Monetary policy in the environment of

recovery: Russian experience

Alexander Kashturov

Head of Market Operations Department

Bank of Russia

2

Prior to the financial crisis

Economy:

– Increasing oil prices and capital inflow

– High growth rates of the Russian economy

– Foreign debt accumulation by private sector

Monetary policy:

– Exchange-rate oriented

– Building-up of FX reserves and rapid M2 growth

– Interest rate policy plays subordinate role

(“impossible trinity” problem)

3

During the stress phase of the crisis

Economy:

– Deep recession: GDP fell by 7,8% in 2009

– Capital outflow and foreign debt refinancing problems

in private sector

– The ratio of nonperforming loans to total loans reached

6,5% by the end of 2009 (1,5% before the crisis)

– Drop in domestic assets prices

Monetary policy:

– Restoring financial stability was the main goal of

monetary policy

– Wide range of measures (next slide)

4

Monetary policy response to the crisis

FX policy – Massive FX interventions and gradual devaluation of the

rouble » FX reserves dropped by around $200 bln during the period

from Sept. 2008 – Jan. 2009

» Nov. 2008 – Jan. 2009: the period of RUB gradual devaluation via widening of the dual-currency boundaries. Introduction of the floating operational band

– Special USD credit line to refinance corporate foreign debt

Interest rate policy – Increase in interest rates aimed at preventing capital

outflow as well as reducing inflation risks

– The BoR started easing cycle only in April 2009

5

Monetary policy response to the crisis

Liquidity injections – Subordinated loans to certain banks (both from budget and

the BoR)

– Unsecured loans (since Oct. 2008 till Dec. 2010)

– Widening of collateral base and longer maturity

(up to 1 year) for traditional refinancing instruments

– Reduced reserve requirements

Special resolution measures in cooperation

with Deposit Insurance Agency

6

GDP growth rates

Quarterly GDP, YoY

-12

-10

-8

-6

-4

-2

0

2

4

6

8

10

12

14

03.2

007

06.2

007

09.2

007

12.2

007

03.2

008

06.2

008

09.2

008

12.2

008

03.2

009

06.2

009

09.2

009

12.2

009

03.2

010

06.2

010

09.2

010

12.2

010

03.2

011

06.2

011

09.2

011

12.2

011

03.2

012

%

Russia Brazil India China

Russian economy was severely hit by the crisis in 2008-2009

7

GDP growth rates

GDP, YoY

-20

-18

-16

-14

-12

-10

-8

-6

-4

-2

0

2

4

6R

ussia

Pola

nd

Lithuania

Fin

land

Sw

eden

Denm

ark

Esto

nia

Latv

ia

%

2008 2009

8

Balance of payments

-150

-100

-50

0

50

100

I Q

20

07

II Q

20

07

III Q

20

07

IV Q

20

07

I Q

20

08

II Q

20

08

III Q

20

08

IV Q

20

08

I Q

20

09

II Q

20

09

III Q

20

09

IV Q

20

09

I Q

20

10

II Q

20

10

III Q

20

10

IV Q

20

10

I Q

20

11

II Q

20

11

III Q

20

11

IV Q

20

11

I Q

20

12

US

D b

n

30

50

70

90

110

130

US

D/b

arr

el

Current account Capital and financial account

Net errors and omissions Average oil price (URALS) (rhs)

Change in FX reserves

Significant capital outflow in the 4th quarter of 2008 created pressure on rouble

9

Banking sector foreign assets and liabilities

90

110

130

150

170

190

210

230

01

.20

08

03

.20

08

05

.20

08

07

.20

08

09

.20

08

11

.20

08

01

.20

09

03

.20

09

05

.20

09

07

.20

09

09

.20

09

11

.20

09

01

.20

10

03

.20

10

05

.20

10

07

.20

10

09

.20

10

11

.20

10

01

.20

11

03

.20

11

05

.20

11

07

.20

11

09

.20

11

11

.20

11

01

.20

12

03

.20

12

05

.20

12

bln

. U

SD

Foreign assets Foreign liabilities

Before the crisis foreign liabilities exceeded foreign assets

BoR interventions during the period of gradual devaluation allowed the banking sector to eliminate its foreign A&L mismatch by the end of 2008

10

BoR refinancing operations

0

500

1000

1500

2000

2500

3000

3500

4000

01.2

008

04.2

008

07.2

008

10.2

008

01.2

009

04.2

009

07.2

009

10.2

009

01.2

010

04.2

010

07.2

010

10.2

010

01.2

011

04.2

011

07.2

011

10.2

011

01.2

012

04.2

012

RU

B b

n

REPO operations Unsecured loans FX swap

Lombard credits and others Subordinated loan to Sberbank

The scale of the BoR main refinancing operations has increased during the crisis

11

Reserve requirements

0

100

200

300

400

500

600

700

800

900

09

.01

.08

04

.04

.08

02

.07

.08

24

.09

.08

18

.12

.08

24

.03

.09

19

.06

.09

11

.09

.09

07

.12

.09

10

.03

.10

04

.06

.10

30

.08

.10

23

.11

.10

01

.02

.11

26

.04

.11

14

.07

.11

16

.09

.11

bln

. R

UB

Reserves averaged-out on the banks' corresponding accounts in the CBR

Reserves blocked on a special account

BoR provided additional liquidity to banks by reducing reserve requirements

12

Money market interest rates

0

5

10

15

20

25

30

01.2

005

04.2

005

08.2

005

11.2

005

02.2

006

06.2

006

09.2

006

12.2

006

04.2

007

07.2

007

10.2

007

02.2

008

05.2

008

09.2

008

12.2

008

%

15

20

25

30

35

40

45

RU

B

Interbank market O/N rate (MIACR) BoR stand-by deposit rateBoR REPO rate BoR refinancing rateBicurrency basket (rhs)

