Inflation Memory Is What Keeps Russia's Real Rates World-Beating

Russia's central bank is keeping rates high in the midst of recession to shore up its credibility

What's "moderately tight" in Russia would be choking in most other places on the globe. Except in Belarus.

At 5.5 percent, Russian real interest rates are the second-highest in the world, according to the investment arm of the country’s biggest lender, Sberbank CIB. While most economies with restrictive rates have them because they're expanding briskly, recession-hit Russia would benefit from easier monetary policy. But inflation running at almost twice the central bank's 4 percent target is feeding memories of runaway price growth that started after the collapse of the Soviet Union.

So Bank of Russia Governor Elvira Nabiullina is choosing to be conservative with what she calls a “moderately tight” monetary policy.

Lauded by Morgan Stanley as the “most orthodox” central banker in developing Europe, she pledged to keep the benchmark up to three percentage points above headline inflation to anchor expectations. Consumer prices rose an annual 7.5 percent in June, the one-week auction rate was kept at 10.5 percent on Friday.

“Overly tight monetary policy and overly high real interest rates bring new risks for Russia,” Sberbank CIB economists led by Anton Stroutchenevski said in a report on Monday. 

For one, they choke credit and threaten to delay the economy's return to growth that the International Monetary Fund currently forecasts for 2017. They also risk attracting speculators to a carry trade that would stoke ruble appreciation and erode exports, according to Sberbank CIB. Borrowing dollars and investing in the ruble has returned almost 18 percent this year, the world’s second-best carry trade after Brazil’s real.

Why then, one may ask. Because inflation in excess of 2,000 percent in the 1990s is still very much on Russians' minds and confidence in the central bank's credibility has suffered after it missed its goal for a fourth straight year in 2015.

Keeping rates high is a way to bolster the institution's reputation after it shifted to inflation targeting in late 2014. Ksenia Yudaeva, a first deputy governor at the Bank of Russia, predicts it will take 15 to 20 years of price growth in line with the 4 percent goal to match the credibility of the European Central Bank. In modern Russian history, inflation was near or below that level for only six months in 2012.

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