I continue to wonder who Bank of Russia President Elvira Nabuillina works for. Seriously. On Friday, in response to solid growth in Russian economic statistics over the past few months, Nabuillina again raised interest rates 0.25%.
She still adheres to idiotic IMF-style ‘inflation targeting’ dogma.
Price inflation in Russia finally got off the roughly 2.5% mat in August steadily rising to 3.8% in November. This prompted Nabuillina to raise rates again, stifling growth which itself was stifled by her overly-cautious rate cutting earlier in the cycle.
The recovery in Russia after the Ruble crisis of 2014/15 was exasperated by her holding interest rates too high for too long. The Russian bond market took way to long to normalize because of this lack of liquidity.
In 2017 and early 2018, every time the Bank of Russia cut rates the Ruble would strengthen, that’s how high demand was for them. The Russian yield curve was approaching normalcy.
And Nabuillina is now, again, undermining it by trying to control price inflation as opposed to letting the market regulate itself.
The short-term Russian bond market is screaming for some relief and the Bank of Russia won’t accomodate. Remember, inflation in Russia is running just 3.8%, so we’re talking a positive real yield on overnight money of 4%. This is not making it easy to liquefy a growing economy. Real yields of 4% on 3 to 5 year money? Ok.
But overnight? I’m all for a cautious central bank that does not inflate massive bubbles but I’m also not for a central bank to do the bidding of a country’s adversaries either by undermining growth with needless austerity.
Central Bank Fallacies
Inflation targeting is not the role of the central bank, if it has one at all. The central bank, at best, should simply exist as a lender of last resort when the banking system is illiquid and needs a temporary backstop to clear interbank markets during times of stress.
The issues we face today in the West evolved directly out of The Fed abandoning that role and becoming an active participant in the market. On this I agree with Martin Armstrong, who has strenuously argued for a return to that original central bank model.
I disagree with him about the need for a central bank in the first place. All they do is introduce moral hazard into the banking system. Banks use the backstop to lever up too far during booms and implode that much more quickly during busts.
Welcome to Austrian Business Cycle Theory 101, folks.
Central banks are truly solutions in search of a problem. In fact, like all government interventions, they foment the very chaos they were designed to assist in controlling.
But, back to the point about who Nabuillina actually works for.
Because here’s the problem for Russia. They are under attack from all angles by the West, but especially financially. Being slow to react to an improving economy in 2016/17 kept Rubles expensive domestically versus zero-bound rates for euros and dollars.
With Putin actively pursuing a de-dollarization policy, the central bank through interest rate arbitrage discouraged de-dollarization of the Russian economy.
Now, sanctions, a stronger dollar and lower oil prices putting upward pressure on the ruble. Nabuillina is combating incipient inflation from a higher ruble by raising rates before the real recovery gained traction.
Wage Growth has fallen all year, disposable income is still flat, so consumer spending growth is sluggish. These are all signs of a recovery stifled by too high a cost of domestic capital.
And U.S. sanctions are making it difficult for Russian small businesses to get access to relatively cheap funds. It’s one thing when your adversaries are screwing you over, it’s another when your central bank is doing the same thing.
What she’s responding to now is continued weakness in the Russian Treasury’s ability to raise funds through bond auctions. Again, something that is not the Bank of Russia’s problem.
Because of U.S. pressure and uncertainty demand for Russian sovereign debt is lower than it should be. It has nothing to do with an overheating economy that needs growth slowed down.
But, the central bank has no control over the long-end of the yield curve. That’s the markets function.
Had she lowered rates to 6.5% or even 6% earlier this year, the yield curve wouldn’t still be broken, the demand for rubles domestically would be higher mitigating the effects of a weaker ruble.
This is not to say Russia is vulnerable to capital flight relative to the rest of the world. It isn’t. Despite Nabuillina’s mistakes Russia is in a very good position to accept inflows of foreign safe-haven capital in 2019 on political unrest in Europe.
But, by keeping interest rates too high she is encouraging that capital inflow at rates which are far more expensive than they should be. This is especially true looking ahead to a global slowdown in 2019 which will be bad for oil prices.
IMF-style austerity is not a benefit to emerging markets like Russia. It is a destructive dogma that overestimates the central bank’s ability to improve the economy through manipulating interest rates.
Nabuillina should have cut rates to 7% and backed away. She should do so now and stop tinkering with rates to please foreign ratings agencies that will downplay Russia’s fiscal position anyway for political purposes.
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