Review of Economies in Transition Idäntalouksien katsauksia 1994 • No. 10 21.10.1994 Reprint in PDF format 2002 Tuula Rytilä Monetary Policy in Russia Bank of Finland Institute for Economies in Transition, BOFIT ISSN 1235-7405 Reprint in PDF format 2002 Bank of Finland Institute for Economies in Transition (BOFIT) PO Box 160 FIN-00101 Helsinki Phone: +358 9 183 2268 Fax: +358 9 183 2294 [email protected] www.bof.fi/bofit The opinions expressed in this paper are those of the authors and do not necessarily reflect the views of the Bank of Finland. TuuIa RytiHi Monetary Policy in Russia 1 Introduction The primary objectives of a country's economic policy usually include stable economic growth, a high level of employment and monetary stability. The central bank contributes to the achievement of these objectives mainly through its ability to affect the money supply and to influence interest rates. The main functions of a central bank are generally divided into conducting monetary policy and supervi­ sing and developing financial and payment systems. The basic theme of central banking policies is stability - stability in the purchasing power of the currency and stability in the functioning of the financial system. Price stability, ie low inflation, is a generally accepted final objective of monetary policy and is viewed as a prerequisite for stable economic growth. The history of Russian economic reforms since January 1992 witnesses quite notable fluctuations in prices and persistent high inflation. Towards the end of 1993, the commitment to tight monetary policy seems to be more anonymously shared among the Russian authorities. The monetary policy operations and instruments of the Central Bank of Russia (CBR) are becoming more like those of Western central banks. The stability of the banking and financial system is another prerequisite for economic growth. Successful reform in the commercial banking sector requires parallel reform in the central banking system. During transition, the central bank should move from directly financing government deficits to providing mechanisms to increase or decrease liquidity in the banking system. The Central Bank of Russia is the highest supervisory body for commercial banking activities. Therefore, the CBR plays a crucial role in developing the Russian financial infrastructure. This paper analyzes Russian central bank policy since 1992. The second section of the paper examines the developments of the legal base and the principle functions of the CBR. Sections three and four focus on the CBR's task of conduc­ ting monetary policy. The third section analyzes the monetary policy objectives and instruments of the CBR and examines Russia's foreign exchange policy. The fourth section focuses on the environment in which the CBR functions. The fifth section describes Russian monetary policy events since 1992. The sixth section turns to the CBR's supervisory task of the financial system and overviews the emerging commercial banking sector. The final section points out some possible scenarios for future central bank policy in Russia. 27 2 Developments in the Basic Functions and Legal Basis for the Central Bank of Russia Developments in the Soviet-Russian financial system can be broken down into 1 three sub-periods • First, there was the Soviet era of the planned economy, where money had only a passive role as account of unit. Gosbank was under total state control and did not its execute own monetary policy. It was a mere instrument for implementing the government's economic plan. Gosbank allocated funds from the state budget to enterprises according to five-year plans and monitored the use of these funds. State budgets were generally balanced. Gosbank fulfilled the role of a mono bank by undertaking commercial banking operations as well as carrying out the central bank's role of controlling all flows of funds. Two kinds of money co-existed: cash money and deposit money. Households could only use cash money, while enterprises had to use primarily deposit money. Enterprises could generally withdraw cash from their accounts only to pay wages. Gosbank automatically balanced enterprise accounts by transferring funds from profitable to non-profitable enterprises. The second time period comprises the years 1987-1992. Characteristic to this period are the dissolution of the mono bank system and autonomy in Russian financial developments due to the break-up of the Soviet banking system. In January 1988, five specialized banks were created alongside Gosbank2. This was the first step towards creating a two tiered banking system. Since the enactment of the law of cooperatives in July 1988, cooperative banks and commercial banks have came into being. Gradually, the state-owned specialized banks began to establish subsidiaries, and in October 1990 the specialized banks were converted into commercial banks. A jurisdictional power struggle between Gosbank and the Russian