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CNBC Transcript: Interview with Geoff Cutmore and Elvira Nabiullina, Governor of the Central Bank of Russia.

Following are excerpts from a CNBC interview with Geoff Cutmore and Elvira Nabiullina, Governor of the Central Bank of Russia.

GC: So I want to start by asking you about your current interest rate view. You appear to have pre-committed the bank now to no change in interest rates until early 2017. Is there a risk in doing that you are dissuading companies from investing in their own businesses as they wait perhaps to see if they can get cheaper financing?

EN: Last week we made a decision to reduce our key rate by 50 basis points and we thought that this was possible because inflation was going down and the inflationary expectations are similarly being reduced and currently inflation is at about 6.5% per annum. However, we see that this doesn't mean that there are no inflationary risks. Although inflation has been going down in accordance with our forecasts these have been affected by external factors, and a stronger rouble and a good crop yield, and in order to ensure that inflation will continue to go down, that inflation expectations will be decreased and this trend strengthens we have sent a signal to the market saying that our policy is going to remain moderately tough in order to ensure that inflation reduces to our target level.

We have noted that the expectations of many of the market players were that we would be quite quick to reduce our key rate but at the same time they were expecting that inflation towards the end of next year would be above our target. Therefore, through the signal stating that this year that we will not be reducing the rate, and unlikely to be reducing it before the start of next year, we wanted to tell market players about our position that the trajectory of the reduction of the key rate is going to aimed precisely at achieving our inflation target. Therefore, we were able to see after our decision that market players were able to adjust their expectations slightly and the yield curve moved upwards slightly and inflationary expectations subsided.

Now, as far as our decisions are concerned with regards their effect on the economy and economic growth and the willingness of businesses to invest. The first thing we see is that the key limiting factor for investment is not so much our high rate and tough monetary policy but rather structural limitations, the state of the investment climate and so on and so forth. Therefore, we believe that through our rate decision we will not be reducing economic growth and that the problems of economic growth have their root in structural limitations. In addition, our country's economy will have to learn to live with a background of a really positive interest rate. This means that we will need investment into the improvement of labour productivity, we will need to improve efficiency and reduce costs, and this is precisely the kind of signal that our monetary policy is sending to the market.

GC: Is there a risk that you have bound your own hands should the data change, should we perhaps get a spike in the energy price after the meeting in Algeria. Or perhaps the government's fiscal budget for 2017 through 2019 is looser than we might previously have imagined. Does that mean you remove some flexibility to react?

EN: We have been saying that a reduction in the rate is very unlikely. But of course if any extraordinary events occur. For example if there is a much higher oil price because of certain other circumstances or drivers which suggest that the overall economic dynamics and inflationary dynamics will be better than those used for our base scenario, which of course can happen. However, we do not see a high probability of these sorts of events unfolding.

GC: It's been remarkable how strong consumer spending has been in the economy. It's really come back this year and wage growth has returned. Do you think these are the reasons why inflation expectations still remain relatively high in the country rather than perhaps being more moderate as you would like, which would allow you perhaps some more room to act?

EN: It is indeed true that inflationary expectations remain fairly high, they are in decline, but they remain above the level that would meet our inflation targets. In many ways this can be explained by the psychological factor because people in Russia have grown used to living in a high inflation environment. For the time being people do not think that inflation could be stable and low in the region of about 4%.

In addition, we see that wages are recovering, but real income growth remains fairly low and the population is continuing to demonstrate a model of behaviour inclined towards saving. Consumption will doubtless gradually recover and start to grow but it is very important for us that these economic dynamics for consumption growth are not stimulated by inflation but are accompanied by an expansion of production that won't lead to a growth in prices.

GC: Now that you're in the business of forward guidance. Can I ask you as you look at 2017 then, the market appears to believe that you will remain on an easy bias and that we could expect further significant rate cuts through 2017. Is that market view correct?

