The Bank of Russia has come under political pressure to cut
lending rates to boost economic growth, which has slowed sharply
in recent months and came to just 1.1 percent in the first
quarter.

The central bank may set a more “dovish”, or expansionary,
monetary course when Kremlin economic aide Elvira Nabiullina, a
trusted adviser to President Vladimir Putin, takes over next
month.

But a majority of analysts believe the bank will stay its
hand this month, in line with its key policy objective of
reducing inflation.

“We believe inflation remaining above the target is an
overwhelming reason for the (central bank) to keep its key
policy parameters unchanged,” Vladimir Pantyushin, an economist
at Barclays Capital, said before the monthly meeting.

The likelihood of rates staying on hold has grown after
inflation data showed the year-on-year rise in consumer prices
accelerated to 7.2 percent in April, well above the central
bank’s 5-6 percent target range for the end of the year.

The case for holding rates steady has also been buttressed
by the most recent economic growth data. Year-on-year growth in
gross domestic product was 2.3 percent in March, recovering from
a 0.4 percent fall in February.

In its quarterly monetary policy report published on Monday,
the central bank viewed both the spike in inflation and the
growth slowdown as temporary, saying it may embark on a
“significant” monetary policy loosening if economic activity
undershoots forecasts for an extended period of time.

CONFLICTING PRESSURES

Nevertheless, the conflicting pressures on the central bank
mean that its decisions are becoming harder to predict, with
analysts divided on the timing of rate cuts.

In a Reuters poll in late April, 7 analysts predicted that
the central bank would keep rates on hold this month while 4 saw
a quarter-point cut in its main lending rates. The consensus
forecast was for rate cuts to begin in June.

A possible compromise would be for the central bank to cut
its medium-term rates, as it did last month.

Such cuts are seen as largely symbolic, as the central bank
mostly provides liquidity to the banking sector through one-day
and one-week repo auctions, with a minimum rate of 5.5 percent.

However, lowering rates on operations for three months and
longer, which presently range between 6.75 and 8.25 percent,
would give some relief to banks complaining of tight liquidity.

“The expected deficit (of liquidity) … creates a basis for
lowering rates on medium-term instruments with the aim of
reducing money market stress,” Rosbank analysts commented.

(Additional reporting by Maya Dyakina; Editing by Douglas
Busvine and Hugh Lawson)

When Alexei Kudrin took Putin to task live on television during the president’s annual question-and-answer session and said the economy was tanking because of a poor business climate in Russia, Putin brushed off the criticism – jokingly calling Kudrin a “slacker” for declining a new government job.

The weight of evidence favors Kudrin.

Facing protests, and with his popularity recently at a 12-year low, Putin has been trying to deflect the blame for a stagnating economy, which threatens to arrest the rise in living standards that has underpinned his support.

He says a struggling global economy, particularly the euro zone, is to blame for growth falling to just 1.1 percent year-on-year in the first quarter, down from almost 5 percent a year earlier.

Blaming other countries for Russia’s woes has been a common refrain from Putin since he returned to the presidency a year ago.

Kudrin, a liberal who is admired in the West and still has influence, challenged him in front of millions of Russians. “The main factors of this slowdown remain internal,” he said during Putin televised session with the public last month.

What Russia really needed, Kudrin said, was deep reform to boost productive investment. Entrepreneurs also want reassurance over Russia’s political future – a veiled reference to middle-class disquiet over Putin’s crackdown on political opponents.

Boris Titov, an ombudsman whose role is to relay the concerns of business to the Russian government, agrees with Kudrin that “a lot needs to be done”.

A detailed breakdown of the figures also supports Kudrin’s diagnosis of what ails the $2 trillion Russian economy, as shown in the graphic below.

“The external dimension of this is less important than the domestic one,” said Ivan Tchakarov, chief Russia economist at Renaissance Capital. “Investment is much less robust than many people, including myself, had thought.”

INVESTMENT SLUMP

Russian businesses have long been reluctant to invest in a country that stifles them with corruption and bureaucracy.

“The main problem for entrepreneurs is that they meet corruption everywhere,” said Valery Tsaturov, a grocery store owner from outside Moscow, at a recent anti-Putin demonstration.

