The Bank of Russia has just slammed its economy into reverse-gear

Friday was a rather extraordinary day for world markets. As I discussed then there was the Bank of Japan emerging from its eyrie in kamikaze fashion as it pressed the monetary accelerator pedal to the metal. But I wish to move to a particular comparison where the consequences of its actions pushed the Yen lower. Overnight it dropped to 113 versus the US Dollar,141 versus the Euro, and over 180 versus the UK Pound for falls of the order of 3%.

Meanwhile a near neighbour of Japan across the sea of Japan took the opposite attitude to currency weakness as we saw the Bank of Russia do this.

On 31 October 2014 the Bank of Russia Board of Directors decided to raise the Bank of Russia key rate to 9.5 percent per annum.

This is a completely different attitude to Japan which is trying to drive interest-rates and yield ever lower. Indeed fans of the current economic mantra of ZIRP (Zero Interest-Rate Policy) were probably singing along with REM at this point.

It’s the end of the world as we know it
It’s the end of the world as we know it

Why did the bank of Russia do this?

If we investigate its explanation we see the following.

According to the Bank of Russia estimates, inflation will remain above 8% till the end of 2014 and in 2015 Q1. Continuing high growth of consumer price will result in persistent increase in inflation expectations creating additional inflation risks. The Bank of Russia will continue to take measures aimed at slowing down consumer prices growth to the target of 4% in the medium run.

Such a forecast only reinforced the current state of play regarding consumer inflation in Russia.

According to the estimates as of the 27 October, annual consumer price growth rate was 8.4%. Core inflation rose to 8.2% in September 2014. Acceleration of inflation was mainly provoked by accelerated price growth for food items from 10.3% in August to 11.4% in September.

So as has been discussed and expected on this blog inflation is raging in Russia caused in essence by the fall in the value of the Ruble. The Bank of Russia estimates that it has added 1.3% to consumer inflation which personally I would say is on the low side. It also musters up its courage and points out that the restrictions on food imports imposed by President Putin have added 1.2% to consumer inflation.

That word “temporary” again!

If we go back to March of this year the Bank of Russia told us this.

The Bank of Russia Board of Directors decided to temporarily increase the Bank of Russia key rate to 7.00%.

Although of course it a way they were right about it being temporary as they later raised it to 8% and now 9.5%! There was a clear implication back then that the next move would be down and not up. Yes one more time we see that up is the new down.

What is really behind this?

In essence the central bank is responding to the fall in the Ruble which at times has become a plummet. Back in March the Bank of Russia was trying to behave in pre-emptive fashion but now it is facing a currency which was at 34 to the US Dollar at the beginning of July and is now at 43.3 for a fall of 27%. This makes all sorts of products and commodities more expensive and has stoked the inflationary fires. Of course Russia has resources such as oil but it still needs to import other goods and there is the problem.

Does the central bank playlist ever work?

Extremely rarely is there any success to be found here. The issue is that it finds itself doing what it should always be doing its best to avoid which are operations in extremis. If we consider an interest-rate rise of 2.5% that is substantial especially in these times but it is dwarfed by the 27% fall in the currency. It is invariably like that and even if we imagine a scenario where a central bank stepped up on the same scale then an interest-rate rise of that magnitude would lead to expectations of economic collapse and so the currency would probably be sold anyway! I tend to feel that the larger the interest-rate rise the less likely it is to work as psychology – why is it necessary?- works against it.

Currency intervention has a similar problem in that world markets are so large that they are likely to dwarf whatever resources the central bank can throw at them. Also the larger traders may welcome central bank intervention as it may allow them to increase the quantity they can sell. Oh what a tangled web and all that. If you are ever in such a situation as I was back in 1992 as the UK was ejected from a forerunner of the Euro you see that the what the central bank was confident about only five minutes earlier disappear in King Canute fashion. Once that happens a few times it starts to look at its rapidly dwindling reserves and depending on the quality of its individuals either start a rethink or panic. The UK saw the latter first and the former second back in 1992.

