RENCAP COMMENT: Time for a Bolder Central Bank of Russia
November 22, 2011
By Ivan Tcharkarov, Chief Economist for Russia and the CIS at Renaissance Capital.
The Central Bank of Russia (CBR) needs to cut rates to support economic growth. We have been very complimentary about the CBR’s newly adopted policy stance to allow more exchange rate flexibility, in an attempt to help cushion the economy from external shocks (see our alert, Russia: No time to feel miseRouble, dated 15 August). However, the ever-darkening global backdrop, a now-certain European recession, significant growth deterioration in the US and a soft landing in China, all argue for the CBR to strike pre-emptively and burnish its newly crafted image of a central bank that has learned valuable lessons from the 2008/2009 crisis.
Forward-looking indicators point to a significant slowdown in growth in 2012. Consensus forecasts for Russia see 2011 economic growth at about 4.0% and next year’s economic growth at a broadly similar 3.6%, despite strengthening global headwinds. We think this is unrealistic as it implicitly assumes almost full insulation of the Russian economy from external developments. Our RenCap-NES GDP leading indicator forecasts that the pace of economic expansion will moderate significantly over the next two quarters, to about 2.0%, which is in line with our 2012 GDP forecast of 2.3% (see our report, RenCap-NES Macro Monitor, dated 15 November). While many demand-side indicators are still broadly robust, they are increasingly not being matched by supply-side indicators, with October industrial production registering its slowest growth since December 2009.
The full brunt of the global slowdown will be felt only in 1H12, so it is essential for the CBR to act now. Our estimates of how global slowdowns transmit to the economy suggest that supply-side indicators react with a one-quarter lag, while demand-side indicators, and in particular consumption, take about two-quarters to adjust (see our alert, Russia: Bear hug, dated 6 September). Hence, if we assume that views regarding global growth started to be re-priced around July/August, we can take 3Q11 as the start of the shock. If so, we would expect to see some softness in supply-side indicators as soon as 4Q11, while consumption should see a more pronounced impact only in 1H12. This is the pattern that has started to emerge and, therefore, given the time-lag involved in the transmission of monetary policy, it is essential that the CBR acts now and stays ahead of the curve.
There is a scope for at least a 50-bpt rate cut. The CBR has recently been trying to strike the right balance between maintaining growth and keeping a lid on inflation, but the deterioration of the growth outlook now argues for a more explicit recognition of the risks to economic activity, in our view. Real rates will become high by historical standards on the assumption that there will be no change in nominal rates (see Figure 1). Therefore, we think that a 50-bpt rate cut, at the very least, would be appropriate at this juncture. Lower rates would have the additional benefit of alleviating the high pressure in the money market, which has been driven by declining banking sector liquidity and strong net capital outflows (see Figure 2).
We are not concerned about the potential negative impact of lower rates on the exchange rate or inflation. Lower interest rates would decrease the interest rate differential, possibly having an adverse effect on the rouble and inflation. However, the exchange rate does not seem to us to be very sensitive to the interest rate differential, although, as expected, the degree of interdependence has moderately strengthened since mid-2009, as the CBR has moved to a policy that is more focused on inflation-targeting (see Figure 3). More importantly, we do not expect the weaker currency to lead to higher inflation, as the potential inflationary impact of a softer rouble will be offset by the deflationary nature of the external shock. This was the case during the 2009 crisis and we think that a similar pattern will develop this time around.