Inflation Makes Russia a Good Bet


Jon Hellevig
Managing Partner
Hellevig, Klein & Usov

www.hkupartners.com

There are three factors that really make Russia an attractive object for investment. These are inflation, corruption and bureaucracy. This sounds weird, I must admit, but when you make an investment you look for value, for hidden value. You want to identify what nobody has realized yet and invest ahead of the horde. This is because you look to capture the value that will become evident to everybody else after you are already invested. This should explain my seemingly odd assertion. What I mean is that the prospect of taming these ills makes Russia attractive.

 Putin recently called inflation the Achilles’ heel of the Russian economy. But corruption and bureaucracy equally affect the social body. Continuing with the somatic metaphors, we could call corruption the stranglehold on society and bureaucracy the social cancer. And these all form part of the same syndrome; the inflation rate showing just how sick the economy is.

 The good news is that inflation has now finally been recognized as the problem it is. And any cure starts from admitting the problem. The fight against corruption is also becoming real, and some big heads have started to roll. The problem is just so endemic that it will take some time before any effect will be evident. Unfortunately, though, there is not much progress on taming the bureaucracy, and indeed the authorities have not realized the essence of the problem. A striking example of this is the amendment to the Competition Law, which now gives the competition authority the right to reject an application if it thinks that not all the necessary information was included in it — and we know that there is no limit to what may constitute the “necessary information.” Earlier the authorities could not reject an application but were required to request additional information, which is the common practice in countries with a developed administrative culture. One may assume that the clerks at the competition authority have complained of their workload and managed to get this “improvement.” Just think what an opportunity this creates for negotiating what is to be considered “necessary.” Cutting bureaucracy while not costing anything would mean a huge stimulus for the economy. Bureaucracy has turned Russia into a vast playground for adults where you churn out document after document, stamping them now with the square stamp, now with the royal round, standing in all kind of queues, jumping over hurdles, and creeping through pipelines. All this results in substantial increases in the cost of doing business, delays in realizing projects, inferior labor productivity and, of course, serves as the main source for corruption. This is all summed up in inflation.

 Of course, inflation is also about monetary policies. There has been a substantial improvement in how the Russian leadership thinks about those, but some of the reoccurring policy statements are bewildering. One of the big things about inflation fighting is about getting interest rates down. In the long run in a market economy, interest rates cannot be below the inflation rate. Therefore you have to set the steering rates in relation to the inflation figure. But here is where the central bankers and cabinet ministers go wrong. They constantly refer to their predictions of how much they expect inflation to be at the end of the calendar year. But interest rates affect the future, and inflation in the calendar year is about history. What sense is there today, in October, to match interest rates to predictions about calendar year inflation? This predilection means that the Central Bank is always late in fixing its benchmark rates. Instead they should set the rates now after comparison with anticipated inflation, which is based on inflation trends and the knowledge on what has changed in the economy that could affect this trend. This anticipated inflation rate — which is the only correct measure — is never used; instead they refer to another historical figure of little value, namely the rolling cumulative rate of the past 12 months. This latter figure is given out as the “official inflation rate.” The CB needs to be braver in looking into the future and stop steering the Russian economy while hooked onto the rear mirror.

 Nevertheless, there is a real chance that the refinancing rates will be cut in the near future to 8 — 8.5 percent. This would make all the difference for the economy, making possible lending rates in the range of 10 — 14 percent, and enabling a real financial sector to develop. The goal should be to reach lending rates of 8 percent to 12 percent. But inflation in an emerging economy like Russia does not have to be totally quenched; inflation below 5 percent or 6 percent would be more harmful than beneficial because it would suffocate the necessary flexibility.