Smile your way to the bank, say investors

Source: Reuters/Vostock Photo

Source: Reuters/Vostock Photo

With interest rates staying below inflation for the last two decades, Russians are turning to banks in larger numbers to park their savings.
For most of the last two decades, interest rates in Russia have stayed below the rate of inflation - known as "negative real interest rates". However, interest rates have turned positive, which means that for the first time, Russians can actually make a profit from stashing their money in a bank. It is a subtle difference of a few basic points, but the flip into positive real interest rates should have a profound and long-term beneficial effect on the economy.

The global economic crisis has changed everything. The sharp drop in demand following a 7.9 pc contraction in the economy in 2009 killed inflation. While prices began to recover somewhat in the first half of this year, the last two months saw a mild bout of deflation again and the government is predicting a modest (for Russia) 6 pc inflation rate by the end of the year. With little pressure on prices, the Central Bank of Russia (CBR) has slashed interest rates a dozen times over the last 18 months. Even so, the fall in inflation has been so steep that by June, interest rates on deposits were marginally ahead of inflation - a mere 0.2 percentage points - for the first time since 1991.

"The changes will be profound, but they will not be dramatic," says Peter Westin, chief economist at Aton investment bank in Moscow. "We are talking about less than 1 pc, so no one is going to get rich on this kind of spread. Still, the motivations have completely changed."

As Russians came to trust their banks, personal deposits have overtaken corporate deposits in size. The banks have used this cheap source of financing to drive a credit boom, which in turn, drove the rapid 6 pc-plus a year growth for five years prior to the autumn crash of 2009. "We are still very early in the cycle, as for every ruble a bank takes in as a deposit, it only lends out 50 kopeks; banks are still very nervous as a result of the crisis," says Westin. "However, the inflow of money means that banks are building up bigger and bigger supplies of capital and getting healthy and stronger as each day passes. It is only a question of time before they feel confident enough to start financing growth again."

Normalcy returns

The appearance of "normal" rates of return should produce a raft of benefits for the economy. "Negative rates are like having a leak in the petrol tank of your car. No matter what you do, eventually, you run out of gas and stop," says Westin. "Thanks to the reluctance of banks to lend, the car is driving very fast now, but as more and more fuel is put into the car, it can go further and faster."

Banks will now be able to manage their cash better, dividing it between equities, bonds and cash, which will make the financial system more robust. Also, lower interest rates have already fed through into the nascent mortgage market, leading to a knock-on effect on the crucial construction sector. Real interest rates will also allow the maturity of bonds to lengthen and will make it easier to draw up long-term investment plans. Most important, real interest rates mean that the Central Bank of Russia's (CBR) overnight rate actually means something, which will allow it to control at the same time, both inflation and the level of the ruble.

Still for all these benefits to really take effect, the CBR has to bulk up the financial system with more cash and introduce more flexibility to the exchange rate, say economists. Over the last year, the CBR has been slowly withdrawing from the foreign exchange markets, as it transitions over to controlling the economy by changing interest rates, rather than simply buying up dollars. But the supply of money in the Russian economy is still only about 45 pc of GDP against the 100-120 pc that is normal in the West.

"You need a really liquid monetary base and in particularly, a big and liquid bond market, before you can really use interest rates as a tool to control the economy; to encourage people to save or invest by raising or lowering rates," says Westin.

The fly in the ointment is the heat wave that has settled over Russia. The Agriculture Ministry has downgraded the forecast for this year's grain harvest to 70 mn tonnes, well off the record of 110 tonnes two years ago. This will drive up prices, reversing the falling inflation and interest rate trends.

The government is, however, actively deepening the bond market. Private companies have been issuing a flood of bonds as the only way that banks are willing to lend to them, but the state has also announced a massive 1.2 trln ($38.9 bn) borrowing campaign for this year as it taps domestic resources to finance the deficit.

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