Bank of Russia Governor Elvira Nabiullina Speaks at State Duma Plenary Session

Good afternoon distinguished colleagues,

Today I would like to present the Bank of Russia’s Monetary Policy Guidelines. It is the basic document that outlines our vision of economic development and the measures that will be taken in order to fulfil our monetary policy goals with the aim of securing price stability.

We have worked closely with the State Duma’s specialised committees to finalise the Guidelines, and I would like to thank my colleagues for their very constructive and professional collaboration.

I will start off by summarising the general economic situation and outlining our forecast.

As the Bank of Russia sees it, the economy is exhibiting growth at a rate similar to the potential. These growth rates are primarily determined by our economic structure and not by external factors. Our economy has almost overcome the aftermath of the shock linked to the drop in oil prices in 2014-2015.

Preliminary estimates suggest that GDP growth in Q4 will almost match that in Q3. Our current estimates show that this year, the economic growth rate will stand at approximately 1.8%.

Our forecast anticipates that the economy will grow by 1.5-2% in the next 3 years in the baseline scenario where oil prices are $42 per barrel, and in the scenario where oil prices rise to $60 per barrel.

1.5-2% can be considered low growth rates and, as such, are not the true economic aim we all have in mind. Our economy can grow at a rate of 3% and 4% per year if structural measures are taken aimed at increasing labour productivity and labour mobility, and improving the investment climate.

I would like to particularly emphasise that it is impossible to achieve new growth rates by means of monetary policy measures. These measures can only stabilise and maintain growth rates near the potential level. Moreover, the Russian economy’s ability to overcome structural limitations and attain a different, higher potential growth level depends on the whole complex of economic policy measures.

Nevertheless, monetary policy makes a significant contribution to the country’s economic development. We consider monetary policy to be part of overall economic policy. Sustainable growth is impossible without low inflation and without macroeconomic stability.

Over the past three years, we have been pursuing a disinflation policy. We have consistently reduced inflation to the 4% target level. I would like to highlight that inflation peaked at almost 17% in spring 2015. Back then, very few people believed it was possible to achieve a sustainably low level of inflation in Russia.

Year-on-year inflation currently stands at 2.6%. Our forecast for the year-end is 2.5-2.7%. We consider that inflation is close to the target; and therefore we do not envisage any special monetary policy reaction being necessary since the current low value is primarily due temporary factors: relatively high oil prices (and the related ruble appreciation) and a bumper harvest. We expect that in 2018, inflation will rebound closer to 4%. We see the potential for further key rate cutting: however, the pace and extent of the reduction will be determined by economic performance dynamics.

The current focus of our policy is anchoring inflation at the 4% target and bringing down inflation volatility. Stable inflation is vital for a sustainable reduction in household inflation expectations and for more assured planning of long-term projects by businesses.

Inflation volatility greatly depends on non-monetary factors. At present, managing them is a crucial aspect of our collaboration with the government. We prepared a special report on non-monetary factors causing inflation, published it, and are discussing the findings with the government. We see the main non-monetary inflation risks in insufficient infrastructure development (primarily, logistics and agricultural produce storage) and natural monopoly tariffs.

I have already stated that the record harvest was one of the factors behind the current inflation slowdown to 2.6%. However, agricultural prices did not drop only because of the good harvest but because farms and small family holdings were forced to sell produce as quickly as possible at low prices due to a lack of storage infrastructure. If insufficient and poor storage causes harvest reserves to deplete, then fruit and vegetable prices may once again peak. This is inflation volatility: a detrimental phenomenon we need to address. To do so requires joint efforts with the government.

I would like to go into a little more detail about inflation because achieving the target and maintaining it is an important goal for us. How does it benefit the economy?

First. Low inflation is necessary for household well-being. Sharp price hikes deny households the chance to plan their family budget, and devalue income and savings. Increased inflation has the greatest impact on the standard of living of those with low incomes.

Last year, inflation at the year-end had already fallen to 2011-2013 levels. Nevertheless, social surveys revealed that it remained the No. 1 problem for Russians. It was only this year, when inflation had been delivered to the target that social surveys began to touch upon other problems.

