09 Feb 2015
Russian Inflation Accelerates: What Are The Implications?

By Sergei Aleksashenko, Former Deputy Finance Minister of Russia

The Russian Federal Statistical Agency (Rosstat) has placed the final figure for the January Consumer Price Index (CPI) at 3.9%. This number is well above all previous estimates (including my own) and the highest in Russia since February 1999. As a result, 12-month inflation in the country has reached 15%.

The main driver of inflation is the weakening ruble. According to expert opinion, an increase of 10% in the value of the dollar (priced in rubles) leads to a 1% increase in the Russian CPI. In the period between November and January, the value of the dollar (priced in rubles) jumped by 60%. The most recent wave of devaluation and inflation emerged a year ago and lasted approximately 5-6 months. That means that even if the current devaluation episode is over and the ruble stabilizes, we are still likely to see a residual rise in inflation in the coming 2 to 3 months.

Though the inflation path is difficult to estimate these days, it seems inevitable that by the end of the first quarter the 12-month CPI will exceed 17%. If monthly inflation were to increase at the same rate as it did in 2000, which was between 1-2% each month until the year-end, the 12-month CPI could reach 25% by this autumn. Even if Russian monetary authorities were able to take inflation under control — and oil prices were to rise by 20-25%, the ruble were to regain 15-20% of its value, and monthly inflation starting in May returned to 2013 levels (the year of the lowest inflation in Russian history) — the 12-month CPI would still remain above 15% until late autumn, and would only recede to 12-13% at the very end of the year.

What inflation means for the Russian government

High inflation will have several implications for Russian authorities.

First, real households wages and incomes are going to fall, including those in the budgetary sector. According to the Russian federal budget, pensions in 2015 will be indexed by 11.4% (the rate of inflation in 2014) while wages in the government sector will increase by only 5.5%. A decline in living standards will become the most serious political challenge for President Vladimir Putin as his electorate will be hit particularly hard (including the military and the siloviki). To avoid potential fallout, the government needs to endorse extraordinary-expenditure amendments to the budget. Unfortunately, this action would increase the risk of destabilizing macroeconomic fundamentals, since a significant portion of the new expenditures would likely be financed by the Central Bank of Russia (CBR) and would add to inflationary pressure.

Second, besides the pressure in favor of additional indexation of wages in the government sector, the Ministry of Finance will face another problem – expenditures of the budget for 2015 were calculated on the basis of inflation forecasts of 7.4% in 2014 and 5.5% in 2015, or 13.3% combined. In reality, inflation will be at least twice this level. If the Ministry of Finance continues to promote an austerity policy and does not adjust expenditures (except wages) to the real level of inflation, this will effectively decrease the aggregate demand in a shrinking economy and make the economic slowdown even more painful.

Third, the Central Bank cut it’s key rate last week in anticipation of declining inflation (from 17% to 15%). After seeing the January CPI, the CBR has to either accept keeping the key rate at the current level (a negative interest rate in real terms) or to acknowledge its own mistake and restore the higher interest rate level, if not making it higher. The first option will result in growing inflationary expectations, while the second will further suppress demand for credit from the banking sector.

Fourth, Russian households may recognize that the current interest rate on bank deposits (10% on average) is well below the level of inflation. This may lead either to the massive swap of ruble deposits for dollar or euro-denominated deposits, or to the withdrawal of deposits in favor of purchasing different durables (that are recognized by many Russians as alternative forms of savings). In any case, this would create additional pressure on the banking system.

It is beyond doubt that inflation will be one of the most serious challenges for the Russian economy. If the authorities lose momentum and are not able to suppress inflationary pressure in the short term, inflation in Russia may soon become as destructive as it was in the mid-90s.

Sergey Aleksashenko is former Deputy Minister of Finance of Russia and former Deputy Governor of the Russian Central Bank. A former scholar-in-residence in the Carnegie Moscow Center’s Economic Policy Program, he is currently and independent consultant for Private Solutions LLC.

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