Tsaturov, dressed as the Grim Reaper with the slogan “korruptsiya” (corruption) written across his cloak, joined the protest after his attempts to build a bigger shop were blocked, he said, by officials demanding bribes.

“The police and prosecutors don’t help – that’s our authorities, our Putin. As long as he’s in power there’ll be corruption.”

When Putin, 60, returned to the Kremlin last year, many analysts had hoped that political stability and promised reforms would boost investor confidence.

Yet the opposite seems to be happening: Slumping investment, not weak exports, has been by far the biggest contributor to Russia’s sliding growth rate.

“Consumption has slowed, but it is doing reasonably well compared with investment, which has collapsed,” said Neil Shearing, head of emerging markets research at Capital Economics in London.

While export growth has been low – around 1.4 percent last year – it accelerated from 0.3 percent in 2011. Meanwhile import growth has declined sharply, implying that net trade has actually helped rather than hindered economic growth.

True, the price of oil, Russia’s main export, has fallen, yet it remains high by historical standards at over $100 a barrel. Moreover, the recent oil price slide comes too late to explain a slowdown that set in a year-and-a-half ago.

POLICY DIVISIONS

Although Russian officials are keen to blame the global economy, they also acknowledge that weakening investment is a concern. But policymakers are divided on how best to respond.

While “doves” have been pressing for more state spending and lower interest rates to revive investment, hawkish policymakers say such measures will be ineffective and inflationary without structural reforms to encourage greater productivity.

Putin, who has long sat on the fence between the two camps, is now prodding his government towards more fiscal and monetary stimulus to shore up growth in the short run.

With the help of such steps, most economists say there will be some recovery in the second half of the year, when the growth rate is expected to return to around 3.5 percent.

Still, this remains well short of the 5 percent growth that the government aims for, and is half the rate at which Russia’s economy grew before the 2008-9 financial slump.

It is a reminder that the economic slowdown owes much to underlying defects – the lack of long-term investment, a shrinking labor force and hostile business climate – that cannot be addressed by pulling short-term policy levers.

“If it was investment that was holding up and consumption that was collapsing, we would say: ‘OK, this is bad for growth in the near term, but it is exactly the kind of rebalancing that we need to make growth more sustainable’,” said Shearing.

“The opposite is happening. Not only is growth slowing, but the very part of the economy that you want to see growing is what has really collapsed.”

(Reporting by Jason Bush, editing by Elizabeth Piper/Mike Peacock)

When Alexei Kudrin took Putin to task live on television
during the president’s annual question-and-answer session and
said the economy was tanking because of a poor business climate
in Russia, Putin brushed off the criticism – jokingly calling
Kudrin a “slacker” for declining a new government job.

The weight of evidence favours Kudrin.

Facing protests, and with his popularity recently at a
12-year low, Putin has been trying to deflect the blame for a
stagnating economy, which threatens to arrest the rise in living
standards that has underpinned his support.

He says a struggling global economy, particularly the euro
zone, is to blame for growth falling to just 1.1 percent
year-on-year in the first quarter, down from almost 5 percent a
year earlier.

Blaming other countries for Russia’s woes has been a common
refrain from Putin since he returned to the presidency a year
ago.

Kudrin, a liberal who is admired in the West and still has
influence, challenged him in front of millions of Russians. “The
main factors of this slowdown remain internal,” he said during
Putin televised session with the public last month.

What Russia really needed, Kudrin said, was deep reform to
boost productive investment. Entrepreneurs also want reassurance
over Russia’s political future – a veiled reference to
middle-class disquiet over Putin’s crackdown on political
opponents.

Boris Titov, an ombudsman whose role is to relay the
concerns of business to the Russian government, agrees with
Kudrin that “a lot needs to be done”.

A detailed breakdown of the figures also supports Kudrin’s
diagnosis of what ails the $2 trillion Russian economy, as shown
in the graphic below.

“The external dimension of this is less important than the
domestic one,” said Ivan Tchakarov, chief Russia economist at
Renaissance Capital. “Investment is much less robust than many
people, including myself, had thought.”

INVESTMENT SLUMP

Russian businesses have long been reluctant to invest in a
country that stifles them with corruption and bureaucracy.