However, we are particularly concerned that household inflation expectations remain high despite their decline. For illustrative purposes we looked at two very simple indices – let’s call them New Year indicators. We investigated the prices of ingredients in traditional New Year dishes, such as the Olivier and the Herring Under a Fur Coat salads to review their growth. Over the course of the year, the cost of the Olivier salad went up by 1.2% – and now stands at 312 rubles, the cost of the Herring Under a Fur Coat fell by 0,9% – and stands at just over 150 rubles. Yet, household inflation perception is much higher. We really want to achieve public trust in our policy: it is our aim that households can manage their family budget without constantly thinking about price hikes.

Second. Low inflation has a positive effect on business conditions and fosters an advantageous environment for efficient projects. Low inflation makes long-term planning possible. It stimulates increased efficiency in companies and does not allow businesses to pass on their high costs to growth in prices and in households’ expenses. In other words, it forces companies to raise productivity and cut their costs.

The formation of a new growth model is conditional on Russian companies raising their productivity. What does the competitiveness of the Russian economy depend on? The answer is twofold: cheap labour and cheap resources, and products with high added value. Clearly, the latter is far more preferable because it is the path undertaken by highly-developed economies. This is why we often call low inflation a catalyst for the structural changes associated with increased productivity.

Third. Low inflation facilitates the de-dollarisation of the economy and the stabilisation of the exchange rate. When people see that inflation is under control, they do not buy foreign currency by force of a precautionary motive to protect themselves against ruble depreciation, and they do not try to repeatedly exchange currencies after external shocks if they are confident that inflation will remain low.

Fourth. Economic growth is fuelled by financial resources. We have often been criticised and are still criticised for the tightness of our policy as it hinders the development of lending and, therefore, prevents accelerated growth rates. In fact, the development of lending is adversely affected not by our high key rate, but by high inflation. I would like to point out that in 2011-2013, the key rate was lower than it is now at 5.5%, whereas interest rates on corporate loans were even higher than now. They are currently falling in line with falling inflation. A robust lending environment, i.e. primarily long-term investment, can only evolve amid low inflation.

We can already see that decline in interest rates in the economy follows the downward path of inflation and our key interest rate. The rates on up-to-one-year loans dropped by 2 pp and by 2.3 pp on long-term loans. Rates on long-term loans are falling at a faster pace. This means that economic agents are beginning to have confidence in low inflation. Interest rates on long-term loans, so important for investment and mortgage lending, are falling faster.

Over the ten months of this year, lending to the economy expanded by 4.7%.

For the period of January-September, the corporate sector saw increased lending in many sectors, including mining (+14.0%), agriculture (+9.0%), manufacturing (+9.5%) and transport and communications (+8.1%).

Unsecured consumer lending grew by 7.8%. As we see it, this is moderate growth not threatening the formation of bubbles. Mortgage lending is exhibiting marked growth (+9.3% in January-September this year). Increased mortgage lending is, among other things, evidence of economic agents’ confidence in low inflation.

Overall, we believe that the banking system is able to further encourage healthy lending. Banks posted profits of 693 billion rubles for the first ten months of the year. This is slightly lower than the results of the same period last year, but profits would have been even higher if it were not for the losses incurred by two banks in resolution, B&N Bank and Otkritie. A key point for us is that the majority of banks are profitable (397 out of 572 credit institutions in operation on November 1 are profitable).

According to our estimates, lending will grow at a rate of 5-7% next year, then 7-10% per year – exceeding GDP growth, and lending will support economic growth.

I would like to highlight that lending resources certainly foster economic growth nonetheless borrowed funds should not be considered the main source of development. It is vital that we generate capital in the economy so that businesses are not afraid of investing their funds. The problem we face is that the volume of investment being financed by raised capital is low, while excessive lending growth is fraught with excessive debt burden, which will then have a negative impact on businesses’ capacity to develop. We can already see that the sectors that have accumulated excessive debts over the years are now lagging behind, and many companies are not in a position to pay them off. We need a good investment climate, we need to develop corporate governance practices, and business transparency. High interest rates are in part explained by risks associated with a lack of transparency among borrowers: they have a complicated ownership structure (often offshore), and similarly complicated and incomprehensible management structure. Therefore, investors naturally do not want to invest in them, preferring to issue loans, at best.

