#4 - JRL 7220
June 11-17, 2003
Strong Ruble amid High Inflation
MIKHAIL ZADORNOV, deputy chairman of the State Duma Committee for the Budget and Taxes, tells Vremya MNs Sergei Guk about the ironies of our economy.
Mr. Zadornov, some economists are saying that a stronger ruble and higher inflation cannot possibly go together, and that in a healthy economy the two are mutually exclusive. How would you explain the paradox?
There is no paradox. The situation is perfectly logical and follows a pattern. Russias balance of payments has been improving, and the country is witnessing large inflows of foreign exchange. In the first quarter of this year, according to data from the State Customs Committee, the country earned $19 billion from oil and gas sales alone, which is $7 billion more than the corresponding figure for 2002. World prices of ferrous metals are today 30% higher than last year, and those of nonferrous metals, 10% or so higher. Furthermore, our business people are keeping far less money abroad: Low interest rates on world markets cannot produce high yields on dollar or even on euro deposits. Because of low interest rates on world money markets, private Russian enterprises of the Gasprom and Alrosa caliber have been borrowing enormous sums from abroad. In this years first quarter, according to the Central Bank, they borrowed $5.5 billion. Moreover, the incoming supplies of foreign exchange exceed domestic demand. Over the last five months or so, the Central Banks forex reserves grew by $15 billion; this, despite the fact that the government in May paid out around $3.5 billion in foreign debts.
Given the large dollar inflows, the Central Bank has no alternative but to buy the surplus on the forex market; hence the strengthening of the ruble, whose current exchange rate is approximately the same as it was 18 months ago. The snowballing ruble mass circulating in the economy has pushed inflation up. Part of the ruble surplus the Central Bank has withdrawn from circulation by the simple expedient of requiring that deposits with it be made in rubles, and by making repo transactions (forex or securities deals in which the seller pledges to buy these things back by a specified deadline and at a specified price. -Ed). Another part of the ruble surplus went into the state budget, parked in federal and Pension Fund accounts. However, the bulk of the ruble surplus is still circulating in the economy, whipping up consumer prices.
Obviously, the government and the Central Bank have failed to live up to their commitments to bring inflation down to 10% to 12%; the inflation rate remains at approximately last years level of 14% to 15%. What is worse, this summer we will probably see no seasonal drop in prices or zero inflation (a drop usually observed in July through August). The reason is that the $15 billion recently bought by the Central Bank is twice the amount originally planned for the whole year. And naturally, the amount of rubles printed is double the figure originally set. While it is true that the economy has been growing and absorbing part of the ruble surplus, a considerable proportion of it remains on the market. What, in your view, are the real ironies of our economy?
Take this example: People who want to prevent their savings from depreciating go to the bank, where they will be offered 12% to 15% in annual interest on their ruble time deposit - a rate not higher than the inflation rate. A bank that accepts deposits must invest the money. Where? Government securities are ruled out - their current yield is no more than six to eight percent. Approximately the same interest rate is offered by the Central Bank.
In other words, banks that buy government securities will make a loss. Investing abroad is not profitable either. The current yield on Russian Eurobonds denominated in foreign-currency is seven to eight percent. At such a rate, your ruble gain at the end of the year will be zero at best; you are more likely to suffer a loss.
People are being incessantly called upon to get their savings from under their mattresses and go to the bank. But in the monetary situation prevailing in Russia, most banks are not interested in the populations savings, and wont accept them on deposit. This means that our economy is exposed to serious disproportions, which must be rectified.
To my mind, a top-priority task of the government and the CB should be to axe inflation within one or two years. Unless this is done first, it will be impossible to achieve any other economic goal, like doubling Russias GDP. Only with zero inflation will the strengthening of the ruble slow down, and the main financial instruments will start bringing banks and investors profits instead of losses.
Unless we accomplish the cardinal task of slashing inflation, we will continue to witness another irony. The government recently announced with pride a 6.5% production growth for the first quarter of 2003; it also announced a rise in incomes and investments. All that is true. But let us also look at other objective facts, such as the index of the populations consumer moods. This index has been falling for four months in a row. People grew increasingly dispirited during the selfsame first quarter owing to the threat of unemployment and wage delays. The proportion of discontented people has grown 2.5 times. While economic growth continues, lots of people still fear for their future. Evidently the redistribution of incomes derived from the economy is taking place in a manner detrimental to the social situation. This irony will last until inflation is suppressed.
Does this mean that the government will have to sharply cut expenditures on social welfare, the army, science and culture?
Nothing of the sort. The first thing to do is to take monetary-policy measures to limit the money supply. Second, a major cause of consumer price growth is the ever-rising tariffs of the natural monopolies and of the housing and public services. Here we have been struggling inside a vicious circle for several years. Only determined action will bring down inflation. Efforts in this direction are needed to eliminate the disproportion between the economy and the social sphere. Which basic targets of the 2003 budget will be attained?
The federal budget will run a large surplus of some 150 billion rubles, as testified by first-quarter results. Probably much less money in ruble terms will be spent on paying and servicing the foreign debt, allowing the state to save a sizable sum. As we proposed in the fall of last year, ruble expenses on servicing the foreign debt must be reduced, and the cash thus saved must go into supporting the regions. They have to give state-paid workers higher wages from October 1 and purchase fuel for the winter; according to my estimates, this will cost them an extra 15 billion to 20 billion rubles for these purposes alone, not seven billion to eight billion as we had thought. Therefore we must correct the current financial plan in September, increasing funds for the regions.