A sort of irony here is that the Bank of Russia started from a relatively strong intervention position as via the country’s oil and commodity resources it has reserves to use. But we observe that the “It won’t make any difference” statement by Newt in the film Aliens applies one more time. Currency intervention has turned out to be like trying to catch a falling piano one more time.

What about the Russian economy?

Any Russian statistician who goes to the Kremlin with paperwork suggesting an economic contraction is either very brave or foolish or both! However the Bank of Russia has edged near to the mark.

According to the Bank of Russia estimates, economic growth rate in 2014 Q4 and 2015 Q1 will be close to zero.

If we look at the domestic economy there are considerable grounds for expecting not only a slow down but a sharp one. Let us start with this.

accelerated price growth for food items from 10.3% in August to 11.4% in September.

If we ignore the usual central banking mantra that food is “non-core” and instead regard it along with energy,water and shelter as being vital we see that a squeeze is taking place on real income in Russia. Also a type of credit crunch is being applied.

According to the estimates, annual money supply (M2) growth rate decreased from 16.1% on 1 October 2013 to 7.4% on 1 October 2014.

Funds (as defined by M2) are now falling in real terms as opposed to quite a substantial rate of growth.

Something that is ever more familiar as we look around the world is at play in Russia now. From the Moscow Times.

In their first decline for five years, real wages in Russia fell 1.2 percent in August, hollowing out the spending power of Russian consumers amid an economic slowdown that shows no sign of quitting, business newspaper Vedomosti reported Monday, citing data from Russia’s statistics agency, Rosstat.

Next year’s budget plans to raise civil servant salaries by on average 5.5 percent.

So should inflation continue on its current path there will be real wage falls of 2/3% for civil-servants in Russia.

Also the parts of the Russian economy which rely on the oil price will have been grimly watching its recent decline. A price of US $86 for a barrel of Brent Crude Oil compares with one a year ago of more like US $106. Of course Russia gets more Rubles per dollar now,except of course they buy less as inflation picks-up. Quite a spider’s web there but the Russian economy is the fly caught in the trap. The offsetting impact of higher export demand faces a few problems, not  the least of trying to expand oil and gas production into a falling-price environment.


There is much to consider here as resources rich Russia faces a sort of (resources poor) Japan in the mirror situation. It has resources and inflation and even had real wage growth all of which Japan wants. However for different reasons they are both in  economic trouble right now with the one thing  they share being a declining currency.

Meanwhile someone somewhere is probably thinking up a new version of the currency carry trade. You would borrow in Yen for 0% and lend in Rubles at 9.5% in stereotypical terms. It would of course require a lot of bravery to do this but if you are either brave or desperate you may see it as worth a go. What could go wrong?

Some of the issues here are off my beat as they are plainly political and some are military as the Russian bear flexes his muscles. But it is hard to avoid the feeling that a people used to hardship are about to see some more of it.

More evidence that the UK is now a bankocracy

From Reuters.

State-backed Royal Bank of Scotland Plc has signed an agreement with the City of London Police to help them with free training and advice on financial crime in a deal to be announced on Monday, the Financial Times reported.




22 thoughts on “The Bank of Russia has just slammed its economy into reverse-gear

  1. Hi Shaun,

    “Any Russian statistician who goes to the Kremlin with paperwork suggesting an economic contraction is either very brave or foolish or both!”

    According to several people that make a living out of closely watching what goes on in the Kremlin, the only people that can currently get an audience with Putin are the military and military intelligence the GRU. He is taking the expansionist nationalist route at the expense of the economy, which suggests there is going to be much more bad news here. The view is now he has broken the implicit contract with the electorate of give me a free hand to run the country and in return I will make you richer, where he can’t deliver on the second part, he has no interest in the economy, hence some of the strange policies, like the counter sanctions on food, where they need to import 25%. They have the land, but their infrastructure in the mid and far east have deteriorated so much, you can’t get tractors and heavy agricultural machinery to large areas of it, so it is not used!

