Inflation turn to put lending rates in spotlight

An expected rebound in Russian inflation rates during the second half of this year has economists saying it’s a matter of when not if the central bank lifts interests’ rates.

But despite 14 consecutive cuts over the last 18 months, retail banks haven’t passed on the lower rates to borrowers, with President Medvedev wanting to know why.

Russia’s Inflation rate has had a long glide lower from 15% two years ago to well under 6% at the end of the first half of this year.

But Natalya Orlova chief economist, Alfa bank says the days of falling inflation are past – with the economic rebound and drought affected food prices meaning the road ahead is up.

“Inflation has reached its bottom of slightly below 6 per cent Starting April-May and it seems that Russia's economy just does not have enough time to benefit from favorable conditions because right now the accelerative inflationary pressure would defiantly see some upward pressure on the interest rates which in a way will have to follow inflation.”

The drop in inflation has give the central bank room to slash the refinancing rate 14 consecutive times to 7.75% in the last year and a half. Theoretically that should have given enabled retail banks to slash their lending rates and boost loans to the real economy.

Many banks certainly have slashed lending rates, but the boost to lending has been sluggish at best and industry says corporate rates are still higher than they should be.

On a visit to Yoshkar Ola this week President Medvedev became aware of one bank still charging 18% – and he wasn’t impressed.

“The mistrust between banks and industry still exists. The refinancing rate is low, all-time-history low, and credit rates are high. I am unpleasantly surprised by 18%, this information need to be checked. 18% is intolerable rate with the current refinancing rate. It means the profit is huge, more than 100 %”

Banks point out that the rates on their loans reflect the risks they need to take as well as the costs they face in getting funds. They say that higher rates reflect more risk.

Domestic borrowing costs will rise when the Central bank lifts rates. But a still undeveloped financial system makes capital even more expensive for end users, acting as a brake on the economy – meaning borrowing rates seen as excessive will invariably attract political heat.