Daily Management Review

Risks to Central Bank Posed by Russia’s Widening Wealth Divide


10/19/2016




Risks to Central Bank Posed by Russia’s Widening Wealth Divide
Yet another downside to how little is left of the country’s middle class is being discovered by the Bank of Russia.
 
Due to growing wealth inequality and the disappearance of the middle-income households that are the most sensitive to interest rates and prices are putting at risk the central bank’s ability to steer inflation, the bank has warned.
 
At a pace unprecedented under President Vladimir Putin, earnings and domestic demand are still withering. The Federal Statistics Service in Moscow said on Wednesday that while real disposable incomes fell an annual 2.8 percent, retail sales dropped in September for a record 21st month.
 
As wages couldn’t keep up with the surging cost of living, consumption has been obliterated. And according to Sberbank CIB’s latest survey of shoppers, since the economic slump started two years ago, it has pushed 14 million Russians -- a population bigger than Illinois -- out of the middle class. After a group that rose to prosperity during the oil boom doubled in size under Putin, the downfall of the group marks a historic reversal. To complement their dwindling incomes and have become more vulnerable to changes in fiscal policy, many of them now rely on government programs.
 
“The decline of the middle class is bad for control over inflation, because risks from fiscal policy are higher. Demand will be more sensitive to budget decisions” since any assistance will have an immediate effect by touching off spending by poorer households,” said Oleg Kouzmin, a former central bank adviser who’s now chief economist for Russia at Renaissance Capital in Moscow.
 
The impact of income polarization on central bank policy is less obvious even as the International Monetary Fund has found that avoiding the “hollowing-out” of the middle class benefits economic growth, and the widening rich-poor divide crimps consumption.
 
According to the Bank of Russia, the task of controlling inflation is complicated and the price elasticity of demand is weakened by deeper social inequality. It said that there s hardly any reactions to changes in interest rates by less-well-off families, usually without savings and little access to loans, spend primarily on basic necessities. On the other hand since they spend such a small share of their incomes on staples, wealthier households are unresponsive.
 
“Middle-income families are the most sensitive to changes in interest rates and consumer prices, which in turn encourages producers to adjust to changes in their demand,” the central bank said in its draft guidelines for 2017-2019.
 
“Economic policy that promotes a more even distribution of incomes in society will create the conditions not only for balanced development and social stability but will also enhance the effectiveness of signals from monetary policy,” it said.
 
For the central bank, risks already abound. After price growth overshot forecasts for a fourth consecutive year in 2015, its credibility is on the line. Policy makers have pledged to keep rates on hold through the rest of the year after reducing their benchmark to 10 percent in two steps in 2016 as they are concerned they won’t deliver on their 4 percent inflation target by end-2017.
 
Bets for a rate cut in the next three months were scaled back by derivatives traders. Compared with this month’s high of 44 basis points, forward-rate agreements indicated eight basis points of easing on Wednesday.
 
The country’s worst currency crisis since the government’s debt default in 1998 was stoked by a conflict in neighboring Ukraine which erupted in 2014 and collapse of oil prices after Putin had ushered in an era of affluence.
 
According to the World Bank more than 60 percent of the population were marked as middle income group - defined as those with per capita consumption equal to or above $10 a day, between 2000 and 2013. 74 percent of total household income and 86 percent of consumption were controlled by the middle class by 2010, the lender estimates.
 
The share of Russians who consider themselves middle class was at 51 percent last quarter, down from 61 percent two years earlier, found a Sberbank CIB’s survey of the “the Ivanovs,” using a common last name to describe the typical shopper. According to the investment-banking arm of Russia’s biggest lender, the middle class is unlikely to shrink further as wages fall in line with inflation.
 
(Source:www.bloomberg.com)






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