“The main problem for entrepreneurs is that they meet
corruption everywhere,” said Valery Tsaturov, a grocery store
owner from outside Moscow, at a recent anti-Putin demonstration.

Tsaturov, dressed as the Grim Reaper with the slogan
“korruptsiya” (corruption) written across his cloak, joined the
protest after his attempts to build a bigger shop were blocked,
he said, by officials demanding bribes.

“The police and prosecutors don’t help – that’s our
authorities, our Putin. As long as he’s in power there’ll be
corruption.”

When Putin, 60, returned to the Kremlin last year, many
analysts had hoped that political stability and promised reforms
would boost investor confidence.

Yet the opposite seems to be happening: Slumping investment,
not weak exports, has been by far the biggest contributor to
Russia’s sliding growth rate.

“Consumption has slowed, but it is doing reasonably well
compared with investment, which has collapsed,” said Neil
Shearing, head of emerging markets research at Capital Economics
in London.

While export growth has been low – around 1.4 percent last
year – it accelerated from 0.3 percent in 2011. Meanwhile import
growth has declined sharply, implying that net trade has
actually helped rather than hindered economic growth.

True, the price of oil, Russia’s main export, has fallen,
yet it remains high by historical standards at over $100 a
barrel. Moreover, the recent oil price slide comes too late to
explain a slowdown that set in a year-and-a-half ago.

POLICY DIVISIONS

Although Russian officials are keen to blame the global
economy, they also acknowledge that weakening investment is a
concern. But policymakers are divided on how best to respond.

While “doves” have been pressing for more state spending and
lower interest rates to revive investment, hawkish policymakers
say such measures will be ineffective and inflationary without
structural reforms to encourage greater productivity.

Putin, who has long sat on the fence between the two camps,
is now prodding his government towards more fiscal and monetary
stimulus to shore up growth in the short run.

With the help of such steps, most economists say there will
be some recovery in the second half of the year, when the growth
rate is expected to return to around 3.5 percent.

Still, this remains well short of the 5 percent growth that
the government aims for, and is half the rate at which Russia’s
economy grew before the 2008-9 financial slump.

It is a reminder that the economic slowdown owes much to
underlying defects – the lack of long-term investment, a
shrinking labour force and hostile business climate – that
cannot be addressed by pulling short-term policy levers.

“If it was investment that was holding up and consumption
that was collapsing, we would say: ‘OK, this is bad for growth
in the near term, but it is exactly the kind of rebalancing that
we need to make growth more sustainable’,” said Shearing.

“The opposite is happening. Not only is growth slowing, but
the very part of the economy that you want to see growing is
what has really collapsed.”

(Reporting by Jason Bush, editing by Elizabeth Piper/Mike
Peacock)

The bank’s moves suggest it is softening its previously
hawkish position. But they also underscore the dilemma the
central bank faces, when Russia is caught between the twin evils
of excessive inflation and a sharp slowdown in economic growth.

“Policymakers are in a bind,” commented Liza Ermolenko, an
emerging markets economist at London consultancy Capital
Economics.

“On the one hand, the slump in economic growth has
intensified over the past few months … On the other hand,
inflation remains well above (the central bank’s) target range.”

The central bank reaffirmed its long-standing concerns about
high inflation by keeping its main policy rates on hold,
resisting mounting pressure to cut them from officials and
businessmen.

It held its one-day auction repo rate at 5.5 percent, the
fixed one-day repo rate at 6.5 percent, the overnight deposit
rate at 4.5 percent and the overnight refinancing rate at 8.25
percent.

However, rates for repo, lombard auction and refinancing
operations for three months and longer were cut by 25 basis
points.

These cuts are seen as largely symbolic, as the central bank
mostly provides liquidity to the banking sector through one-day
and one-week repo auctions, at the unchanged 5.5 percent rate.
But they are designed to improve the transmission of monetary
policy.

Analysts interpreted the move as a strong signal that the
central bank is likely to cut its main policy rates in the near
future.

“This is a very dovish decision and a signal that the
central bank will soften its position, which increases the risk
of further interest rate cuts,” said Vladimir Osakovsky, chief
Russian economist at Bank of America Merrill Lynch.

The rouble fell following the decision, reflecting
expectations of lower interest rates that would reduce demand
for rouble-denominated deposits and bonds.

