Step to fine-tuning: Russia's Central Bank moving to cautious easing

Consolidating the stabilisation effect of fiscal injections

“We have moved to our standard step in changing the key rate," Elvira Nabiullina said in a detailed commentary on the decision of the Bank of Russia to reduce the key rate to 4,25% per annum on 24 July. According to her, more fine-tuning of monetary policy is needed now, in contrast to the “coronavirus” spring, when more decisive actions were justified. “In general, we believe that there may still be room for monetary policy easing," she said.

The head of the Central Bank does not rule out that the key rate may be revised again at the September meeting. “We will see how much we can take advantage of this, based on how the situation in the economy will develop, and we will evaluate all incoming data," Nabiullina said, answering the question from journalists about the likelihood of another reduction. At the same time, she once again repeated that the effect of the Central Bank's actions is not instantaneous but works with a time lag for several quarters.

It is expected that the Central Bank's measures should consolidate the stabilisation effect that was achieved through immediate budget injections into the economy in the spring of this year. “This year, the government has expanded budget expenditures more significantly than the budget rule suggests, in order to support the economy and citizens at a time of a powerful negative shock," said Elvira Nabiullina. “And this is absolutely justified, especially at the initial stage of the crisis. At this point, fiscal policy can provide faster and more meaningful assistance to the economy than monetary policy, whose impact is fully apparent only within three to six quarters.”

New state support measures are not required

The head of the Central Bank said that there is no need for additional measures to support the economy now. “Because the main measures of the government will continue to operate almost until the end of the year. These are serious measures that have an impact on economic activity, supporting it," she added.

Why has the Central Bank lowered the rate yet again? According to Elvira Nabiullina, there are still risks of deflecting inflation down from 4% in 2021.

Despite the fact that in the second quarter, GDP is going to decline by 9-10%, the Central Bank predicts that by the end of the year GDP will fall by 4,5—5,5%. And in 2021 and 2022, recovery growth of 3,5-4,5% and 2,5-3,5% is expected, respectively. Economic recovery will take more than a year and a half.

The Bank of Russia has clarified the estimate of the neutral rate range to 5-6%, taking into account the target for annual inflation near 4% (this is the “invisible” rate that determines the long-term horizon of the key rate — editor's note). “At the current stage, we have revised down our estimate of the neutral key rate range in real terms to 1-2% from 2-3%. This means reducing the range of the nominal neutral rate to 5-6%, taking into account the target for annual inflation near 4%," the head of the regulator said, specifying that the decision was made simultaneously.

We do not intend to introduce negative rates on ruble deposits

The head of the Central Bank reported on the adoption of three important decisions for the capital of Russian banks. First, the updated methodology for assessing mortgage loan reserves will be implemented at an accelerated pace. This will free up an additional 300 billion rubles. Second, the purchase of perpetual bonds under special conditions will be encouraged. Third, the settlement of the situation in problem banks is possible through the exchange of debt for capital, but this is a temporary measure for 2 years. “The fall was deep, the risk ratio [of borrowers] will be reduced," Elvira Nabiullina promised.

After another reduction in the key rate, deposit rates on deposits gradually decrease. Doesn't it threaten an outflow of capital for banks? However, the head of the Central Bank assured that the current rates are higher than the inflation rate, and banks are monitoring the attraction of liabilities. Answering the question about the probability of introducing negative rates on foreign currency deposits, she said that they are not going to return to this topic yet. They do not intend to introduce negative rates on ruble deposits

On the other hand, the head of the Central Bank expects growth in consumer lending. Instead of a projected 5% decline, it is expected to grow by 4-5% at the end of the year. At the same time, the Central Bank intends to maintain restrictive rules for calculating the maximum debt load of the borrower when issuing loans, so that citizens do not fall into credit bondage. In general, lending to the Russian economy will grow by 6-9% in 2020, and in the next two years it is going to be about 7-11%. “We forecast an increase in lending to the economy by 6-9% by the end of 2020 and by 7-11% in the next two years. This will make a positive contribution to the dynamics of GDP," Nabiullina said.

“A reduction in the key rate will lead to a further reduction in rates for the most reliable borrowers, as well as possibly for mortgages," said Maksim Petronevich, senior economist at Otkritie FC Bank. “At the same time, the interest rate correction will be less pronounced than the reduction of the key rate. The interest rate for the most reliable corporate borrowers is largely determined by the yield of medium-term government bonds. After the yield has fallen to near the lowest levels among the BRICS countries, it is less responsive to a reduction in the key rate and will increasingly be determined by international capital flows. The average mortgage rate is now largely determined by the terms of existing government programmes for preferential mortgages in the primary market, to a lesser extent — by market conditions. At the same time, the reduction in the key rate will be reflected in the rates on market unsubsidised mortgage loans, which will contribute to the growth of transactions in the pre-owned real estate market.”