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The average non-oil and gas deficit of the federal budget in the period under review remained within 1-per cent of GDP with seasonal upsurges at the end of each year. In 2007, the average annual non-oil and gas deficit in GDP made 3 per cent, whish is lower that the relevant indicator of 2006, but is still rather high. It reflects the sustained risks to the stability of public finance and requires prevention from excessive mitigation of fiscal policy on the part of the government. In accordance with our estimates, made in November 2007 survey, by the end of preceding year non-oil and gas deficit has reached its peak value of 19 per cent in GDP. The reason for such upsurge is clearly observed in the diagram of federal budget expenditures (see Fig. 3); in November the expenditures accounted to 31,3 per cent in GDP, which is one more historical peak within the past three years.

The Ministry of Finance gas not provided the data for the RF budget expenditures in March 2008 as yet. The RF average annual oil and gas revenue in 2005 was 9,9 per cent of GDP, in 2006it was 11.2 per cent of GDP, in 2007 - 9.per cent of GDP.

25% 20% 15% 10% 5% 0% -5% -10% % % Fig. 2. Oil and gas revenues and non-oil-and-gas deficit of the federal budget in 2005-2008 (per cent in GDP) 35% 30% 25% 20% 15% 10% 5% 0% . . . . . . .

2005 2006 2007 Fig. 3. RF budget monthly expenditures in 2005 2008 (% versus GDP).

That upsurge, started at the last quarter of 2007, was largely induced by the trend of high public spending, provoked by political, rather than economic grounds. Capitalization of development institutions made for expansion of public expenditures as well. Their average growth rate within recent years amounted to 16 per cent per annum in real terms and to 25-30 per cent in nominal terms. After the presidential elections one can expect more prudent fiscal policy and reduction of the share of public expenditures in GDP, as compared with the level of the second half of 2007.

However, the Ministry of Finance forecast high annual growth rates of the budgets at various levels. Thus, as early as in the first quarter of 2008, the average nation-wide growth of regional budgets in Russia amounted to 37 per cent against the relevant period of preceding year.

Inconsistency between the estimated and actual values of the basic macroeconomic indicators and reduced assessments provoke unaccounted surplus funds, derived from federal budget execution. Thus, as per % .....................................% financial results, the variance in revenues, actually obtained by the budget, made 11.7 per cent and the same in expenditures made 9.5 per cent. In February 2008, significant amendments were made to the recently approved budget for the three-year term, which were largely urged by changes in macroeconomic indicators within 2007-2008. Among other amendments, the volume of oil and gas proceeds was upgraded by 7.6 per cent for 2008 (i.e., RUR 234.9 bln).

The revised three-year RF budget is being completed by the Ministry of Finance. Proposal on the revised three-year budget should be submitted by the Ministries to the government in the first decade of May and in June the new basic indicators of the revised budget should be approved by the government. Healthcare and pension systems will be prioritized issues in the nearest years. The innovations are establishment of the upper threshold and tough control over the new of budget line expenditures, including federal targeted programs, which will be selected with great prudence. There are restrictions, planned in utilization of oil and gas revenues2.

A unified social tax reform is planned to be developed in the current year, which may be introduced since 2010. Moreover, by August 1, 2008 the Ministry of Finance will present a draft of financial development plan for 15 years, until 2023.

The total volume of the Reserve Fund as of April 1, 2008 amounted to RUR 3,068.43 billion, i.e., 9.3 per cent of GDP. The gross total of National Welfare Fund made RUR 773.57 bln, i.e., 2.3 per cent of GDP.The dynamics of Stabilization, Reserve and National Welfare Funds revenues is presented in Fig. 4). As one can see, Stabilization Fund was demonstrating steady growth and reached a historical peak of 13.3 per cent in January 2008. However, in the first quarter of the current year the volume of Stabilization Fund was reduced by 2.1 per cent of GDP. This is attributed to the exchange rate variance, applied to estimates of balances in the accounts of the Reserve Fund and the National Welfare Fund in foreign currency in the period from January 30 to March 31, 2008, amounted to (-) RUR 29.21 billion and (-) RUR 9.23 billion, accordingly.

