Editor’s Pick: Persistent Russian Inflation
The Russian government’s announcement that it would extend price controls to fight inflation has received a lot of attention – especially coming so close to December’s parliamentary elections. Russia’s inflation has been reaccelerating in recent weeks – part of the trend of global food price rises – other countries are either extending price controls (China) or rolling back plans to cut subsidies (Syria, Egypt).
The IMF’s recently released selected issues paper on post-1998 Inflation dynamics takes a look at Russia’s persistent inflation dynamics – more persistent, they note, than other EMs especially in Central and Eastern Europe. Though other CIS countries face similar rates. Although Russia’s inflation fell dramatically from 30% in 2000 to about 10% in 2003, it has remained vaguely around that level since then and this year it will surpass the 8% target.
Different measures of inflation point a similar degree of entrenchment (Figure 1). Core consumer price inflation, which excludes the effects of administered prices and volatile prices of fruits and vegetables, followed a disinflation process similar to that of headline consumer price inflation,although it had already become entrenched at 10–13 percent in 2002 and remained in that range until mid-2005. Core inflation has generally been lower than headline inflation because it excludes administered prices, which have been a major contributor to headline inflation. Producer price inflation has followed a more volatile path, albeit a more pronounced one, characterized by an initial decline, followed by a period of entrenchment at rates between 10–30 percent year on year.
They explain this persistence as follows and suggest an inflation targeting regime: This appears to be a reflection of strong backward-looking behavior in price setting. The identified backward-looking component in the inflation process might reflect the CBR’s limited commitment to disinflation against the backdrop of a policy that limits nominal exchange rate appreciation. An explicit inflation-targeting framework may help reduce firms’ uncertainty about the future. This, in turn, may allow firms to be more forward looking, thereby reducing persistence.
So what should the Russians do? Exchange rate appreciation has been the main inflation-flighting tool, allowing the rouble to rise against its basket. Russia’s real effective exchange rate rose almost 40% from the end of 2001 to June 2007 – in part encouraging the now somewhat cheaper imports which are growing at a rapid pace.
Rouble appreciation was limited by concerns about inflows and the effect of the strong rouble on non-oil sectors which remain fairly uncompetitive. Russia attracted $67 billion in inflows in the first half before credit turmoil prompted about $9 billion in investment outflows in the third quarter.
With the CBR’s current focus on restoring liquidity to the Russian banking system, especially to the less efficient lower-tier banks, inflation-fighting may be on hold for the rest of the year. Fitch warned that more actions may be necessary to avoid crises in some banks although as a whole the sector has quite substantial liquidity and foreign borrowing is relatively subdued. Other factors may increase the money supply and thus inflation Furthermore spending deferred from earlier this year might also affect inflation expectations as will planned spending increases in 2008. The central bank has been reluctant to raise interest rates which are low and negative in real terms and officials already warned that investors should not expect further appreciation of the rouble. So price controls must have seemed politically expedient ahead of the elections.
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