EN: We definitely see the possibility of our key rate going down. But the trajectory of its reduction will depend on the economic dynamics, what the inflationary risks are. And in this way we will reduce the key rate so that in the final analysis we will achieve our target. Let me remind you that our target is not just 4% by the end of next year but to achieve and maintain a low level of inflation over the mid-term perspective.

But at the same time our rates shall remain positive. In other words, in order to ensure the reduction of inflation and inflationary expectations. To peg them to a low level we will have to maintain our key rate above inflation in order to strengthen this trend.

GC: Can I just ask you about the improving outlook for the economy? We have seen the capital flow now positive for August. Do you believe you have seen the worst of the sanctions related pressure on capital to flee and on the economy to underperform?

EN: Capital outflow and in general the balance of payments have adjusted themselves to the kind of situation when because of the sanctions Russian banks and companies had limited access to capital markets. And this year we have definitely noted a considerable reduction in capital outflow over 8 months that was the equivalent of about 10 billion dollars. At this point I should remind you that over the 12 months of last capital outflow came to 60 billion dollars. Our forecast for the next 3 years suggests that capital outflow will remain at a low level of around 25 billion dollars.

The reasons for this reduction in capital outflow compared with the figures we have seen in previous years is firstly that there has been a very considerable reduction of external debt among Russian companies and the schedule of the forthcoming payments for foreign debt indicate that there are no risks of pressure on the balance of payments. Secondly, because we have been maintaining positive real rates in the Russian economy, Russian assets are becoming attractive to investors. The third factor is that the reduction of inflation is also making Russian assets more sought after.

Therefore, we see that capital outflow has stabilised itself to this level of around 25 billion dollars. We have now switched over to the floating exchange rate and this will consequently be reflected in the current account balance, which shall remain positive but slightly lower than in previous years precisely because capital outflow will continue to decrease.

GC: Can I get your view on the international picture? We are in a critical week for central banks in Japan and the United States. The broad message continues to be, we push easy money, we pursue more and more creative policies to try and manipulate the yield curve. And yet Arian has just put out a report saying that in 2015 global financial household assets fell in value. Not increased, as you would expect, given all this stimulus that we're seeing. Have we reached the end of the effectiveness of this action do you think? Is it time for a re-think?

EN: We are proceeding from the premise that in the immediate future and this is a basic factor, the main external factor, which is influencing our decision making. We are proceeding from the premise that the global economy is going to grow at a low tempo. And at the same time there will be quite high volatility, the risk of high volatility in the financial markets. The era of cheap money has indeed has led to the kind of situation where financing and investment was put into projects with low productivity, which all things being equal and under tougher monetary conditions would not have been financed. And this has led to a situation whereby almost throughout the whole world we see a very low rise in labour productivity in the leading economies. And this is a reason behind the risk of economic growth becoming very slow.

Essentially, the lack of structural balance in many of the economies of many countries have remained. In my view the key aim of economic policy in many countries, and particularly in Russia, should be the sort of policy that stimulates productivity growth because only on the basis of growth of labour productivity can we enjoy healthy growth. And we are certainly taking this into account. For example the possibility of the global economy demonstrating very low growth, which in turn will be reflected in oil prices. But at the same time because of the continued easing of monetary policy in many countries there is also the possibility that a higher level of financial market volatility will persist.

Although, we note here that many central banks, the central banks of many leading economies seeing the response of the market and their very high level of sensitivity, do try to follow a very moderate, cautious policy, trying to manage expectations and to create as few surprises for the markets as possible. And the overall direction of policy at the Federal Reserve and the Central Bank of Japan and the European Central Bank are clear because here we are talking about fairly specific timeframes but the market players are generally aware of the overall path that needs to be followed. Therefore, it's very important that there aren't any surprises because the response from the markets could be very sensitive.

GC: But the market fears that the banks have run out of real ammunition to affect outcomes in economies because we're already at the lower bound on interest rates and we have, what is it, 13 trillion dollars negative yielding sovereign debt now. Have the central banks that are pursuing these policies lost credibility in your eyes?

