VZCZCXYZ0012
RR RUEHWEB

DE RUEHMO #5200/01 3031157
ZNR UUUUU ZZH
R 301157Z OCT 07
FM AMEMBASSY MOSCOW
TO RUEHC/SECSTATE WASHDC 4918
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC

UNCLAS MOSCOW 005200 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
STATE FOR EUR/RUS, EEB/IFD 
TREASURY FOR TORGERSON 
 
E.O. 12958: N/A 
TAGS: EFIN ECON RS
SUBJECT: RUSSIAN INFLATION REACHES DOUBLE DIGITS 
 
 
¶1.  (U) This message is sensitive but unclassified and not for 
internet distribution. 
 
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Summary 
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¶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." 
 
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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. 
 
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Comment 
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¶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.