This is also an important factor in terms of overcoming structural limitations in the economy.

I would now like to say a few words about our policy over the forecast horizon.

We will continue to cut the key rate, though relatively smoothly. It is possible to gradually reduce the key rate from the current level of 8.25% to the equilibrium level of 6-7% over one to two years in the absence of unfavourable external factors.

We are often told that we can reduce the rate faster now that inflation has slowed down below 4%. Yet, we need to weigh the benefits and risks. As a result of a more rapid rate cut, there will be short-term economic benefits. Yet, we believe them to be negligible in comparison to the potential problems that would arise if inflation deviated upwards from the target and we would have to radically reroute our policy. This would disrupt the basis underlying the generation of long-term money sources, which are just beginning to emerge. It is too early to achieve equilibrium rates when inflation expectations are elevated, indeed, according to the latest data, household inflation expectations are at 8.7%, despite the fact that actual inflation is 2.6% ... This, of course, holds us back. We believe that a predictable and consistent policy, formulating a clear outcome, is much more important for businesses as it encourages them to make plans and, therefore, to develop.

Some other aspects of our policy:

We are not planning to revise the inflation target. 4% is in line with our economic structure, it reduces the risks of deflation in certain sectors and, at the same time, prevents inflation from growing too quickly, thereby depreciating savings and investments.

We remain committed to the floating exchange rate regime of the ruble. This is also outlined in the Guidelines. The floating exchange rate regime allows our economy to sustain external shocks more easily, be more flexible in the development of a new economic growth model, and also balance the interests of importers and exporters.

We have almost completed all anti-crisis measures; the economy and the financial system are able to cope with challenges on their own. In the near term, in the coming years, we will be gradually abandoning the use of the so-called special refinancing tools that were in place to support high-priority and vulnerable sectors during the crisis. It is our intention to do it smoothly and in a well-ordered manner.

There is a similar situation in terms of foreign currency refinancing for banks. Credit institutions’ demand for Bank of Russia foreign currency refinancing operations continued to decline in 2017; in early November 2017 banks fully repaid their outstanding amounts on foreign currency operations. However, if necessary, we are ready to resume these operations.

The volume of our international reserves will remain at a stable level throughout the forecast period. We have set a benchmark for increasing reserves to $500 billion, but we have no plans to buy foreign currency to replenish our reserves until we are absolutely sure that both inflation and inflation expectations have stabilised at a low level.

My speech today is about monetary policy but when talking about monetary policy, it is inevitable that economic growth will also be broached. Therefore, to conclude, I will say a few words about other areas of our financial market development policy, which, we believe, also promote economic development.

The Russian financial system on the whole is stable, both in the banking and non-banking sectors. We are paying a great deal of attention to developing the bond market as a supplement and alternative to bank loans, improving the quality of corporate governance, developing the national rating industry, and toughening requirements on the use of pension savings. Each of these sectors of the financial market contributes to facilitating access to financial resources for competitive Russian companies.

We are also working on improving the accessibility of financial services for small businesses. We are switching to proportional regulation in the banking system and are grateful that the Duma has adopted the corresponding legislation. It is our hope that banks with a basic licence, which will emerge early next year, will effectively support lending to small businesses. The fact that profits have been posted by three quarters of the banking system, and not just by major banks, strengthens our confidence in it.

And my final point.

A year ago, our economy was just emerging from a recession. Whereas today, we can confidently state that growth has recovered faster than many expected. Yet, we rapidly reached a 1.5-2% potential economic growth rate. We now have no reason to refrain from structural changes: as the economy is stable, we can and should see faster growth. It is our sincere hope that the decisions to be made on structural measures will also allow us to make an upward revision of our gross domestic product growth forecasts compared to the forecast under consideration now. The Bank of Russia, on its part, will make every effort to maintain price and financial stability, and foster the viability and development of the financial market in line with the needs of our growing economy.