    Government spending is beginning to be affected, especially where increased spending on the expansion and modernization of the military is a priority at the expense of other departments. Money had to be diverted last year from the state pension fund to cover the cost of Crimea and their invasion and war in Eastern Ukraine, along with their frequent white ammunition, sorry humanitarian convoys and armoured columns and large numbers of troops in the field can’t be cheap. There were protests in Moscow over the weekend by health workers, where budgets are being cut against a backdrop of poor health and falling age spans!

    Who would want to invest in a country where the shutting down and in some cases (eg. Roshen) the confiscation of businesses has happened, along with the threat of further sanctions, possibly excluding you from doing business and the possibility of capital controls, where capital flight has been steadily growing, where rich people want their money out of the country.

    Putin aims to survive though expansive nationalism, so the west can expect more foreign military adventures, with a large build up of Russian troops and heavy armour in the Donbas region making a major attack likely, probably on the 4th / 5th while the US is concentrating on mid-term elections. One objective will be a land bridge to Crimea where water and supplies are critical, as the ferries and port facilities can’t cope, so more sanctions may happen sooner rather than later.

    • Hi Rods

      Whilst I do my best as ever to avoid any politics any depreciation acompanied by both intervention and interest-rate rises has political elements to it. As to the economics your points add to the strom clouds setting over Russia. Putin would be far from the first leader to use military expansionism to divert eyes from economic problems.

  2. You miss a very important point, most Russians don’t pay rent or mortgage. They have free or almost free healthcare and education, energy is cheap. This price inflation will probably trigger investment in local product producing they are forced to produce it locally. When this blimp in history is over this could be the best thing happening to Russia to divert there economy from leaning heavily on servicing and trading to a more sustainable with more production and asset backed companies.

    • What you describe bears an uncanny resemblance to free state services within a seven year industrial planned economy. I think they tried that before, seemed to have problems wondering what to do with all that steel they produced. Could build more tanks and battleships I suppose. Sounds like a geat future ( for us all!)

    • Free healthcare ? The Warsaw pact countries found, You want care, chances are you need to bribe the medical staff. Likewise, any medicine sold under cost will be rationed to “friends” and “gift givers”.

      On topic of housing, inherited flats/houses is viable for small families only. This implies demographic decline.

      • It is the same in Ukraine where doctors aren’t interested in treating somebody unless they are paid, plus you have to buy your medicines. At the moment it doesn’t help that many doctors and teachers since November 2013 have only been paid occasionally and then only a percentage of their salaries.

  3. Hi Shaun
    Global politics I’m afraid, straying from your usual ‘patch’.
    The US had a choice several years ago; befiriend a ‘new Russia’, help build its economy and ‘democratic’ institutions, trade with a newly formed ‘1st world’ country; or slowly crush it, eventually access its resources after economic impoverishment. It had a half-hearted attempt at the first to begin with, then quickly fell back to the preferred tactic encouraged by its own industrial/military complex.
    Its sad and worrying. Sad because Putin’s obviously inherent paranoias have been left to develop, and worrying because besides some vague ‘eurasian empire’ no-one least of all I suspect himself, has any idea what he’s likely to do next.

    • I’d suggest that the pragmatic and intelligent Gorbachov could have been “bought in from the cold”. But Blair & Washington chose to invade Iraq & take military action in Kosovo. They acted like braggards in violation of good international behaviour (and maybe law), and none of them have been held accountable for their farcical claims of Iraqi WMDs etc.

  4. Trying to catch a falling piano, wasn’t that a Laurel & Hardy film?
    The Bear’s position is, as you say, at odds with that of Japan and they are certainly running out of currency reserves fast. They probably need to be singing an anti-Billy Idol song; “Less Less Less” (oh and thanks for the H/T last week by the way!)

    • Hi Andy

      No problem and I was intrigued to note that Billy Idol has a new album in the US charts. I had not heard of him for some time. As to the falling piano issue I do recall a Laurel and Hardy film where they had a lot of trouble with a piano. However one of the trading pits I worked in had someone who kept repeating that phrase whenever option volatility took a pounding….

      As the day progressed the Ruble continued to drop and ended (if you can say a currency ended the day) at 43.49 to a US Dollar.

