major task aimed to boost investment.
– Does the rate help curb inflation or are there other equally efficient tools, both in Russia and globally?
– These include any measures that help reduce the supply and demand gap. The rate dampens loan activity while increasing the return on savings, which is necessary but highly insufficient.
We need to boost supply, which is rather hard to achieve amidst the current conditions; for instance, we just did exactly the opposite by raising taxes. Therefore, we are observing moderate preferential loans, whose effectiveness is yet to be assessed. We need to set clear goals and choose certain projects to incentify as part of major national projects aimed at securing technological sovereignty.
And obviously, we need investment incentives, which are currently non-existent as a consistent policy. We have yet to decide as to which industries and investors will enjoy federal income tax deductions, with the said tax amounting to 17% when fully imposed.
There is no certainty and no general clarity as regards the extent we can utilize this incentive. Initial plans included RUR 300 bln, which is obviously highly insufficient.
– The Central Bank sets the inflation targeting at 4%. Why this particular figure? Why not 3% or 5%?
– There is no clear explanation. However, Russia’s experience has shown that the inflation rate at 5% and higher results in the lack of investment growth. What we are observing is a stretch to a certain extent because there is a very high potential inflation: we purchase machines and equipment for large amounts of money while those are actually similar or maybe even lesser volumes.
And obviously, there is the special military operation underway, with production of advanced military equipment counted as investment.
Without all these factors, judging by our country’s experience that we have gained since the 1990s, we need the inflation rate at 4-5%, which is a more or less adequate figure.
In general, each economy across the globe has its own indicators. Europe and the United States have it at 2%, but there are slightly different calculation methods that involve correlation between inflation and unemployment. Basically, factors are plentiful.
The Central Bank calculates these indicators based on the level of responsibility entrusted by the government.
Discussions are currently underway; some say the inflation rate amounting to 6% is still adequate, while others claim that we require it at 3%. Only actual events can prove either scenario to be true.