At 1155 GMT, the rouble was down 0.24 percent on the day at
31.16 against the dollar and down 0.18 percent at
35.13 against a euro-dollar basket.

ECONOMIC SLOWDOWN

The central bank is coming under pressure to cut its rates
in order to counter an intensifying economic slowdown.

In another sign that the central bank’s position is
softening, it said recent macroeconomic data pointed to
“increased risks of (the) economy slowing down” – a phrase not
seen in its previous statements.

The central bank also said that “economic confidence
indicators are gradually deteriorating”, a change from previous
language which said these indicators “remain positive overall”.

In February, annual growth in Russia’s gross domestic
product was just 0.1 percent, with other macroeconomic data also
pointing to a sharp slowdown.

The shift in the central bank’s rhetoric coincides with
growing concerns about the slowdown among senior officials about
the outlook for economic growth.

Speaking at a meeting of government officials on Tuesday,
Prime Minister Dmitry Medvedev said: “This, of course, isn’t a
plus. We need to understand what to do so that our economy will
develop according to the scenario that we have defined.”

Russia’s Deputy Economy Minister recently said that the
ministry will cut its official growth forecast this year from
3.6 percent, with growth below 3 percent likely on current
trends.

Despite the mounting concerns over growth, the central bank
also remains worried that inflation, which was 7.2 percent as of
March 25, remains above target – which would lead expectations
of higher inflation to become entrenched.

But the overall balance of the central bank’s rhetoric is
becoming clearly more dovish, analysts said, with some
predicting that it may cut its main policy rates at its next
meeting in May.

“Considering the (rate) decision and the statement as whole,
one can suppose that the central bank is more dovishly inclined,
and a reduction of key rates is possible as early as the next
meeting,” said HSBC’s chief Russia economist Alexander Morozov.

But for some, the president’s choice – announced on Tuesday
at the expense of frontrunners within the bank’s existing
management – signals the decline of a liberal economic policy
elite that has dominated strategy since Putin rose to power 13
years ago and shows central bank independence only goes so far.

Either way, the 49-year-old will find herself, once she
succeeds the widely respected Sergei Ignatyev in June, at the
heart of a tussle between Putin’s desire for economic growth and
those who fear inflation could undermine investor confidence.

Admirers describe Nabiullina as an accomplished academic
economist and experienced civil servant who has the
self-assurance to speak truth to power – in private at least if
not in public: “She is one of the people who isn’t afraid to
tell Putin what he doesn’t want to hear,” said Yevgeniya Albats,
editor of opposition-minded newspaper New Times.

“There are very few people like that in Putin’s circle,”
Albats told Ekho Moskvy radio.

Yet others say her background in the Economy Ministry – long
the government’s “department for growth” – equips Nabiullina
poorly for the task of steadying Russia’s oil-dependent economy
and keeping the state-dominated banking system in line.

“It is hard to see what credentials Elvira Nabiullina …
has in order to run the Central Bank of Russia,” commented
Renaissance Capital economist Ivan Tchakarov.

In a sign that she is aware of starting in the role as an
outsider, Nabiullina asked for Ignatyev to stay on as an adviser
and Putin assented – an exchange captured by television cameras
covering the president’s announcement of the new bank governor.

But Vladimir Tikhomirov, chief economist at Otkritie Capital
in Moscow, did not see the presence of Ignatyev after his
retirement as an indication of continued central bank autonomy:

“The Central Bank of Russia under her leadership would be
seen by many as a department of the Kremlin administration and
not as an independent voice,” he said.

BIG SHOES

During Ignatyev’s 11-year tenure, the central bank has
quietly established itself as one of Russia’s most respected
economic institutions.

Investors and economists are especially impressed by the
steps that Ignatyev has taken in recent years to embrace
inflation targeting – a monetary policy framework, now orthodox
in western countries, whereby central banks use the goal of low
inflation as their central benchmark.

Nabiullina’s appointment comes at a sensitive time, when the
new policy regime, a work in progress that will be fully adopted
by 2015, is facing its first real test.

Despite a barrage of criticism, including from within the
government, the central bank has steadfastly refused to cut
interest rates as long as inflation – presently running above 7
percent – remains well above its target ceiling.