  5. Great column, Shaun.

    Unlike Ukraine, Russia looked like it was heading into recession even before the February 2014 ouster of Ukrainian President Viktor Yanukovych. The Sochi Winter Olympics meant a tourist boom in the first quarter and a construction boom in the preceding quarters. A softening of the economy seemed likely. The political bungling since then has just made things worse.

    The BIS database shows quarterly residential property price indexes for Russia, with the index for existing dwelings showing an annual increase of 1.1% in 2014Q2, up from -1.1% in 2014Q1, and the index for new dwellings showing an increase of 3.2%, up from 1.2% in 2014Q1. I don’t know much about how they are calculated, but when one sees they are based on prices per square metre, one suspects that they have all the defects usually associated with unit value series. Nevertheless, for what it is worth, they suggest that real housing prices are falling substantially in Russia, since these increases are much below the official CPI increases.

    • Hi Andrew

      Thank you for the numbers. Should we begin to see sustained house price falls it will be interesting to see how President Putin responds. I agree also that Sochi seems to have marked an economic peak which as some have already suggested above makes him even more dangerous.

  6. The situation in Russia is of concern to the West once again and I agree with JW that we missed an opportunity a few years ago to bring Putin ‘in from the cold’. Sadly we may live to regret that.

    On a totally different subject (apologies for going off topic) I have just been reading an article here in the Algarve concerning an interview with Medina Carriera a former finance minister. He argues that Portugal has missed its bailout targets by a wide margin ( for example state expenditure to be cut 66% and only 22% achieved ) and that economic growth in non existent and that Portugal cannot service its existing debts. As a result they will, in time, need another bail out. Next door in Spain the slow motion car crash that is he November 9th Catalan vote is getting nearer without any compromise on either side. The new left wing Podemos party would win an election in Spain if they were held today. Meanwhile in Greece the likelihood of Syriza in power draws ever nearer. I have always thought that it would be political upheaval that might sink the Euro project and I wonder if it could survive these changes if they come about? 2015 could bring about dramatic changes and not just in the UK!

    • Hi Pavlaki

      We get the 3rd quarter GDP numbers for Portugal at the end of next week and I am waiting to see what they tell us. For a while back in 2013 there was some economic momentum which may well be fizzling out which of course would be consistent with its economic history.

      Also if we think of the value of the Euro my last two updates have shown currencies (Yen & Ruble) against which it is rising as the currency wars regain some momentum.

  7. Hi Shaun,

    State-backed Royal Bank of Scotland Plc has signed an agreement with the City of London Police to help them with free training and advice on financial crime in a deal to be announced on Monday, the Financial Times reported.

    Would that be help in solving financial crimes or further help in committinh=g them?

  8. “Currency intervention has turned out to be like trying to catch a falling piano one more time” Perhaps for Russia but for the SNB in one direction and the BOJ in the other?? Perhaps it depends on which country and economy you are managing and what you are trying to achieve.

    • Hi Noo2

      I should have defined my terms better. What I meant to say was the type of currency intervention when it is weak and you are supporting it. On this side of the coin reserves even for a country like Russia are finite. On the other side of the coin and currency strength a central bank can use its own currency for which reserves can be infinite if it chooses. So yes you are right.

      • Hallo Shaun, what I find really interesting about this situation is that I guess the Bank of Russia and the Government wants foreign currency too. One way, at least for US $, is via pumping more oil, yet I read somewhere that Russia’s break even price is just under $90 a barrel, so they have the choice of pumping more oil for extra foreign currency and increasing their operational losses at current price, or increasing interest rates, or maybe a bit of both. I can’t see a way out for them until oil price increases substantially.The Saudis have said they are happy to tolerate circa $80 a barrel for a year or so!!

  9. What I remember from my elementary macroeconomy course, the central bank (of a state with GDP like Italy or this year actually less) CAN NOT win. Any position that is not close to optimum is simply undefendable. There is no magic, we are just experiencing the end of the oil-age with the BIG SALE.

    • Hi Vskiper and welcome to my part of the blogosphere

      There are real difficulties for a country and a central bank in this sort of position I agree. But the military expeditions in the Ukraine are just making it all even worse.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.