The government is putting pressure on the head of the Bank of Russia, Elvira Nabiullina, to soften her rhetoric regarding inflation forecasts and, accordingly, the key rate. Bloomberg sources say the government wants a clear signal from Nabiullina to cut the rate by the end of the year, but the head of the Central Bank is not ready to make such forecasts, as she fears that the risks faced by the economy could make adjustments to economic policy.
Sources believe that the head of the Central Bank does not intend to follow the lead of her colleagues from the government and promise a rate cut by the end of the year, on the contrary, she planned to announce that there is little room for a rate cut in 2023 and a serious drop in rates amid rising inflationary expectations should not be expected. . The only concession that the regulator agrees to is to allow a rate cut if economic conditions improve, tying this to improved government forecasts. Agency sources note that this is an unusual conflict within the economic bloc.
Until now, the government and the Central Bank have been able to find a balance in the issue of monetary and financial policy, but the vector of economic development in 2023 will depend on the rhetoric, the agency notes. The government is under unprecedented pressure amid a record drop in oil and gas revenues, rising military spending and the largest budget deficit in recent years – in such conditions, a softer policy from the Central Bank can mitigate the consequences for the budget, but in this case, the Central Bank may lose its independence, which is extremely important for the banking sector and the financial system as a whole.
“If government spending picks up as forecast and the government continues to sell foreign currency, the central bank could resume cutting its discount rate in the first half of this year,” said Alexander Isakov, Russia economist at Bloomberg Economics.
Currently, the Bank of Russia’s inflation forecast for 2023 is in the range of 6.5% to 8.5%, while the key rate is at 7.5%, a neutral level sufficient to contain price growth. However, the rate is a benchmark for the debt market, which determines the rates on loans and deposits. The same factor is now negatively affecting the government bond market, which, under Western sanctions , is becoming one of the most important sources of government revenue. Probably for this reason the government wants to hear positive rhetoric from the Central Bank, which could lead to a reduction in the cost of borrowing.
At the moment, the Ministry of Finance is forced to hold auctions for the sale of government bonds with premiums, as the market understands the difficult situation with the budget and the rather high risks of financing the budget deficit. In such conditions, banks are in no hurry to lend to the state at current rates, realizing that in the future they may rise, but this option, apparently, does not suit the government, which wants the Central Bank to signal a possible rate cut by the end of the year. This could lead to a reduction in the cost of lending right now and make it easier for the government to build up public debt.
In addition to lowering bond rates, lowering the key rate will weaken the Russian currency against foreign currencies, which will make Russia's exports more profitable in terms of ruble revenues to the budget. Such a measure could relieve pressure on the budget by increasing its ruble content, but a sharp rate cut increases the risks of rising inflation. The government insists that real inflation in the country has been around zero for a long time, so there should not be high risks here. The Central Bank sees new risks in increasing budget spending, including benefits and social payments, as well as in the labor shortage in the labor market.