Few expect to see any imminent change of heart. Most
forecasters are sticking to their view that there will be no
change in rates at the central bank policy meeting on Friday.

But there are rising expectations of rate cuts in the second
half of the year, with many analysts now predicting that they
will be larger, and perhaps sooner, than previously anticipated.

The danger for those who see benefits in its autonomy is
that if the central bank eases up policy too readily, it will
appear to be responding to political pressure from the Kremlin.

“The central bank has taken great strides towards credible
inflation targeting,” said Christopher Granville, managing
director of Trusted Sources, an emerging market research firm in
London.

“It’s being tested by … the economic slowdown, and
obviously the political leadership is looking for relief. The
question is whether they will jeopardise the credibility of the
new framework.”

Russia’s economy grew by 3.4 percent last year, and its
nominal gross domestic product of $2 trillion is on track to
overtake the recession-bound economies of Italy, Britain and
France in the coming years.

But that is not enough for Putin, whose first two terms as
president saw growth averaging double that pace. The 60-year-old
Kremlin leader, elected for a third term a year ago, needs
faster growth to placate an increasingly restive middle class.

FUNDAMENTAL CHALLENGE

A further challenge facing Nabiullina will be overseeing and
implementing the legal and institutional changes that are now
needed to cement inflation-targeting.

While the central bank favours a clear mandate that focuses
on the primary goal of fighting inflation, critics within the
political establishment are pressing for a broader, and fuzzier,
one that also emphasises economic growth.

Since news of Putin’s backing for his aide, the rouble has
weakened slightly, while yields on long-term bonds – a measure
of inflation expectations – have risen.

But for now, financial markets and most analysts are giving
Nabiullina the benefit of the doubt. At least in terms of its
formal strategy, the central bank priorities established by
Ignatyev seem unlikely to change.

Nabiullina is expected to rely heavily on the advice of
Ignatyev’s existing team of deputies. One key leader responsible
for monetary policy, Alexei Ulyukayev, has made clear that he
intends to stay on.

“As head of the central bank,” said Granville at Trusted
Sources. “She’ll tend to take the central bank’s view, which
speaks for reasonable continuity.”

“Stimulating the economy in the short term would just spill
over into more persistent and higher inflation and would
ultimately derail growth in the longer term,” said Kaspar
Richter, World Bank lead economist for Russia, presenting the
report in Moscow.

It forecast growth in gross domestic product would fall to
3.3 percent this year, down from 3.4 percent in 2012 and 4.3
percent in 2011.

It cut the 2013 forecast from 3.6 percent, saying that the
revision partly reflected a more pessimistic outlook for global
economic growth.

“The growth we have projected – 3.3 percent – is not weak
growth given the weak external environment. In fact it’s the
growth rate that reflects the growth potential in Russia at this
point,” Richter said.

Despite the slowdown, unemployment is unusually low and the
use of productive capacity at a record high, signifying that the
economy is close to full potential with limited scope to grow
faster in the short term.

The World Bank’s analysis comes at a time when Russian
policymakers are divided over macroeconomic policy. The central
bank has faced criticism from senior officials for not cutting
interest rates in response to slowing economic growth.

The World Bank backed the central bank’s hawkish position,
arguing the priority for monetary policy should be reducing
inflation, running at above 7 percent, rather than stimulating
growth.

Economic growth has more than halved since before the onset
of the 2008 financial crisis. The World Bank argued that this
largely reflected supply-side weaknesses, such as falling growth
in labour productivity and low levels of investment.

It said growth potential could only be lifted through
long-term structural reforms aimed at reducing the state’s role
in the economy, addressing pressures caused by an ageing
population, and cutting red tape and corruption.

It drew attention to a decline in the size of the
working-age population – shrinking by around 1 million people a
year – which will cause a sharp rise in the ratio of dependents
to workers in the coming decades, requiring tough decisions in
areas such as pensions.

“In order to strengthen growth you have to do it the tough
way – through structural reforms,” Richter said.

(Reporting by Jason Bush; Editing by Douglas Busvine and Alison
Williams)

Bastrykin, the head of Russia’s Investigative Committee, appeared to be responding to concerns raised by the central bank over illegal schemes to siphon tens of billions of dollars out of the country each year.

