After a period of soaring inflation, it now appears that the Russian monetary authorities have stabilized the growth in prices to a manageable level. By the end of the year, the inflation rate could be as low as 6 percent.

Russian citizens felt the dramatic price gains in the most painful way possible – with their pocketbooks. Photo: Kirill Kuhmar/TASS

Fears of hyperinflation in Russia, which emerged as a reaction to the economic crisis within the country starting in 2014, appear to be waning. Inflation in Russia at the end of May, in annual terms, has stabilized at 7.3 percent, according to the Central Bank of Russia. This is a very high figure by world standards, but when it comes to the Russian economy, this can be considered as a very significant achievement.

After all, consumer prices rose 12.9 percent in Russia in 2015. This was the highest level since 2003, with the exception of the crisis year 2008, when prices soared even higher, to a level of 13.3 percent. Thus, today, as Russia heads into the second half of 2016, it is possible to claim that the Russian monetary authorities have managed to curb inflation, which for about the last six months has fallen almost in half.

Acceleration and braking

Of course, the inflation situation looks different today than it did at any previous period in the past two years. For example, in December 2014, against the backdrop of a sharp devaluation of the ruble, inflation rose to a 10-year monthly high figure of 2.6 percent. Then, in January 2015, even this record was smashed, when the monthly rate hit 3.9 percent.

As of December of last year, according to the Russian State Statistics Service (Rosstat), the consumer price index had risen 12.9 percent, compared to the same month in 2014, against an 11.4 percent increase a year earlier.

Statistics show that over the past eight years, since 2008, prices have doubled, and one-quarter of this increase came in the years 2014 and 2015, when the economy experienced multiple inflationary shocks caused by declining oil prices, as well as the government’s ban on the import of certain categories of food products.

During almost all of last year, with the exception of December, the annual price index never fell below 15 percent. Food prices were the fastest to climb – 20.8 percent on average on an annual basis. Prices for fruits and vegetables accelerated 3.4 times faster, in comparison with the year 2014 – achieving an almost 30 percent increase. Cereals rose by 42 percent, sugar by almost 40 percent, and sunflower oil by 31 percent. Other price growth champions included: consumer electronics (26 percent on average per year), pharmaceuticals (23 percent), and the costs of foreign travel (37 percent).

It is clear that everyday Russian citizens felt these dramatic price gains in the most painful way possible – with their pocketbooks. So what caused price increases to slow down in the first half of 2016?

The monetary authorities themselves attribute this to the low effective demand on the part of the population, and the strengthening of the ruble during the first few months of 2016. According to private sector experts, there are three key reasons for the sharp deceleration of inflation in the country in 2016.

First, there is the effect created by using the high starting base. The monthly inflation date in 2016 was compared with the corresponding figures of 2015, when, due to the sharp collapse of the ruble, inflation was soaring. Accordingly, in purely statistical terms, it is now relatively low.

Second, the crisis has led to quite a noticeable drop in the real incomes of the population – for example, income levels decreased by 5.7 percent in May 2016, when compared with May 2015. As a result, the purchasing power of the people fell significantly. It became pointless for sellers of goods and services to raise the prices of their products – people just could not afford to buy them. This factor also significantly contributed to the slowing down of inflation – a sort of blessing in disguise.

Third, the strengthening ruble played a role as well. During the first five months of 2016, the Russian currency has strengthened by almost 10 percent against the dollar.

However, it would seem that perhaps the most important role in the stabilization of the pressure on prices was played by the moderately tight monetary policy of the Bank of Russia. The Central Bank has refused to succumb to the populist monetary recipes (promoted in particular by Russian presidential adviser Sergey Glazyev), which call for pumping up the economy with liquidity. The nation’s central bankers reasonably believe that this would be a direct path to an uncontrolled surge in inflation.

The Central Bank pursues a consistent policy of inflation targeting, trying to use monetary methods to control price dynamics – and in particular, adjusting the prime rate, which during the crisis, the Central Bank has changed 10 times, and which now stands at 10.5 percent. To a large extent, it was the policy of the Central Bank that has contributed to the sharp slowdown in the country’s inflation rate.

Record landmark

The Central Bank of Russia considers this slowing down in the growth of prices as a long-term trend. In any case, given the current positive price dynamics, it has lowered its forecast for the inflation rate at the end of 2016 to 5-6 percent.

