Russia has similar inflation to the UK but interest-rates are ~8% higher

As a contrast to the Bank of England move or not at midday which I analysed yesterday let us look at developments at another point of the interest-rate cycle. To do this we need merely to look at Russia where this was announced this last Friday.

On 27 October 2017, the Bank of Russia Board of Directors decided to reduce the key rate by 25 bp to 8.25% per annum.

We learn various things here. Firstly even in this time of Zero Interest Rate Policy ( ZIRP) and indeed NIRP where N = Negative we see that there are countries where the trend has bypassed. Much of Africa has been too. I also note that 0.25% moves seem to be en vogue for which we in the UK should be grateful as I recall the Bank of England hinting at a 0.15% cut this time last year as its Forward Guidance shot itself in the foot. Returning to the Russian situation on the face of it the move looks a bit weak in the circumstances as frankly what is moving from 8.5% to 8.25% really going to achieve? Especially if we note this about inflation.

Annual inflation holds close to 4%. Estimates as of 23 October 2017 indicate that annual inflation is 2.7%. Its downward deviation against the forecast is driven mainly by temporary factors. In September, food prices showed stronger-than-expected annual price decline, on the back of larger supply of farm produce. This extra supply owes its origin to growing crop productivity and the shortage of warehouse facilities for long-term storage. The slowdown of inflation was also triggered by exchange rate movements.

Inflation is projected to be close to 3% by late 2017; going forward, as the temporary factors run their course, it will approach 4%.

So we see that the inflation situation currently has quite a few similarities with the UK as our inflation will also be close to 3% late this year and our inflation has a strong exchange rate influence as well. Yet interest-rates are around 8% different! Central bankers eh?

Let us look deeper.

Oil and Gas

This is a powerful player in the Russian economy and the recent rise in the oil price will put a smile on economic developments. In July an economic paper from the University of St. Petersburg put it like this.

In the first phase of the shock, the government’s income suddenly increases. In other words, the price rise enhances the real national income through the increase in the petroleum exports revenues. This might lead to the reinforcement of the national currency value (or foreign currency depreciation) in the exchange rate systems (fixed or managed floating systems). In the floating exchange rate system, the foreign exchange coming from the increase in the world oil prices would lead to the appreciation of the real exchange rate.

Actually the value of the Rouble and the oil price are correlated over time. If we look back to a nadir for oil prices back in early 2016 when the Brent Crude benchmark fell into the mid-30s in US Dollar terms then it took 75 Roubles to buy one US Dollar. If we skip forwards to today when Brent Crude is around US $60 we see that it takes only 58 Roubles to buy one US Dollar. They do not always move in lock step but over time there is usually a similar trend.

Thus we get to the conclusion that a higher oil price reduces Russian inflation. This does not mean that it does not raise domestic inflation as of course there will be familiar price rises from fuel costs which will trigger other price rises. But that there will be an offsetting move from a higher currency that usually is larger. Accordingly I find this from the Bank of Russia a little strange.

Inflation expectations remain elevated. Their decline has yet to become sustainable and consistent.

We are back to a timing issue as in you need to move ahead of events rather than waiting for them to happen and chasing them.

Impact on the Russian economy

The US Energy Information Authority published this on Tuesday.

Russia was the world’s largest producer of crude oil including lease condensate and the third-largest producer of petroleum and other liquids (after Saudi Arabia and the United States) in 2016, with average liquids production of 11.2 million barrels per day (b/d). Russia was the second-largest producer of dry natural gas in 2016 (second to the United States), producing an estimated 21 trillion cubic feet.

So a big deal which has this impact domestically.

 Russia’s economic growth is driven by energy exports, given its high oil and natural gas production. Oil and natural gas revenues accounted for 36% of Russia’s federal budget revenues in 2016.

Also it is the major export.

In 2016, Russia exported more than 5 million b/d of crude oil and condensate……..Russia also exports fairly sizeable volumes of oil products. According to Eastern Bloc Research, Russia exported about 1.3 million b/d of fuel oil and an additional 990,000 b/d of diesel in 2016. It exported smaller volumes of gasoline (120,000 b/d)[50] and liquefied petroleum gas (75,000 b/d) during the same year.

As to the impact on the overall economy it is not easy to be precise as Factosphere points out.