central bank continued until the break-up of the Soviet Union in late 1991. At that time Gosbank was merged with the CBR, to be officially dissolved shortly thereafter. The framework laws governing Russia's banking system date back to 1990. Under these laws, Russia has a two-tiered banking system with the central bank and its subunits as the first tier and commercial banks as the second. According to the 1990 law on the CBR, the bank was accountable to the Supreme Soviet. This accountability influenced Russian thinking on central bank policy through 1992, which focused on maintaining the rouble area for the CIS countries, emphasizing the problems of the payment system and interenterprise arrears and de-emphasizing the need for an inflation objective. The years 1993-1994 constitute a third period for the Russian financial system. There is a single currency - the rouble - and the idea of the rouble zone seems to have been abandoned. The CBR has operations similar to those of western central banks. This diminishing importance of direct central bank lending 1 For a good description of the developments in the Russian financial system up to 1993, see Fuchita et al. 1993 and Kivilahti - Kero - Tekoniemi 1993. 2 Even before 1987, three separate specialized financial institutions existed. Sberkassa took individual savings, Vneshtorgbank dealt with foreign currency operations and Stroibank provided long-term financing. 28 is increasing the reliance on the CBR's more indirect instruments. Rapid developments in the banking and financial system emphasize the need to strengthen the central bank's supervisory capacity. As stated in the 1990 law on the Central Bank of Russia, the main tasks of the CBR are still to maintain the money supply, to pursue a uniform monetary and credit policy and to preserve the stability of the rouble. The CBR is also a major player in the development of Russia's securities markets and it issues government securities. In addition to these functions related to the conductment of monetary policy, the CBR acts as a supervisionary body. It issues licences for operating as a commercial bank and supervises commercial banks' domestic and foreign acti­ vities. It is the major exchange control authority in Russia. The CBR receives deposits from commercial banks, settles payments between commercial banks and provides banks with credit. The central bank is an important force in developing the legal infrastructure for Russia's financial sector. Financing state budget deficits continues to be one of the CBR's most import­ ant functions. In Russia, budget deficits have been almost automatically financed by the central bank. These subsidized loans have traditionally been at zero or low interest. In July 1993, drafts of revised versions of the central bank law and the law on banks and commercial banking were published in the Russian press3• New laws were not approved before the president dissolved parliament in September 1993. In July 1994, the first reading of the revised draft on the CBR law was passed in the lower house of the new parliament, the State Duma. According to Russia's new constitution approved by referendum on December 4 12, 1993 , the Duma appoints and can dismiss the chairman of the CBR on a proposal by the president. The 1994 draft of the CBR law states that the CBR is accountable to the Duma, which appoints the chairman of the central bankS. There is a Duma committee on central bank monetary and credit policy by which the Duma monitors the general direction of CBR monetary and credit policies, influences the auditing procedures of the CBR and conducts preliminary discus­ 6 sions on the appointment of the bank's chairman . Both in 1993 and in 1994, an international auditing company has conducted an audit of the CBR for the par­ liament. The draft law on the CBR of 1994 also contains new regulations for central bank policies that would take effect in January 1996. They prohibit the central bank from granting credit to cover the state budget deficit and from buying government securities in the primary market. 3 Delavoy Mir 1.-2.7.1993. 4 Izvestiya 28.12.1993. 5 See e.g. Izvestiya 21.7.1994 or Segodna 21.7.1994. The draft law differs from the law of 1990 in that it states that the CBR is directed by a board of directors of 12 members including also inde­ pendent specialists. The board members are nominated by the president and approved by the Duma. So far the board of directors has consisted of the chairman of the CBR and his deputies. The central bank has opposed this plan and the discussion will continue in October 1994, after the summer recess of the Duma. 6 Nezavisimaya Gazeta 9.2.1994. 29 There are also several additional laws governing monetary policy in Russia. The former draft law of the CBR mentions four such laws 7. Nevertheless, the legal basis for the Russian central bank and banking has long been inadequate and lags behind economic and political changes.