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. Last Updated: 07/27/2016

Ruble Cuts Both Ways

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In the aftermath of the gruesome murder of Central Bank First Deputy Chairman Andrei Kozlov and his driver, this may not be the most appropriate moment to debate the Central Bank's conduct of monetary policy. But calls for the Central Bank to allow nominal ruble appreciation to fight inflation from many corners (notably some investment bankers) are heard fairly regularly. Such a stance tends to simplify the dilemma faced by the Central Bank, which has, in fact, done an admirable job in walking the policy tightrope between allowing gradual ruble appreciation and taming inflation.

In sum, these critics argue that the bank should forget about protecting industry (leave that to the government, as The Moscow Times argued in a Sept. 7 editorial) and let the ruble appreciate in nominal terms. In so doing, less of the current account surplus will be monetized and the inflation rate will fall. The implication is that the Central Bank is not allowing the ruble to rise in order to protect the profits of domestic industrial interests. By printing rubles as the counterpart to its rapidly rising reserves, money-supply growth has accelerated relative to demand, and so the population has borne the consequences in the form of higher inflation.

But it's not that easy. Even if the Central Bank sticks strictly to monetary policy, it still faces a dilemma that has nothing to do with protecting Russian industry from foreign competition.

Along with the huge positive terms of trade shock, an additional complication is that Russia, just prior to the Group of Eight Summit in St. Petersburg in July, removed its last vestiges of currency controls whereby foreign investors were required to operate through special accounts that were subject to taxes. By making the ruble fully convertible, Russia's further integration into the global market should benefit the economy through greater diversification and the development of domestic savings. In the short run, however, it also makes Russia an even more attractive place for foreign investors. For the first time, Russia is running a surplus in both its current and capital accounts (as seen, for instance, by that fact that reserves are growing faster than the current account surplus -- reserves grew by $78 billion in the year through August, despite early debt repayments to the Paris Club of $23 billion).

Over the longer run, especially if the terms of trade remain favorable, the ruble is bound to appreciate, at least in real terms (adjusted for inflation differentials). A purposeful policy of nominal ruble appreciation in the short-term as an anti-inflationary stance could be self-defeating, however, as foreign investors perceive the ruble as a safe bet and monetary inflows become even higher. This is what is happening right now. So, simplistic advice, if implemented, could lead not only to a higher ruble but to higher inflation as well. It would be wise for the Central Bank to leave investors guessing. For instance, the IMF, after its most recent mission to Moscow, said the bank "should refrain from stipulating even indicative nominal and real exchange rate targets."

Unfortunately, some at the Central Bank may not be listening. At a UBS conference in Moscow last week, a senior Central Bank official said that he thought investors were right to bet on the ruble as "foreign exchange risks are zero in Russia." He went further to remark that, in dealing with inflation he favored letting the ruble appreciate (the best method, in his view) and raising Central Bank deposit rates and reserve requirements. He noted all of these methods were being used and that he saw inflation meeting the 9 percent target forecast by the government for this year. But by motivating larger capital inflows, he is just making the bank's task more difficult and the inflation target harder to achieve.

Russia does not need to shoot itself in the foot. It can do little to affect the current account, so it should not be adding its influential voice to encourage further capital inflows.

In fact, the Central Bank should be commended for its efforts to contain inflation, as it should also be for the efforts of Andrei Kozlov and his colleagues to reform the banking system. It has conducted monetary policy about as well as could have been hoped for with a current account surplus running at about 12 percent of gross domestic product. Finance Minister Alexei Kudrin's fiscal policy should also come in for praise: The budget surplus, running at almost 7 percent of GDP, and the Stabilization Fund are acting as the main sterilizers of the monetary inflows. By international standards, this performance is rare. As we see in government plans to increase spending by 26 percent in 2007, this kind of performance is also hard to sustain.

The fact is that in the absence of much higher ruble demand the Central Bank's policy dilemma in the short term can only be addressed through even tighter fiscal policy in order to absorb excess liquidity. For its part, the bank, working closely with the Finance Ministry, should exercise restraint in making public pronouncements on exchange rate prospects. They could also demonstrate their resolve to deny speculators an easy bet by keeping the nominal rate unchanged, or even slightly depreciated, for short periods of time.

Martin Gilman is a professor at the Higher School of Economics.