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Rate cuts: is the incentive enough?

30 May 2022

Ershov Mikhail V. Principal Director on Financial Studies, Head of the Financial Analysis Department

Mikhail Ershov, Principal Director on Financial Studies, Head of the Financial analysis Department at the Institute for Energy and Finance, commented to Expert magazine on the key rate reduction issues.

The rate cut by the Bank of Russia by 3 percentage points is obviously a very necessary step for the economy. It also forms positive expectations, given that this is already the third large-scale rate cut in a short period. This is especially important in conditions when the demand of economic entities - the population and business - is sufficiently suppressed and it needs to be activated, finally. Although the profitability is still lower than the rate, but the distance is already shorter.

Another thing is that the rate cut itself at this stage may not be entirely sufficient, so as it is a high level of uncertainty. Therefore, the Russian banking sector has again moved to a liquidity surplus, when money does not flow into the economy. Of course, lower rates will increase the demand for money, but it is not certain that the banks themselves will want to send this money there. Therefore, mechanisms are also needed, the so-called, monetary transmission, which would stimulate the movement of money in the necessary areas through tax, regulatory and other relief.

Also important is the recently announced by the Bank of Russia (March this year) intention to buy the Federal loan bonds. It will also create market conditions for rate cuts for the economy. In many countries, national central banks buy between 20% and 50% of their total government debt market, thus providing targeted long liquidity for their economy. It is important that in Russia such purchases are not one-off or remain just a statement, but become a significant element of economic approaches. In addition, this approach will significantly expand the possibilities of budget spending, which is especially necessary in the face of the new tasks of supporting the economy under sanctions. We have not used this tool yet. Note that these are important mechanisms of economic policy at all times. But under sanctions, this is already a mechanism of geo-economic policy. Combined with falling rates, this could be a major boost to economic growth.

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