Elvira Nabiullina: 'High inflation is an indicator of growing economic overheating'

Growing economic overheating

It is already customary to determine trends in the work of the Central Bank by the brooches on the suits in which Elvira Nabiullina goes out to communicate with the press. This time, the nonverbal symbol has been a brooch in the form of scales, probably hinting that the Bank of Russia is trying to balance the economy.

“Today we have decided to raise the key rate by 100 basis points, to 9,5% per annum. It is based on a significant revision of the vision of the economic situation and its prospects. Contrary to our expectations, there has been no change in the dynamics of inflation to date. Moreover, its stable components have even strengthened. The main reason is a growing imbalance in the economy. A tighter monetary policy is required than we previously assumed," the head of the Central Bank stated.

According to her, high inflation negates economic growth, threatening real incomes and savings of people and reducing the standard of living of the population. Nabiullina called high inflation an indicator of the overheating of the economy, which arose as a result of an imbalance between supply and demand:

“We now expect inflation to return to the target 4% only by the middle of next year. We see an increase in consumer and business activity. The net profit of Russian companies is almost twice as high as before the pandemic. Unemployment has updated the historical minimum. These are impressive results, if not for one 'but'. High inflation. The observed growth rates of the economy in the current conditions are mistakenly considered stable or balanced. High inflation is an indicator of growing economic overheating. If measures are not taken to return the economy to a balanced growth trajectory, its overheating will intensify and will lead to an increase in inflation and a subsequent slowdown in the economy, up to a recession.”

At the moment, in her opinion, it is necessary to direct forces to combat excess demand, which overheats the economy, as a result of excess demand, not consumption, but prices are growing. This explains the cycle of raising the key rate. At the same time, at the moment, according to the the Central Bank, GDP is forecasted to grow at a steady pace.

“According to our forecast, taking into account the policy, GDP will grow by 2-3% this year. Next year, the growth will be 1,5-2,5%. By the end of the forecast horizon, it will return to 2-3%, which we consider as a steady pace," Nabiullina stressed.

“If it were not for the rate increase, inflation could rise much higher than 10%"

According to Nabiullina, last year prices doubled the inflation target, and annual inflation increased again in January. Temporary pro-inflationary factors on the supply side turned out to be longer, and international logistics continues to be a bottleneck for many imported goods for two years. Restrictions on foreign travel lead to a rise in the price of domestic tourism.

“Temporary factors gave the effect of stable ones, which significantly affected the inflation expectations of the population and businesses. There appeared an opinion that the increase in the key rate does not restrain the growth of prices in any way. In fact, if we had not started raising the rate in the spring of last year, inflation today would have been much higher than 10%. Our rate prevented this. The actual pressure of pro-inflationary factors turned out to be much greater than could have been assumed.”

Peak of inflation was passed in October

Taking into account the impact of all factors, the inflation forecast this year has been expanded to 5-6%. The Central Bank expects inflation to return to 4% by mid-2023. Currently, there is no need to talk about a slowdown in inflation yet:

“We have passed the peak of inflation, it was in October. If we talk about annual indicators that take into account the price growth over the past 12 months, then we are being at the peak value now. So far, there has not been a reversal so that we can say that there is a trend for slowing inflation. We expect a slowdown by the end of the first quarter, in the second quarter. But we can talk about the trend later, when we see that it is stable. Our economy recovered fairly quickly. The recession that was during the pandemic was quickly overcome. To avoid overheating, it is necessary that the economy grows at a pace close to potential. But it continued to grow at a rate much higher than potential.”

To reduce inflation, it is necessary to switch to the regime of tight monetary conditions, the head of the Central Bank is convinced. There should be higher savings rates on deposits so that people understand that these rates will not be eaten up:

“We will raise deposit rates. Then the excess demand will turn into additional savings, which will expand the opportunities for long-term financing, lending to the corporate sector, then inflation will slow down and return to our goal.”

Now inflation is deviating from the target by more than two times. Raising the key rate is a mechanism that affects over time. The effect of it, according to the expectations of the Central Bank, will manifest itself at the end of this year and the beginning of next.

How much mortgage will become more expensive

The Central Bank records an increase in mortgage rates but notes that they have grown less than the key one. And the mortgage itself is growing at a high rate. The pace of mortgage development is also not balanced, it should be less. Preferential programmes, according to the head of the Central Bank, should be targeted. In 2021, mortgage loans increased by 27 percentage points. An increase in the key rate will contribute to a decrease in the cost of housing and its availability.

“The main thing is the availability of housing for people. This is influenced by both the cost of credit and housing prices. The cost of long-term loans is more influenced not by the key rate, but by the yield of long-term bonds. Our policy is related to the rise in the cost of short-term, current money," the head of the Central Bank added.

Nabiullina focuses on that mortgages with a low down payment or without it are particularly serious risks for the economy:

“A mortgage without a down payment is not that bad, it is extremely bad. The ability to save up for a down payment is an indicator of a person's ability to service a loan. Such loans are less than one percent. But even a low level of down payment can create problems. Our system of macro-prudential allowances is set up to discourage banks from issuing loans with a low down payment.”

Central Bank against cryptocurrencies

The Bank of Russia sees a threat in the expansion and development of the cryptocurrency market both for the welfare of citizens and for financial stability in general. According to Nabiullina, the involvement of citizens in this market should be reduced, which contradicts the recently published concept of the Ministry of Finance:

“We see the risks of the easy possibility of using cryptocurrencies for illegal operations. The concept of the Ministry of Finance speaks about some advantages of the legalisation of cryptocurrencies. This argument confuses us, we will discuss it. Even more embarrassing is that the concept of the Ministry of Finance does not yet respond to the risks that we point out. The approaches proposed by the government do not allow us to offset the risks that we see and create new threats.”

The risks of legalising cryptocurrencies in the country, in her opinion, are significant. Currently, the tools that will help to stop these risks have not been worked out:

“I will give an example with a foreign currency mortgage, it is on everyone's lips. People took out a foreign currency mortgage, all this seemed attractive to them, not understanding what risks they were taking on. And when all this happened, the question arose — why didn't all this become forbidden? These problems had to be solved by the government and the Central Bank. Then the scale was much smaller than with cryptocurrencies. Another problem with cryptocurrencies, it is important for the Central Bank. We have been fighting illegal operations for many years. But cryptocurrency by its nature will open a new large-scale channel for such operations. Together with illegal operations, conditions will arise for tax evasion in the economy as a whole.”