Too much money
The Board of Directors of the Bank of Russia following the meeting of 29 July 2016, left the key rate unchanged at 10.5% per annum and kept a moderately rigorous approach to the conduct of monetary policy.
The Central Bank decision coincided with the opinion of most experts, who took part in the survey by Bloomberg, while this conservatism is likely to come as a disappointment to a number of business representatives, economists and politicians, far from understanding the mechanisms of functioning of financial markets.
What makes the Bank of Russia to carry out such a conservative monetary policy? The answer to this question is given in the published press release of the Central Bank, but something that remained outside of the official reports. So, the Bank of Russia in its publication marks a pause in the decline in inflation expectations, the balance of real (inflation-adjusted) interest rates, the heterogeneity of economic activity across sectors and the uncertainty of future fiscal policy.
Currently, the liquidity of the Russian banking system has improved markedly, the volume of refinancing of credit institutions by the Central Bank is limited to relatively low demand of the banks themselves, therefore, the level of the key rate has no direct effect on lending to the economy.
Moreover, the country continues to process a credit crunch and a further fall in investments. Banks have reduced loan portfolios and accumulate excess liquidity, as it is not able to adequately assess the risks of their clients and debtors increasingly difficult to find collateral for Bank loans.
The capital market clearly shows that companies and corporations with high credit quality, however, and the Ministry of Finance may, by issuing bonds, to attract long-term money at rates significantly lower than the current key rate of the Bank of Russia.
And the only thing in this situation is to do the Bank of Russia is to ensure the stable operation of the banking system and try to avoid drastic action so as not to cause turmoil in the financial markets.
The core of the economy
The first time almost two years from the press release of the Central Bank disappeared the word “oil”, but while it is obvious that the dependence of budget revenues from prices for hydrocarbon raw materials is still high, although the problem is not as acute as six months ago. Besides Russia’s oil exports for the first half of 2016 increased by 5.8%, was sold to a record of 116.4 million tons, partially offsetting the reduction in the cost of a barrel in ruble equivalent at the expense of volumes.
But the instability of oil trends clearly manifested in July, negatively affects the dynamics of the Russian ruble. The Russian currency can not respond to almost a 20% reduction in the cost of a barrel of oil with respect to the June highs.
The current fall of the ruble may help to reduce the budget deficit, but it also increases inflationary expectations, which has been shown in the past year, increase in proportion to the weakening of the Russian currency.
In this difficult situation it is key rate is now the rod that holds the financial markets together with the economy stable, despite the negative dynamics of oil prices, further decline in the ruble against the dollar, the uncertainty of fiscal policy and inflationary expectations. A significant difference in percent on ruble-denominated instruments and interest rates on foreign currencies largely compensates investors with current risks.
Hasty reduction by the Bank of Russia key rate could trigger a significant outflow of speculative capital and a new wave of dollarization of assets of legal and natural persons, and not economic growth.
For a start, economic growth is necessary to create favorable conditions for attracting investment and the formation of available credit and investment resources from domestic sources and on a long term basis. Only one monetary policy and the money supply start economic recovery impossible. Maintaining the key rate at the current level aims to stimulate savings, which will serve as source of investment credit.
A weak ruble is preventing the update of the industry, reduces effective demand and harm financial stability, and a strong ruble creates the problem of financing the budget deficit. The task of the Bank of Russia is just search “Golden mean” in the foreign exchange market and the reduction of inflation.
Therefore it is better to manage expectations and maintain the market’s confidence that the future rates will decline and with it, the Bank of Russia copes than to provoke the attack on the ruble speculators, and profit in Russian bonds.
Importantly, the Central Bank has not abandoned the principle of the floating of the ruble and does not try to influence the exchange rate intervention, because monetary policy cannot be effective in the artificially formed or fixed exchange rates. A moment to reduce the key rate still will come, no doubt.
The authors ‘ point of view, articles which are published in the section “Opinions” may not coincide with ideas of editorial.