The ability of BoR to control market interest rates before and during the crisis was restrained by the FX policy goals

13

The period of economic recovery

Russian economy underwent slow but stable

recovery in 2010 – 2011

– Negative output gap has closed by the end of 2011

The economy is driven by the consumer sector

which is supported by tight labour market

conditions, fiscal stimulus and credit

expansion

Favorable oil market conditions are balanced

out by persistent capital outflow

14

Monetary policy in the environment

of recovery

BoR started normalizing monetary policy as the

stress phase of the financial crisis was over:

– Lowering policy interest rates to support economic

recovery

» The easing cycle lasted from April 2009 till June 2010

– Unwinding non-standard measures such as unsecured

loans and longer-term operations

– Increasing RRRs to rebuild liquidity chest

At the same time BoR started to enhance its

monetary policy and move towards price stability

as the main policy objective

15

Monetary policy in the environment

of recovery

In the next three years BoR will complete

transition to inflation targeting

In order to facilitate the transition BoR works

in several directions

– Increasing flexibility of the exchange rate policy

– Improving interest-rate policy

– Increasing monetary policy transparency

16

Exchange rate policy framework

Managed floating regime

– Limiting excess exchange rate volatility » BoR uses dual-currency basket (the sum of 0.55 USD and 0.45

EUR) as an operational target of FX policy

– No explicit or implicit exchange rate target

– No fixed borders

– Borders of the floating operational band are

adjusted according to automatic rule

(depending on the volume of interventions)

17

Exchange rate policy framework

Flexibility of mechanism has increased

significantly since 2009

– Step-by-step widening of the corridor (from

2 to 6 roubles)

– Increasing the elasticity of the borders

At the moment rouble exchange rate is

predominantly determined by the market

forces

18

RUB exchange rate and BoR interventions

24

26

28

30

32

34

36

38

40

42

44

46

48

01

.20

08

07

.20

08

01

.20

09

07

.20

09

01

.20

10

07

.20

10

01

.20

11

07

.20

11

01

.20

12

RU

B

-80

-70

-60

-50

-40

-30

-20

-10

0

10

20

30

40

US

D b

n

BoR FX interventions (rhs) Bicurrency basket Floating band Fixed band

The amount of BoR interventions has decreased since the introduction of the floating band mechanism

19

Interest rate policy framework

Interest rate corridor formed by the interest

rates on the BoR standing facilities

In between there are interest rates on main

OMOs: REPO auctions and deposit auctions

– Traditionally the system used to operate in a

surplus of liquidity, so the policy framework

used to be close to the floor system

– Since September 2011 the system switched to

the shortage of liquidity, so the REPO auctions

have become the key policy instrument

20

Interest rate policy framework

In 2010-2011 BoR continued to gradually

narrow interest rate corridor in order to tighten

control over the market rates

– At the moment the width of the corridor is

225 b.p. (425 b.p. in 2009)

This along with better liquidity management

resulted in reduced volatility of market interest

rates, which contributed to improved

transmission of monetary policy signals

21

Money market rates and BoR instruments

0%

2%

4%

6%

8%

10%

12%

14%

16%

01

.20

08

07

.20

08

01

.20

09

07

.20

09

01

.20

10

07

.20

10

01

.20

11

07

.20

11

01

.20

12

BoR refinancing rate BoR stand-by REPO rate

BoR stand-by deposit rate BoR minimum REPO auction rate

Interbank market O/N rate (MosPrime) Interbank market O/N rate (RUONIA)

BoR maximum deposit auction rate

Volatility of the market interest rates has decreased significantly, and BoR’s ability to control them has improved

Transition

to liquidity

shortage

22

Inflation and current monetary policy stance

At the moment monetary policy stance is neutral

BoR did not respond to record low inflation at the beginning of 2012 as the decline in inflation was technical in nature (postponed increase in regulated prices and base effect)

Going further where are inflationary risks associated with budget spending, tariff increases and unfavorable base effect

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

22%

2007 2008 2009 2010 2011 2012

CPI YoY Core CPI YoY Food prices YoY

Latest figures

CPI 3.6% YoY (Apr)

Core CPI 5.3% YoY (Apr)

23

Transition to inflation targeting

2%

4%

6%

8%

10%

12%

14%

16%

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

CPI YoY GoalGoal

Inflation objectives are set each year in the “Guidelines for the Single State Monetary Policy” in terms of Dec/Dec inflation rate

BoR has a poor historical record of reaching them Since 2009 BoR has become much better at achieving its goals Still there are many obstacles to moving to inflation targeting

24

Inflation targeting: obstacles

Limited ability of the central bank to control inflation

– Inflation is to a great extent explained by non-monetary factors such as state-regulated prices and supply-side factors

– High rate of growth of tariffs and other regulated prices prevents sustainable decline in inflation

– High share of food in CPI (37.3% of CPI basket in 2012)

25

Inflation targeting: obstacles

Inefficient transmission mechanism of monetary policy

– Underdeveloped financial system

– Low capitalization of both banking sector and financial markets

High dependency on external conditions, hence, a lack of political will to allow free float of rouble

Requires top-level political decision and (preferably) changes in the legal framework

26

Conclusions

In the pre-crisis period BoR’s policy was exchange-rate oriented which led to the “impossible trinity” problem and absence of independent monetary policy

Monetary policy has experienced dramatic changes during 2009-2011

Increased flexibility of FX rate and improved interest-rate policy enabled tighter control over market interest rates

BoR continues to enhance its policies in order to complete transition to inflation targeting by 2014