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Analysis & Opinion
20.04.11 Inflated Expectations
By Tai Adelaja

Russian Prime Minister Vladimir Putin gave an upbeat report on the economic achievements of his government on Wednesday, predicting that Russia would shake off the negative effects of the global economic crisis come 2012, a year earlier than many analysts predicted. The prime minister also assured deputies that runaway inflation – Russia’s perennial problem – will be tamed and kept under 7.5 percent this year. "The inflation has begun to decrease in March and April of this year," Putin told lawmakers on Wednesday. "We do not expect it to rise beyond 6.5 percent to 7.5 percent."

Earlier this month, Russia's Economy Ministry changed its 2011 inflation target to 7.0 percent to 7.5 percent, compared to the previous official target of a six to seven percent rise in consumer prices. However, in its own state of the economy report published on Tuesday, Federal State Statistics Service (Rosstat) gave little reason to let out a sigh of relief. Real wages were down 0.4 percent in March after rising 2.4 percent in February, indicating that inflation continues to take its toll on the economy. March inflation increased 0.6 percent month on month, bringing yearly inflation to 9.5 percent, slightly down from February. Real disposable income decreased by an annualized three percent in the first quarter of 2011, according to the first quarterly report.

The latest Rosstat report also gave economists some cause for concern. While investment shrank 0.3 percent year on year against analysts' expectations for a 2.3 percent increase, retail trade turnover increased by 4.7 percent – an indication that Russians have been spending more despite a decline in real incomes and wages. Igor Polyakov, an analyst at the Center for Macroeconomic Analysis and Short-Term Forecasting, said the increase in purchasing power for consumer goods indicates that Russians have started to dip deep into their savings to satisfy consumption needs. The main driver of growth in the retail sector is the high demand for consumer goods bought using consumer credit or the withdrawal of private bank deposits, Polyakov said. The growth in demand for food products has been cancelled out by rising inflation.

According to the report, nominal wages grew 10.1 percent in the first quarter compared to 9.6 percent in the same period last year, but the growth was not significant enough to keep up with rising inflation, which grew 9.5 percent from 7.2 percent over the same period. Real incomes fell 2.9 percent in the first quarter for the third month in a row. However, retail trade continues to grow, with demand for food products up 1.2 percent, while demand for consumer goods climbed 8.3 percent. In further proof that Russians may be living on their savings, the aggregate saving rate declined 15.7 percent between January and February, compared to a 10.9 percent decline in the same period in 2010. At the same time, the share of income allocated to the purchase of goods and services has increased to 80.1 percent, compared to 74.7 percent for last year.

Mainly reflecting soaring food prices, consumer price inflation has risen four percent since the start of the year, despite the Central Bank's seven percent price growth target in the whole of 2011. An added fear, economists say, is that Russia may witness the relaxation of budgetary discipline in the run-up to the Parliamentary elections in December and presidential elections next spring, further raising the risk of inflation. The government raised social pensions by 10.3 percent on April 1 and could raise retirement pensions from August 1 of this year, if inflation in the first half of the year exceeds six percent, Putin said during a video teleconference with regional leaders earlier this month. Putin noted that an increase in pensions and allowances will require considerable amounts, but said that money has been set aside for this in the budget.

Underscoring such fears, Finance Minister Alexei Kudrin said in Washington last week that Russia will direct about $10 billion windfall oil and gas revenues to the country's special funds this year, to keep market liquidity levels at bay and avoid the risk of higher inflation, Reuters reported. "We are not going to increase the inflow of oil dollars into the market and create additional inflationary risks," Kudrin told journalists at a briefing on the sidelines of the International Monetary Fund and World Bank spring meeting in Washington. Rising crude oil prices is expected to put more than $51 billion in extra budget revenues this year and experts say the windfall could encourage politicians to plan an increase in public spending ahead of the Parliamentary elections.

Kudrin told an economic forum on February 19 that consumer price inflation in Russia may still be lower than the official target of seven percent in 2011, adding that the government has not abandoned its goal to keep inflation within that limit. But some economists are skeptical. Sergei Aleksashenko, a former first deputy chairman of the Central Bank and director of Macroeconomic Research of the Higher School of Economics, said there is little likelihood that inflation will be below seven percent this year "unless Federal State Statistics Service tweaks its figures." "My fear is that now that Kudrin said that inflation will be seven percent and the prime minister also says we need to keep inflation around seven percent, we may eventually see Rosstat come up with 6.9 percent," Aleksashenko said. Aleksashenko predicted that inflation will be around 8.5 percent and nine percent in the current year.

Central Bank governor Sergei Ignatyev told journalists early this month that full-year inflation at six to seven percent was still "achievable" if there is a normal harvest. The Russian harvest was devastated by drought and wildfires last year, pushing up the cost of food and driving a surge in headline inflation. Economists have suggested that the latest Rosstat figures are an excuse for the Central Bank to delay raising interest rates this month as widely expected. The bankers’ bank may now want to keep rates low in order to stimulate investments through cheaper bank lending. "The figures are weak," said Alexandra Yevtifyeva, an economist at VTB Capital. "We are leaning more toward the fact that the data are negative from the Central Bank's viewpoint. The probability of an increase in interest rates is falling."

Struggling to contain rising prices and discourage inflows of speculative capital, the Central Bank raised all of its key interest rates by 25 basis points in February. It also raised the overnight deposit rate to three percent, as expected, and the refinancing rate to eight percent. The decision was taken due to continued high inflation expectations and the likelihood of capital inflow into Russia against the backdrop of high global oil prices, the Central Bank said in a statement.
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