Banks Awash in Cash a Reason for Yudaeva to Go Slow on Rate Cuts

  • Russian liquidity jump means more caution, central banker says
  • Bank of Russia kept key rate on hold since July amid recession

Add another reason for the Bank of Russia’s reluctance to ease policy faster.

As the second year of deficit spending floods the country’s financial system with cash, the inflows are weaning lenders off central bank funding. The shift into liquidity surplus is affecting the transmission of Russian monetary policy and is threatening the inflation outlook, central bank First Deputy Governor Ksenia Yudaeva said in an interview in Washington.

“Even with the key rate unchanged, the transition from a liquidity deficit into surplus alone results in a natural easing of monetary policy,” she said on Saturday. “Since we are now in the midst of an easing cycle one way or another, this in principle means that we need to cut slower, to take into account the impact on inflation.”

The increasing overlap between fiscal and monetary policies means a longer detour before the Bank of Russia can restart easing after high inflation expectations put an end to its interest-rate cuts in July. With the economy in recession for a second year, rate setters have remained on pause after five reductions in 2015 and even warned last month that their “moderately tight” policy may last longer than previously planned.

‘Acting Cautiously’

“The onset of a structural surplus is an additional factor for acting cautiously when making a decision on rates,” Yudaeva said.

The central bank overshot its target for price growth in 2015 for a fourth consecutive year and has conceded it’s at risk of missing its 4 percent goal in late 2017 after turmoil in the oil market and the ruble. The annual price index slipped to 7.3 percent in March, the slowest pace in almost two years.

Derivatives traders continue to price in monetary loosening ahead. Forward-rate agreements are signaling 36 basis points in rate cuts during the next three months, the biggest wagers in two weeks. The ruble is up almost 9 percent against the dollar this year after a 20 percent loss in 2015.

“The softer the fiscal policy, the tougher the monetary policy, and vice versa,” Yudaeva said. “We can adjust monetary policy to reach targets for inflation even if budget spending is increased. But I hope there won’t be growth in spending.”

Cheaper Funding

The world’s biggest energy exporter is running the widest deficit since 2010 after oil prices crashed. As the Finance Ministry boosts ruble liquidity by tapping one of its two sovereign funds to cover the gap, money-market rates are declining even without any shift in monetary policy.

With central bank funding becoming less attractive for lenders, net borrowers from the regulator since 2011, its ability to sterilize excess liquidity is waning, presenting risks to inflation.

Flush with cash, banks are already lending to each other at a lower rate than they borrow from the central bank. The overnight money-market rate known as Ruonia has averaged 10.91 percent this year, down from more than 17 percent at the start of 2015. That compares with the central bank’s benchmark of 11 percent.

The Bank of Russia, which kept borrowing costs on hold in March for a fifth meeting, warned in its last rate statement that “some uncertainties surrounding budget configuration” are among the reasons for lingering inflation risks.

Spend, Spend

A parliamentary election later this year is adding pressure on the government to spend more. The Finance Ministry is already struggling to keep the budget gap within its target of 3 percent of gross domestic product at an average oil price of $40 a barrel after it reached 2.6 percent last year. The deficit widened to 3.7 percent of GDP in the first three months of the year.

The Finance Ministry plans to transfer 2 trillion rubles ($30 billion) from the Reserve Fund in 2016 to cover the gap after channeling 2.6 trillion rubles in 2015. The central bank estimates that as much as much as 3.8 trillion rubles may be used this year.

As liquidity swings into surplus, the central bank is also on the lookout for the risk of “bubbles” in mortgages as well as loans to companies and households, something the regulator will watch “carefully,” according to Yudaeva. It can use deposit operations to assert control over short-term money-market rates, she said.

Shortsighted View

For Yudaeva, a bigger risk to Russia is “short-term budget thinking,” whose threat extends beyond its impact on inflation. The lack of fiscal strategy may explain instability in financial markets and the exchange rate, she said.

Russia needs a three-year plan for stabilizing public finances, with a view to introducing the so-called budget rule, according to Yudaeva. Such a program needs to include a range of measures, from balancing the budget to streamlining spending, she said.

“A restrained fiscal policy, even this year, is certainly a factor reducing the real exchange rate,” she said. “Consequently costs for companies will be lower.”

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