EN: You are quite right. This is the subject of a very broad discussion. Whether the central banks still have in their possession the types of tools to influence this situation. Whether they are already finding themselves on the brink of negative interest rates and some are already in negative interest rate territory. These are most certainly not trivial problems.

But as far as the Russian economy is concerned, we find ourselves in a totally different situation. Unlike many other countries we have high inflation, we have high interest rates, we still have the option of lowering them. Therefore, we are keeping a close eye on these discussions, taking into account the kind of challenges that our foreign partners have to face. However, the task facing the Central Bank of Russia is different.

GC: Does that mean you are looking to somewhat protect the Russian economy in the event of a dramatic slowdown in US consumption at the end of the year, maybe into 2017? If there is an electoral outcome that causes uncertainty?

EN: Undoubtedly, whatever is happening in the major global economies, be it in the United States or in the economies of our major trading partners such as the European Union or China does affect Russia. And among other things, one of the main channels of influence is the oil price, undoubtedly the situation in the market can affect the oil price via financial assets. Nevertheless, I believe that our main challenges and problems are domestic ones. Irrespective of what kinds of events that may have been taking place in these various countries in different parts of the globe. Our monetary policies are capable of coping with those shocks that might come to pass. We have a sufficient number of tools that we've used in the past and continue to use. But the main challenges that we need to meet are internal ones.

GC: But can I ask you, as you look at the pound sterling, which has enjoyed a sizeable place in the reserves. Has the outcome of the referendum vote changed your view of the strength of the pound? Given how much it declined very soon after that decision?

EN: You know each currency or each asset that we invest in have their own pros and cons and their own risk profile. And of course we take these into account. There aren't that many reserve currencies that can generate a very large income and yield. And every time we have to assess these risks we have a special investment committee, which deals with this.

GC: Let me just come back then to Russia. You have fought a war against inefficient banks that are overleveraged, banks that appear not to be dealing with their NPL problems over the last two years. How many licenses do you think you'll revoke or pull from lenders in 2017?

EN: We don't make plans to revoke licenses ahead of time. I can only tell you how many licenses we have already revoked. But with regards how many we are going to revoke. That really depends on how the banks develop. What kinds of problems will be identified. Over the last 3 years we have revoked about 280 bank licenses. We have revoked them for two main reasons. The first is chronic financial instability of a bank. When a bank is no longer capable of resolving the problems it is facing. And the second problem was their deep involvement in servicing the shadow economy and the dubious nature of some transactions. This policy is undoubtedly aimed at improving the banking system as a whole, to improve the capitalisation of banking institutions and at the end of the day to raise the level of trust among businesses and households towards financial institutions. The banking system had been through some very difficult periods over the last two years, like the economy as a whole. But this year we can see that the banking system is demonstrating a very steady recovery, in terms of recovering their profitability. Bank profits this year over the last 8 months in comparison with the same period in the previous year have grown seven times.

So quite clearly the past two years have seen bad loans arising. We have all been going through an economic recession. But we are also seeing NPLs stabilising. The main thing is that bad assets are covered by a sufficient level of reserves. Nevertheless with regards the banking system as a whole, apart from continuing the policy of improving its health, the banking system as a whole is facing some serious challenges because the economic structure is evolving, the profile of the sectors that are demonstrating profitability is changing. Therefore, it is very important for the banks to start learning how to work and find new good quality loan providers, essentially developing a new business model for banks. In addition to this there is the challenge of fintech, the ability of dealing with cyber risks in another challenge that they have to master. We note that the current banking system complies with all the banking regulatory requirements but complications are still possible. Therefore, the banks have to learn to comply further. But on the whole the banking system remains stable, resilient and is fully able to respond to these challenges.

GC: So not quite job done, but you're much happier where you are now?

EN: There has been a certain amount of progress but there is undoubtedly a lot of work still left to do.


Sarah Whiteacre


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