16% 14% 12% 10% % 8% 6% 4% 2% 0% . . . . . . . .

2006 2007 Fig. 4. RF Stabilization Fund monthly dynamics in 2006-2008 (per cent in GDP), since 2008, Reserve Fund and National Welfare Fund.

Monetary and Credit Policy P. Trunin As of March results, the CPI in the RF stayed at a high level, having reached 1.2 per cent as compared with 0.6 per cent in the relevant period of preceding year. Therefore, the growth of consumer prices actually Expenditures o oil and gas proceeds has grown from 2 per cent of GDP in 2004 to 5.1 per cent of GDP in 2008.

made it impossible to achieve the Government's benchmark for annual inflation rate of 10 per cent. Herewith, foreign currency reserves were being accumulated in the country, the volume if which amounted to USD 518 bln. In April, to support liquidity level, the Bank of Russia started to place untied budgetary funds to deposits in commercial banks.

Consumer price index in March made 1.2 per cent (versus 0.6 per cent in March 2007) ( See Fig. 1). Like in February, foodstuffs made the utmost input in consumer prices growth in March. Therefore, prices for the basic food products continued their growth despite the agreement of the government with the leading trade networks. It was understood in April, that the agreement will not be extended upon expiration of its term. In our view, such agreements provide low effect in the economy, but provoke more distortions in prices. Herewith, with regard to the speedy growth of products prices, which were frozen, we do not foresee an upsurge of those prices in May. The utmost growth rates were observed in prices for pasta (+ 6.1 per cent), fruit and vegetables (+5.9 per cent), oil (+4.6 per cent), bakery products (+ 4.3 per cent), grits and beans (+2.2 per cent) and granulated sugar (+ 2.2 per cent). The price for eggs has been downgraded by 0.7 per cent.

In February the traditional upgrading of prices for commercial public services was continued and reached 0.6 per cent as of month results. The utmost growth was observed in regard to public services (by 1.9 per cent), healthcare (+ 1.4 per cent), culture organizations services (+1.3 per cent), pre-school education (+1.per cent), health resorts (+1 per cent), gyms and other sports sites (+1 per cent), international tourism (+0.per cent) and public transport (+0.7 per cent). There was no decline in prices for any type of services in March.

In March, the growth was observed also in regard to non-food items, which average nation-wide prices have increased during the month by 0.7 per cent. The highest growth rates were noted in March for motor gasoline (+1.7 per cent), tobacco (+1.1 per cent) construction materials (1.1 per cent) and pharmacy products (+1 pee cent). Herewith, no downgrading was observed in any type of non-food items.

Therefore, as of March results, consumer price index stayed at February level, what has aggravated the inflation upsurge and deepened the gap between the level of the current year prices growth rates and the level, noted in the relevant period of preceding year.

As we mentioned in earlier surveys, a sharp increase in budget expenditures at the end of 2007 will contribute to inflation in April-May of the current year. High inflation rate is also urged by continued growth of prices for food products in the world market. It is worth mentioning, that some downgrading of monetary offer growth rate at the beginning of current year, as well as grown offer of agricultural products might restrain the inflation in summer. Herewith, inflation inertia stays rather explicit, what provides serious grounds for higher CPI level in 2008 against the indicators of preceding year. The government pays special attention to inflation process monitoring. Thus, the Russian Statistical Service for the first time since has resumed publications on CPI weekly estimates.

The basic consumer price index3 in June 2008 made 1.1 per cent (versus 0.5 per cent of the relevant period of preceding year). According to our estimates, the CPI in April made 1.4 1.6 per cent.

Within March 2008, the volume of monetary base (in broad definition4) has been increased by RUR 83.bln to the amount of RUR 4871.4 bln (- 1.7 per cent). Let us consider the dynamics of monetary base in broad definition by components.