The Ministry of Finance agrees with this forecast, predicting by the end of 2016, the lowest inflation rate in Russia’s recent history - 6 percent.

The forecast of the Ministry of Economic Development (MED) slightly differs from that of the Central Bank – according to the MED, inflation could reach 6.5 percent in 2016. On June 23, Alexey Ulyukayev, head of the Ministry of Economic Development, announced that inflation was slowing faster than expected in Russia. The MED traditionally revises its macroeconomic forecasts for the current year each September, so there is still time for adjustments.

What is the reasoning behind this optimism of the monetary authorities?

Last year, the main drivers of inflation were growing food prices – something painfully felt by the population. Now the situation has changed. In its reports, the Central Bank has noted that food prices grew moderately in May, on an annual basis, in comparison with the prices being charged for industrial goods and services. This was made possible by the “high level of supply of agricultural products, and the successful active implementation of the import substitution program in the food industry.”

However, this does not mean that a further decline in price growth is inevitable. Risks that inflation will accelerate again remain, and the monetary authorities see these.

In its June bulletin, the Central Bank made a short, but fundamentally important, observation: inflation risks persist, due to the absence of a fiscal consolidation strategy and uncertainty about the indexation of salaries and pensions.

In addition, according to Elvira Nabiullina, the head of the Central Bank, there is support for the intentions of the Ministry of Finance to reduce the state budget deficit (which currently stands at approximately 4.7 percent of GDP) by 1 percentage point each year. However, these intentions must be backed up by actions.

The head of the Central Bank also believes that additional state expenditures, not backed by the growth of production, lead to an acceleration of inflation, and thus risk the exhaustion of reserves – and if inflation accelerates, the incentives for investment will be reduced, and in turn, without these investments, domestic production will not grow.

In implementing this approach, the Central Bank will have to conduct a more assertive policy, warns Nabiullina. In the meantime, the Central Bank intends to maintain its prime rate at today’s level – 10.5 percent. The prime rate is so important because it effectively sets the lending rate for credit institutions within the economy.

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According to Alexey Pogorelov, analyst at Credit Suisse, in the next 2-3 months, inflation expectations will decline, but when it comes to the state budget, things will remain uncertain until the new Duma is formed after the upcoming elections. According to him, the Central Bank may reduce its prime rate down to 9.5 percent by the end of the year.

Chief economist at Alfa-Bank Natalia Orlova told Russia Direct that the inflation rate by the end of 2016 would mainly be determined by the nation’s fiscal policy:

“Some inflation risks, associated with the indexation of pensions, remain unclear. Apparently, the Ministry of Finance will be guided in this based on the oil situation. That is, when oil prices are high, they allow themselves to index social spending, and when they are low – they can follow a tighter script. The Finance Ministry, in its policy, does not seek to counter external volatility, but adjusts to it accordingly. This is not a very good thing.”

As a result, Orlova does not believe that by the end of the year inflation will fall below 6 percent. The more likely figure, she says, is 8 percent.

Igor Nikolaev, director of the Institute of Strategic Analysis at the Anti-Corruption Foundation, agrees that total inflation in 2016 may be higher than the optimistic forecasts of the Central Bank and Ministry of Finance, since “consumer activity will increase significantly in the fall, and with it consumer prices.”

“Our economy is not characterized by a high level of competition, and so in trying to compensate for falling revenues, companies will increase the prices they charge. That will be the fundamental reason behind the high inflation that will remain with us,” concludes Nikolaev.    

Another expert interviewed by Russia Direct, chief economist of the Eurasian Development Bank Yaroslav Lisovolik, believes that, if the Central Bank follows a tight monetary policy and there is a favorable external environment (first of all, relatively high oil prices), then it is possible that inflation will slow down to 6-7 percent. He explained that a tight policy on the part of the regulator would lead to the reduction of inflationary pressures, while high oil prices and the strengthening of the ruble will further weaken inflationary pressures.

Lisovolik believes that the dynamics of the ruble exchange rate will be an important determinant of inflation this year. “As for the slowing demand – this factor will continue to have a dampening impact on inflation, however, we should not base our forecasts on this, because the priority of the government should be encouraging economic growth,” says Lisovolik.

To reduce inflation, it is better to use a combination of fiscal and monetary policies, which allow slowing down the pace of inflation, while simultaneously creating preconditions for the restoration of economic growth, the economist concluded.