“A range of measures has been worked out to decriminalize the Russian economy and oppose the illegal export of capital abroad,” Bastrykin said at a meeting of Committee officials, linking the creation of a financial police to these measures.

His comments, reported by Russian news agencies, came a day after the head of the central bank, Sergei Ignatyev, said that $49 billion was illegally transferred out of Russia last year.

More than half of that sum was shifted out of the country by “one well-organized group”, Ignatyev told the Vedomosti daily in an interview, also published on the central bank’s web site, without elaborating.

The claim has highlighted the rampant scale of corruption in Russia under President Vladimir Putin, raising embarrassing questions about law enforcers’ effectiveness. Russia has several agencies responsible for investigating financial crimes.

Both the Ministry of the Interior, which controls the police, and the Federal Security Service, the successor to the KGB, have economic security departments tasked with fighting fraud and corruption.

In addition, most ministries and state companies have internal security and oversight divisions that are tasked with monitoring expenditures.

Bastrykin said that this system of internal control was ineffective, referring to recent scandals at the Defence Ministry that have cast a spotlight on high-level government corruption.

Last year, losses from corruption in the armed forces amounted to 7.5 billion roubles ($248 million), the Investigative Committee’s top military investigator told RIA news agency on Thursday – two-and-a-half times more than in 2011.

TURF WARS

Bastrykin’s proposal to create a single financial police force is likely to run into resistance from the existing agencies as they jealously guard their powers.

For example, Bastrykin’s Investigative Committee is frequently at loggerheads with the Interior Ministry. The two agencies have recently clashed in public over the investigation into Defence Ministry corruption.

An additional complicating factor may be widespread corruption within the law enforcement agencies themselves.

Russian investigators have frequently been accused of complicity in financial crimes – including ones that they are investigating.

In one of the highest-profile cases, London-based investment fund Hermitage Capital Management accused Interior Ministry and FSB officials of complicity in the theft of its subsidiaries and $230 million in budget funds – a charge Russia denies. ID:nL6N0BI1CX]

Bastrykin told the Rossiyskaya Gazeta newspaper in 2009 that state officials were “in almost all cases” involved in thefts of companies, including police who “frequently” steal corporate documents and accept bribes to open criminal cases.

An opinion poll by the Levada Centre last year showed that 83 percent of Russians regard corruption of the law enforcement agencies as a serious problem, compared with 11 percent who think otherwise.

(Reporting by Jason Bush; Editing by Douglas Busvine, Ron Askew)

The central bank has faced criticism from business and
politicians for refusing to loosen monetary policy, including
from the country’s president Vladimir Putin.

Recent data on retail sales and industrial production have
also been weaker than expected, adding to the pressure.

“The key task of monetary policy is to maintain a low and
stable inflation rate,” the bank’s chairman Sergei Ignatyev said
in testimony to the Federal Council upper house of parliament.

“We expect inflation to fall in the next few months, and if
that happens we may start to cut interest rates. But there’s no
promise,” he said, reiterating similar remarks he made last
week.

In an interview with the Vedomosti newspaper published
earlier on Wednesday, Ignatyev also rejected criticisms that
interest rate policy was to blame for the slowing economy.

He argued that slower growth did not reflect a lack of
aggregate demand, but was the result of supply-side bottlenecks
such as poor infrastructure.

Ignatyev pointed out that the effective rate of interest
that the central bank charges on its loans, in the form of repo
credits, was 5.6-5.7 percent – below the rate of inflation,
which was 7.1 percent in January.

He also emphasised that unemployment was low. “To cut
interest rates against a background of rising inflation and
record low unemployment would be very strange,” Ignatyev said.

However, he said that there was a 90-percent certainty of
the central bank meeting its 5-6 percent inflation target this
year, implying that inflation will fall.

IMF SUPPORT

The central bank’s reluctance to cut rates received support
on Wednesday from the International Monetary Fund, which argued
that if anything Russia may have to raise interest rates to bear
down further on inflation.

Presenting the Fund’s annual economic outlook for Russia,
the IMF’s Moscow representative Odd Per Brekk said that in the
short run the IMF is recommending “to keep monetary policy on
hold, but with a tightening bias”.

“This is because the key policy objective… should be to
bring inflation credibly on a path towards the official
targets,” Brekk added.

