Is the economy overheating?

Monday’s interest rate hike by the Russian Central Bank is the latest move to cool what some see as an overheating economy. However, tightening money supply may lead to further pressure on the banking system.

At a Moscow conference on Tuesday, all eyes were on the state of the Russian economy following the Central Bank’s move to tighten its monetary policy to keep the economy from overheating.

Frank Gill, Standard&Poor’s analyst says “the medium-term objective of the Central Bank is to target a positive real interest in Russia.”

“For many years inflation has been higher than the nominal interest rate. So, essentially you’ve had negative real interest rates, which have probably overstimulated the economy,” he said.

Russia’s capital expenditures last year grew by more than 40%. The Finance Ministry says that spending added to inflationary pressures.

“We think budget spending should be increased very carefully. Obviously, Russia has plenty of social and infrastructural problems that budget money could help solve. But we should always keep in mind that increased spending leads to an overheated economy, and that's a risk we cannot afford to take,” Dmitry Pankin, Deputy Finance Minister said.

But while some lobby for a tightening of monetary policy, others, including the head of Russia’s second largest bank, VTB, disagree. Andrey Kostin says the country’s fledgling financial system cannot afford further interest-rate hikes.

“As a banker, I am very much concerned that the struggle against inflation will be focused on the banking sector only. I think the banking sector, its development and growth, is one of the key elements in the growth of Russia’s economy. I think more expensive money will not help this. I’d prefer the central bank to see other ways of coping with inflation rather then restraining the activity of Russia’s banking sector,” Kostin said.

Russia’s inflation is now running at about 14%, over two percentage points above last year's level. But the country’s policy-makers are yet to reach a consensus on whether the economy is showing real signs of overheating.