Cablegate: Russian Inflation Reaches Double Digits


DE RUEHMO #5200/01 3031157
R 301157Z OCT 07





E.O. 12958: N/A

1. (U) This message is sensitive but unclassified and not for
internet distribution.


2. (U) At a public event October 26, Deputy Prime Minister and
Finance Minister Aleksey Kudrin stated that inflation since the
beginning of 2007 had reached 8.9 percent and would be close to 11
percent by the end of the year. He acknowledged that rising food
prices have exacerbated the growth of the consumer price index (CPI)
and said domestic monetary factors "would put the final result above
9 percent even without higher food prices." Kudrin said that wage
increases, which have tended to exceed productivity, and government
spending, which will be 3 percent of GDP higher than originally
budgeted, were the main components of the climbing CPI. Kudrin
downplayed the role government policies have played in the rising
inflation and did not announce any broad changes. Some of our
contacts echo Kudrin's assessment that Russia's increasing inflation
is rooted in monetary factors, but add that government policies are
in fact a key driver. End Summary.

2005 All Over Again

3. (U) Deputy Prime Minister and Finance Minister Kudrin said that
the GOR would exceed its 2007 inflation target of 8 percent. Kudrin
had reportedly conceded as much during recent Cabinet meetings, as
had other ministers and Central Bank officials, but without giving a
range. However, in his remarks before the Federation Council and
the National Economy Association, he said the year-end figure would
exceed 10 percent.

4. (U) Rising world food prices, droughts, and the end of various
EU agricultural subsidies have contributed to higher commodity price
levels in Russia, Kudrin said. He added, however, that even without
the inflationary push of higher food prices Russia's inflation for
2007 would exceed 9 percent. Inflation for the year had reached 8.9
percent by October 22, Kudrin said, and base inflation for October
would be 1.5-2 percent. He observed that even "if inflation goes no
higher, we will have returned to levels seen two years ago."

GOR Spending, Monetary Policy to Blame

5. (U) Kudrin said the main causes for the rising inflation were
monetary factors. He told the Federation Council wages had risen
faster than productivity in recent years. He observed that these
"salary overhangs" went directly into the economy, which, in
conjunction with almost USD 70 billion in net capital inflows,
helped trigger 52 percent growth in the money supply during the
first half of the year. Kudrin also conceded that government
spending, particularly for public sector employees, had also spurred
inflation. (Note: Amendments to the 2007 budget law show that the
GOR's spending for the year will equal 20.3 percent of GDP, whereas
the original 2007 budget law forecast expenditures totaling 17.5
percent of GDP. End Note.)

6. (U) The Finance Minister estimated that monetary factors
accounted for 3.4 percent of the CPI's growth, whereas in the EU
they account for only 2 percent. Nevertheless, he announced no
changes in the GOR's efforts to control inflation and observed that
the USD 6 billion in net capital inflows during October indicated
investors were not concerned about Russia's macroeconomic policies.

Underinvestment Also Drives Inflation

7. (SBU) Troika Dialog Chief Economist Evgeny Gavrilenkov and ING
Bank Economist Tatyana Orlova told us Kudrin is right that Russia's
inflation is at root a monetary phenomenon, but that government
policies are in large part to blame. Gavrilenkov observed that the
Central Bank's (CBR) stated priority of ensuring sufficient
liquidity during 3Q07 in the wake of subprime mortgage concerns had
been inflationary. The CBR sought to sustain confidence by
expanding the list of instruments banks could use to secure
short-term funds and reducing lending rates. For example, from
January through July, currency swaps between banks and the CBR
totaled USD 1 billion, but swelled to USD 18.4 billion from July
through September when the CBR lowered rates. Gavrilenkov also
suggested that Kudrin had understated the inflationary impact of
government spending. He noted that the amendments to the 2007
budget law showed that expenditures for the year are on track to
exceed those of 2006 by 4 percent of GDP.

8. (SBU) Gavrilenkov and Orlova emphasized that underinvestment had
also exacerbated inflation. Gavrilenkov, again, agreed with Kudrin
that salary increases have outstripped productivity gains. He said
that Russian incomes on average have risen at double-digit rates in
recent years and consumption has followed suit. As a result of
this, however, domestic producers have not been able to keep pace
with the demand for higher quality products. Producers have made
some investments to expand capacity, according to Gavrilenkov, but
imports of consumer goods-including food-have filled the gap left by
domestic producers and have also exacerbated inflation.

9. (SBU) Orlova said that increasing the capacity and
competitiveness of Russian firms would need to be part of a
long-term inflation-fighting strategy going forward. She speculated
that if the GOR had made "the hard choices" in 2000 or 2001 to
reduce investment barriers-from broad energy and transportation
infrastructure improvements to support for small and medium-size
enterprises-domestic firms would be better positioned to satisfy
domestic demand. In such a scenario, she explained, competition
between domestic goods and imports would tame inflation. As it
stands, however, imports into Russia and their prices are growing.
Orlova mentioned that domestic demand for food has more than doubled
in real terms since 2000, domestic production has increased only 20
percent. She said that rising global food prices will make
themselves felt in Russia since an estimated 40 percent of the
country's food supply is imported.


10. (SBU) Kudrin's public comments attempted to downplay the effect
the GOR's spending has had on inflation. However, Putin's promise
to increase pensions, the recent establishment of development
institutions, like Special Economic Zones and the Investment Fund,
along with a growing number of state-owned corporations, like the
Nanotechnology Corporation and the Olympic Games Corporation, as
well as plans to improve infrastructure ensure the GOR's spending
spree and concomitant inflation will continue for the foreseeable
future. End Comment.

© Scoop Media

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