Inflation will be around 6 percent both in 2013 and 2014,
the IMF forecast, implying that Russia may struggle to meet the
5-6 percent inflation target this year – and would miss its
tougher 4-5 percent target for 2014.

Brekk said that the IMF regards Russia’s economic growth
this year as being in line with its underlying potential, which
the Fund estimates at around 3.75 percent per year.

“Growth cannot be increased durably through stimulus to
domestic demand – be it through budgetary or monetary policies.
Attempts to do so will lead to pressure on the price level and
the balance of payments,” he said.

The IMF’s hawkish analysis tallies with that of the Russian
central bank, which also argues that economic growth is in line
with potential and that there is no output gap that provides
room for monetary or fiscal stimulus.

The importance of the central bank’s inflation targets is
increasing, as Russia completes the transition towards a formal
inflation targeting regime, which also entails a mostly
free-floating exchange rate.

In his comments to the upper house of parliament, Ignatyev
reiterated the goal of completing the switch to inflation
targeting by the end of 2014, but said that the central bank
will not fully abandon currency market interventions.

“Transition to a completely free float of the rouble may
lead to excessive volatility… Perhaps it will be necessary to
keep some kind of mechanism to smooth out volatility,” he said.

(Reporting by Katya Golubkova and Jason Bush; Writing by Jason
Bush and Lidia Kelly; Editing by Toby Chopra)

Analysts had expected the central bank to hold rates after
inflation rose above 7 percent in January, feeding doubts about
its chances of achieving its 5-6 percent target range for 2013,
and the rouble continued to strengthen slightly to 34.74 against
a euro-dollar basket after the announcement.

In recent weeks some senior officials and businessmen have
criticised the bank for not cutting rates to help a slowing
economy. The bank, stepping up its anti-inflation rhetoric, is
refusing to budge.

“There is a slight lurch in the direction of emphasising
inflation over growth risks, which flies in the face of mounting
political pressure to ease monetary policy,” said Ivan
Tchakarov, chief Russia economist at Renaissance Capital.

The central bank kept the one-day auction repo rate
unchanged at 5.5 percent, while the fixed one-day repo rate, a
de facto ceiling for the money market, remains at 6.5 percent.

The overnight deposit rate, a floor for interbank rates, was
left at 4.5 percent. The refinancing rate, the cost of overnight
loans from the central bank, was held at 8.25 percent.

INFLATIONARY RISKS

In a statement, the central bank said it expected inflation
to exceed its target range through the first half of 2013, which
raised inflationary risks by reinforcing expectations of higher
prices.

“The statement is a bit more hawkish than the previous one
(in January),” said Alexei Pogorelov, economist at Credit
Suisse.

“The phrase that they do not see inflation declining below
the target level in the first half of the year … means they
are not discussing policy easing in the first six months.”

The latest inflation forecast is more pessimistic than a
prediction last week by Alexei Ulyukayev, the bank’s First
Deputy Chairman, that inflation would be back on target by the
end of the second quarter.

The central bank was relatively upbeat on the state of the
real economy, acknowledging a growth slowdown but playing down
its gravity.

It said that economic output “remains close to its
potential”, while risks of an economic slowdown connected with a
tightening of monetary conditions “are considered minor”.

This relaxed view contrasts with concerns expressed by
government officials, among them President Vladimir Putin, that
high interest rates are stifling growth.

Economists, too, are divided on whether the central bank’s
tough policy stance is striking the right balance.

“The central bank is right when it notes that in current
conditions a softening of policy wouldn’t stimulate growth, but
would stoke inflation,” said Alexander Morozov, chief Russia
economist at HSBC.

But Danske Bank economist Vladimir Miklashevsky said: “Such
a hawkish policy is poisoning fixed investment growth and
economic growth in the longer run,” adding that the policy could
do little to tame inflation which was rising for other reasons.

ING economist Dmitry Polevoy said the hawkish policy skew
was marginally supportive for the rouble, but is postponing
inflows into Russia’s recently-liberalised treasury bond market
because of uncertainty over the next rate move.

LEVELLING PLATING FIELD

While leaving rates on hold, the central bank tweaked its
minimum reserve requirements, in effect levelling the playing
field for foreign and domestic investors putting money to work
in Russia.