Experts estimate the share of Oil&Gas sector in the Russian GDP to vary from 15% to 20%, but that does not take into consideration effect of a number of related and supporting industries that depend on O&G sector performance (equipment producers, transportation, etc.). Therefore, the overall influence of the sector on the Russian economy and GDP shall be much higher.

Comment

There is a fair bit to consider here but if we stick with the inflation issue then with Brent Crude Oil around US $60 per barrel it seems unlikely that Russia will see much imported inflation generated. Quite possibly the reverse. We know that the Urals production is cheaper but the principle remains. Thus the difference between it and the UK in terms of inflation prospects hardly seems to justify an around 8% interest-rate gap.

There is one clear difference though which ironically would be seen as a success in the UK. From Trading Economics.

Real wages in Russia rose 2.6 percent year-on-year in September 2017, following a downwardly revised 2.4 percent gain in August and missing market expectations of 3.9 percent. Average nominal wages jumped 5.6 percent to RUB 37,520 while annual inflation rate slowed to 3 percent, the lowest since at least 1991.

So higher interest-rates yes but nothing like that much higher. The fun comes in figuring out how much the Bank of Russia and the Bank of England are wrong!

Meanwhile it seems set to be a relatively good year for the Russian economy and a nod from it to OPEC for its efforts in raising the crude oil price. Looking ahead there are of course issues as we mull the impact of having large resources on the wider economy or what became called the Dutch Disease. One of them is the transfer of resources and wealth or if you prefer the oligarch issue.

Currently there is also the issue of economic sanctions on Russia.

Me on Core Finance TV

http://www.corelondon.tv/bank-of-england-timing-mess/

13 thoughts on “Russia has similar inflation to the UK but interest-rates are ~8% higher

  1. Hello Shaun,

    “Thus the difference between it and the UK in terms of inflation prospects hardly seems to justify an around 8% interest-rate gap.”

    well if it not , its not . Then you have to propose why there is a difference

    could be that they sell real stuff and we just sell houses to each other – the economies are just that different

    Forbin

    PS: and of course Russia is a hated enemy for sometime now – meaning economics is a form of warfare

    • Hi Forbin

      I agree that some of the 8% gap is cover against the sanctions environment but even so there is a large differential. Your point about houses made me check the house price index which is at 88.8 ( 2nd Quarter) where 2010 = 100 . So unsurprisingly considering the interest-rates there has been no house price boom in Russia.

  2. According to a good few articles I have read over the last while, the sanctions have resulted in the Russians developing a program of becoming increasingly more self sustainable, especially in food production – while for farmers in parts of the EU, it has been the equivalent of being shot in the foot by those who apparently know best.

    • Amazing though what nations can do when they’re not falling apart due at a 0.25% increase in interest rates and all the men being outed as probable sex pests.

      And then when they flog that food they buy Facebook ads to tell us all how to think .. those pesky Russians.

    • Hi Dutch

      Thanks for the link and there is another gem in it.

      “In its Quarterly Inflation Report, released with the announcement on rates, the Bank estimated inflation was likely to peak this month at 3.2%.”

      So why raise now then? And of course there is no questioning of this.

      “The move reverses the cut in August of last year, which was made in the wake of the vote to leave the European Union.”

      I have BBC Breakfast news on in the morning whilst I do my knee rehab and this morning the business presenter ( Sean) rambled on about mortgage rates with not a sniff of a mention of the Funding for Lending Scheme.

  3. You have to wonder at the thinking of the BoE. It “sees through” inflation that is there, fiddles the inflation figures, waits years to raise interest rates (only back to the pre-Brexit level after the panic cut).
    What does it know that we don’t or is it just incompetence?

    • Did you see the Carnage conference, my word i’ve never seen a man try to come up with a complete new language to come across as intelligent until now.

      He just talks complete and utter nonsense at an amazing speed and the MSM just nod like they know what he’s talking about and that it makes sense.

      Emperors new clothes should be renamed Carneys new language.

    • It’s both James. The BoE knows something we don’t, and it’s incompetent.

      But look on the bright side. The Master Monetary Lever has moved from “Panic” back to “Emergency”

  4. Great blog as usual, Shaun.

    One wonders why the Russian central bank isn’t lowering its inflation target as well as its key rate. Olivier Blanchard of the IMF may like it, but a four percent target rate looks to be too high. The 3% CPI inflation rate for September is the lowest inflation rate ever for the Russian Federation. The inflation rate was at 5% in January 2017.

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