Russia continues trying to extricate itself from U.S. hybrid war tactics, but the truth is they are still not free to set policy independently from the U.S. The Bank of Russia is acutely aware of this and refuses to lower interest rates to unlock the Russian economy’s potential.
The Bank of Russia announced that its current benchmark lending rate, 8.25%, is sufficient to offset the risks of the U.S. expanding its sanctions regime against Russia. Charting a path of extremely conservative monetary policy while relations between the two countries is at an all-time low is not the wrong approach.
That said, however, the MIACR – Moscow InterBank Actual Credit Rate – yield curve is still not fully normalized with 31 to 180-day rates being lower than 8 to 30 day rates. A normally functioning yield curve should rise with time and a hump in the middle of it suggests that the central bank policy rate is too high if the cost of borrowing for 180 days is lower than that of 10 days.
And I know that BoR President Elvira Nabullina knows this. I know she’s not stupid. This is why the BoR lowered rates from 8.5% to 8.25% in October. The shape of the yield curve has improved with each rate cut, but the work isn’t done.
So I question stopping the rate cuts now when there is obviously much more work to do to spur the kind of growth the Russian economy is capable of.
Growth is a Defense Mechanism
The best defense against further attack by the U.S. is encouraging domestic lending that is ruble-denominated to encourage organic economic growth. By keeping the policy rate so high versus lending costs in dollars or euros it is encouraging the same strong ruble/Western-bank-dependent dynamic that existed in 2014 before oil prices dropped.
While both consumer and business lending are growing finally, the BoR is still encouraging Russian companies to seek out loans denominated in anything other than Rubles at a time when the avowed policy of the Russian government is to de-dollarize as much as possible.
In other words, the high interest rate policy is encouraging the very behavior the BoR says it is trying to fight, by inviting foreign capital into Russia only to see it fly out in the event of a new attack by the U.S. on its banking system.
Foreign ownership of Russian bonds is now 30% versus just 5% at the start of the year, thanks to high interest rate arbitrage.
High interest rate policy in 2015 made sense to arrest the slide in the Ruble, tame inflation and spur local savings and investment in Rubles. But, now that the economy is looking to expand, it’s time for the BoR to loosen the shackles faster than they have.
There is some good news, however, real wages are growing much faster than the rate of inflation (4.3% vs. 2.7%). That gap needs to remain to assist Russian households rebuild wealth lost during the past recession. So, the Russian economy is generating new real wealth and a sustainable pool of real savings right now.
The fear here is that Nabullina fails to walk the right line between growth and fear of another ruble crisis. And the Russian interbank market yield curve has been screaming for two years to loosen up. Nearly every time that she has lowered rates the first response of the ruble was to strengthen not depreciate.
And that’s because latent demand for rubles was so high that lowering rates actually increased the demand to lend in rubles. Conditions are far better today than they were this time last year, but the market is still asking for a sub-8% benchmark lending rate if Russian treasury bond prices are any indicator.
One-year Russian debt is now trading at 7.2% while overnight rates are still closer to 8%. I’ve been saying all year that I thought Nabullina needed to cut rates to around 7% by year-end to properly clear the market and it looks like I’m going to be right about that call.
Growth Wins in Geopolitics
Because the best defense against yet another tiresome hybrid war attack on the Russian financial system by a U.S. Deep State refusing to admit its losing the war is a robust Russian economy. GDP Growth rates up near 4% or 5% and real purchasing power growth between 1.5% and 2% should be the goal, not inflation rate targeting. That’s a dead giveaway that the Bank of Russia still operates under the IMF’s influence.
These growth rates will make it so much more difficult for European Union leadership to keep the ruinous sanctions in place. With Trump’s tax cut plan chopping U.S. corporate rates to that of Russia’s, 20%, the arbitrage that was there for Russia is now gone. As capital flees Europe and heads to the U.S. some of that capital flight should go to Russia. And with the Fed keeping rates below 2% for the foreseeable future, Nabullina and company better start looking at 6-7% for the benchmark rate and not 8.25% or that’s not going to continue.
You don’t just want foreigners buying Russia’s sovereign debt you want them investing in Russia’s real economy.
And if Putin’s ultimate goal, geopolitically, is to cleave at least part the EU from the U.S.’s control, like the Visigrads, Italy and Greece, then there is no better way to exert maximal political pressure than the promise of radically increased trade. For the Visigrads, this is an easy choice since none of them ever adopted the euro.
The incentives are already there. But for countries like Italy, suffering from Angela Merkel’s disastrous refugee policy, a euro easily 25% over-valued and Russian economic sanctions, the choice becomes more dramatic. These are the reasons why non-performing loans in Italy are skyrocketing.
With the Germans unable to build a stable coalition, other Northern European states are filling the power vacuum, like Denmark trying to stop the Nordstream II pipeline by barring it from crossing their waters.
Bavarian Governor Horst Seehofer stepped down as the leader of the CSU in Germany. Putin loses a key ally to get the sanctions lifted as Seehofer has been at the forefront of keeping relations between Russia and Germany amicable during all of this post-Maidan nonsense.
It is incumbent on Nabullina and her staff, many of whom are of questionable loyalty to Russia as I understand it, to continue rate normalization and allow the tenuous Russian expansion to take off in 2018.
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