It brought into line the reserve requirements on liabilities
to residents and non-residents, with a unified rate of 4.25
percent. Previously the rate was 4 percent for resident
liabilities and 5.5 percent for non-resident ones.

The central bank said the change reflected a reduced need to
regulate capital flows, as the rouble floats more freely. It
described the measure as neutral for the banking sector and
monetary policy.

“It is linked to the liberalisation of the market and a more
equal access for all investors,” said Pogorelov from Credit
Suisse. “The share of liabilities in roubles is much higher, so
unifying the rate is neutral in terms of liquidity.”

(Writing by Jason Bush; Additional reporting by Maya Dyakina,
Oksana Kobseva, Vladimir Abramov and Yelena Orekhova; Editing by
Douglas Busvine/Ruth Pitchford)

Under political pressure to cut rates in response to slowing
growth and tightening credit, the central bank said financial
conditions are “neutral” and Russia’s growth rate is in line
with potential.

“The monetary gap – it is neutral,” First Deputy Chairman
Alexei Ulyukayev told reporters on Wednesday.

“We don’t see a significant gap between potential growth and
actual growth. In this sense we consider monetary policy as
neutral considering the risks.”

He also said inflation could fall within the central bank’s
target range of 5-6 percent in the second quarter of this year,
notwithstanding a spike in January to 7.1 percent.

Ulyukayev, a leading contender to replace outgoing Chairman
Sergei Ignatyev in June, emphasised the central bank’s
independent thinking at a presentation of its first quarterly
monetary policy report.

The Bank of Russia is making greater efforts to communicate
its rationale for keeping key interest rates on hold since last
September. Government leaders have called for monetary easing to
revive flagging growth.

The bank is seeking to complete a shift towards
western-style inflation targeting, away from a focus on the
exchange rate and instead prioritising steering inflation
expectations and fine-tuning interest rates.

As it tries to make monetary policy more predictable and
systematic, the bank has for the first time published two of the
key indicators – often referenced by Western central banks – it
uses to make its rate call each month.

“In this text we show the ‘cooking’ of how we take
decisions,” Ulyukayev said, highlighting sections of the report
that measure the monetary and output gaps.

The central bank uses an Index of Financial Conditions that
is designed to show how far conditions in the financial sector
are impeding or encouraging economic growth.

This measure – a composite indicator combining factors such
as interest rates, money supply trends, the level of the
exchange rate and the stock market – was just below zero as of
last November, with a positive trend since mid-2012.

The bank interprets this as contradicting recent comments by
officials, bankers and businessmen that the central bank’s
interest rate policies are contributing to a marked economic
slowdown.

The bank also looks at the output gap, the difference
between current economic output and the potential level. It says
this gap has shrunk from more than 6 percent of GDP in 2009 to
zero at the end of last year – implying that easing monetary
conditions right now would stoke inflation, and not growth.

POSSIBLE COMPROMISE

Hinting at a possible compromise, Ulyukayev said the central
bank would discuss bringing its 8.25 percent refinancing rate,
which is largely symbolic, closer into line with its main policy
rates.

“Such a prospect exists – not only for macroeconomic
reasons. The refinancing rate, as you know, isn’t a key policy
rate but is more of a historical one,” he said.

The central bank, which next reviews policy on Feb. 12, is
expected by economists to keep its main lending rate – its 5.5
percent minimum one-day repo rate – on hold.

The central bank has continued to sound hawkish on
inflation, but the growth versus inflation dilemma could become
less pressing in the next few months, Ulyukayev suggested.

He said that inflation was close to its peak and would enter
a downtrend in March, falling within the central bank’s 5-6
percent target range in the second quarter. That view diverges
from the central bank’s own forecast that it will hit target
only in the second half of 2013.

“We have the possibility in the second quarter of returning
to target, considering the growth of the monetary base and the
money supply,” Ulyukayev said, referring to 10 percent and 12
percent growth respectively.

A recent strengthening of the rouble, a levelling off of
global food prices and a statistical base effect also pointed to
moderating inflation trends, he added.

Ulyukayev said policy makers would propose widening their
inflation target to 2 percentage points from the current
one-point range, saying: “It would be more correct and
realistic.”

(Editing by Douglas Busvine/Ruth Pitchford)