As of April 1, 2008 cash in circulation with regard to the fund balances in credit organizations made RUR 3.79 trillion (remained unchanged versus March 1), correspondent accounts of credit organizations in the Bank of Russia made RUR 596.3 billion (plus 1.4 per cent), mandatory reserves made RUR 339.3 billion (plus 7.2 percent), bank deposits in the Bank of Russia made RUR 122.7 billion (minus 1.9 per cent), the value of shares of the Bank of Russia with credit organizations made RUR 18.8 billion (minus 85.4 per cent). Thus, in March, furhter reduction of excessive reserves of commercial banks was observed, which was the result of gradual deterioration of the situation with liquidity in the banking system due to the redemption of foreign debt and the tax payments to the budget. At the same time, the volume of reserves is still at a rea Basic index of consumer prices is an indicator of the inflation level without regard to seasonal price reduction (fruit and vegetable products) and to administrative measures (tariffs for government-regulated services, etc.). It is estimated by the RF Statistics Service The RF monetary base in broad terms with no regard to the cash issued by the Bank of Russia and the balance of Compulsory Reserve Accounts on credit organizations in national currency, deposited in the Bank of Russia, taking into account the assets of correspondent accounts and bank deposits, allocated in the Bank of Russia.

sonable level, what is evidenced by rather low interest rates in the interbank market, as well as insignificant number of REPO transactions between commercial banks and the Central Bank.

The Growth Rate of the CPI in 2002 - 2008 (% per month).

3,5% 3,0% 2,5% 2,0% 1,5% 1,0% 0,5% 0,0% -0,5% Source: RF Statistical Service Moreover, on April 17 the Ministry of Finance of Russia held the first auction on additional placement of untied federal budget assets on deposits in commercial banks for a period of 26 calendar days. The volume of banks' bids made for RUR 23.4 and was covered completely. Herewith, weighted average rate of interest was 7.31 per cent. It is worth noting, that the maximum amount of placements made at RUR 300 billion.

Herewith, the interest rate was approximately at the level of current interest rate of the Central Bank lombard credits for the period of 7 days (7.25 per cent per annum) and 1 p.p. higher than REPO interest rate for one day (6.3 per cent per annum). However, commercial banks can take credits from the Bank of Russia only under bond security, whereas credits from the federal budget are provided without security. On April 24, the Ministry of Finance of Russia held one more auction, where placement for RUR billion was made with an average weighted rate of RUR 7.26 per cent.

Therefore, credit organizations demand was insignificant despite favorable conditions of placements, what reflects current positive situation with liquidity in banking system in general. Nevertheless, in case the situation with liquidity in banking system gets deteriorated, that instrument for liquidity replenishment will be in higher demand.

In March the amount of cash in circulation remained unchanged, while mandatory reserve funds were growing (by 7.2 per cent), what has led to the growth of monetary base in narrow definition (cash plus mandatory reserve funds)5 by 1.1 per cent (see Fig. 2). Herewith, the volume of foreign currency reserves of the Central Bank of the Russian Federation in March increased by 3.3 per cent and amounted to USD 507 billion by April 1. Within three weeks of April, their volume has grown by another 2.3 per cent to the level of USD 518.8 billion. Herewith, sterilization of incoming liquidity at public accounts in the Bank of Russia was continued: The volume of public deposits has grown within March by 4.2 per cent and accounted to RUR 6.trillion.

We should remind, that the monetary basis in broad terms is not a monetary indicator, but an indicator of the Bank of Russia liabilities in national currency. The monetary base in narrow terms is a monetary indicator (one of the indicators of monetary supply), ultimately controlled by the Central Bank of Russia.

Jul Jul Jul Jul Jul Jul Jan Jan Jan Jan Jan Jan Jan Oct Oct Oct Oct Oct Oct Apr Apr Apr Apr Apr Apr Changes in the Monetary Base and in the Gold and Foreign Currency Reserves in 2007 - 3740 2940 Monetary Base (billion rubles) Gold and Foreign Currency Reserves (billion dollars) Source: RF Central Bank Indicators of Ruble`s Exchange Rate Dynamics 38 36 34 32 30 28 26 24 22 20 Official USD/RUR exchange rate (end of period) Official EUR/RUR exchange rate (end of period) Value of the two-currency basket Real effective exchange rate index (right scale) Source: RF Central Bank data, authors estimates.

In March, the inflow of foreign currency to the country was continued as a result of sustained high oil prices. At the same time, according to the assessments of the RF Central bank, the outflow of capital from the RF was declined and within the first three weeks of February an inflow of commercial capital was noted.

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