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1 The base consumer price index reflects the inflation level on the consumer market less the seasonal factor (prices of vegetable and fruit products) and the administrative factor (tariffs on regulated services, etc.); it is calculated by the RF Statistics Service.

INFLATION AND MONETARY POLICY In the course of March, 3,5% the RF monetary base in a 3,0% broad sense1 rose by 395.bn Rb to 6,363.9 bn Rb (+6.2,5% %). For reference: as of 2,0% March 2010 the volume of the monetary base in a broad 1,5% sense amounted to 5,968.1,0% bn Rb. Let us consider the behavior of the monetary 0,5% base in a broad sense by 0,0% component.

As of 1 April 2010, the -0,5% cash-in-circulation volume, including the cash balances of credit institutions, was Source: RF Statistics Service 4.419 trillion Rb (+ 0.7 %, as compared to 1 March 2010), Figure 1. The growth rate of the CPI in 2002 2010 (% per month) the correspondent accounts of credit institutions with the Bank of Russia amounted to 579.5 bn Rb (+ 4.3 %), mandatory reserves to 167.7 bn Rb (+ 5.4 %), banks deposits with the Bank of Russia to 469.6 bn Rb ( + 21.4 %), and the value of the Bank of Russias bonds held by credit institutions to 735.9 bn Rb (+50.8 %). Thus, March 2010 saw the continuation of the rise in the excess reserves of commercial banks, resulting from the rapid increase in the volume of their liquid resources caused by the inflow of capital and the recovery in economic activity.

Nevertheless, banks are still very cautious in granting credit to the real sector of the economy because of the persisting risks and the uncertainty concerning further economic development. As a result, banks persist in accumulating their funds on deposits with the RF Central Bank or in the form of Bank of Russia bonds.

The above-mentioned 0.7-percent increase in March of the cash-in-circulation volume, accompanied by a simultaneous 5.4-percent rise in mandatory reserves, resulted in a 2.3-percent growth, over the same month, of the monetary base in a narrow sense (cash + mandatory reserves)(see Figure 2). At the same time, the volume of the international reserves of the RF Central Bank rose in March by 2.4 %. As of 1 April 2010 it amounted to 447 bn USD. In the first two weeks of April, the RF gold and foreign currency reserves increased by another 0.4 % to 448.6 bn USD.

In March, Russias net foreign exchange inflows continued to grow due to the persistently high prices for energy carriers. As a consequence, the real effective exchange rate of the ruble increased, in March, by 2.4 % and practically reached its pre-crisis maximum registered in November (see Figure 3).

In March, the foreign exchange market saw the US dollar to euro exchange rate becoming stabilized in response to indications that the EU would help Greece cope with its financial problems.

As a result, by the end of March the US dollar dropped to 29.36 Rb, as compared to 29.95 Rb on March. The weakening of both the US dollar and the euro against the ruble led to an 82-kopeck reduction in the value of the bi-currency basket3 over the course of March. As a result, by the end of March the euro dropped to 34.01 Rb.

1 The RF monetary base in a broad sense, in addition to the cash-in-circulation issued by the Bank of Russia, and the residuals, on the accounts, of mandatory reserves of the funds in the national currency attracted by credit institutions and deposited with the Bank of Russia, includes the funds in corresponding accounts with credit institutions and bank deposits placed with the Bank of Russia.

2 It should be remembered that the monetary base in a broad sense is not a money aggregate; it is a characteristic of the Bank of Russias liabilities denominated in the national currency. The monetary base in a narrow sense is a money aggregate (being one of the characteristics of the money supply volume), fully controlled by the RF Central Bank.

3 The bi-currency basket is an operational benchmark applied by the Bank of Russia for its exchange-rate policy.

At present, the bi-currency basket is set at 0.45 euro and 0.55 USD.

Jul Jul Jul Jul Jul Jul Jul Jul Jan Apr Jan Apr Jan Apr Jan Apr Jan Apr Jan Apr Jan Apr Jan Apr Jan Oct Oct Oct Oct Oct Oct Oct Oct RUSSIAN ECONOMY: TRENDS AND PERSPECTIVES 595 On 26 March 2010, the Bank of Russia announced 4500 that the refinancing rate would once again be cut 490 from 8.5 % to 8.25 % per annum. Simultaneously, the RF Central Bank made 3800 an 0.25 pp. cut in a number of interest rates of the 3600 instruments for granting liquidity to the banking sector and in the rates of deposits attracted from credit institutions. The reasons for Monetary Base (billion rubles) Gold and Foreign Currency Reserves (billion dollars) that decision, as stated in the press of the RF Central Source: RF Central Bank Bank, were practically similar to those that had Figure 2. Changes in the monetary base (in a narrow sense) and in the gold been announced before the and foreign currency reserves of the Russian Federation in 2008 2010.

previous cuts in the rates. In particular, according to the information provided by the Bank of Russia, the reason for the rate cut was the stable downward trend in inflation and the necessity to stimulate the credit activity of commercial banks for the purpose of speeding up the recovery of economic growth. Also, the RF Central Bank noted that the cut in interest rates would contribute to moderating the inflow of short-term foreign capital.

Thus, the Bank of Russia has once again for the eleventh time in a row relaxed its interest rate policy. The key factor behind the Bank of Russias ability to cut interest rates is the current slowdown in inflation compared to the previous year. However, the persisting rise in money supply and the base effect (in April, inflation began to rapidly decelerate) may put an end to the fall in the annual rate of Russian inflation. This situation makes it unlikely for interest rates to drop further by more than 0.25 0.5 p.p. It should also be noted that currently the rate of inflation has been falling more rapidly than the RF Central Banks rates. Thus, the rates have been rising in real terms. At the same time, interest rates on the interbank market have dropped below 4 % due to huge reserves of liquidity accumulated by banks.

50 Therefore, as before the crisis, the RF Central Bank is once again being actually deprived of any effective 35 instruments of monetary policy. In this respect, the major culprit is the Bank of Russias policy on the 20 foreign exchange market, which implies that at each resistance point the regulator Official USD/RUR exchange rate (end of period) in the person of the Bank of Official EUR/RUR exchange rate (end of period) Russia buys / sells around Value of the two-currency basket 700 bn USD and then shifts Real effective exchange rate index (right scale) this point by 5 kopecks. As Source: RF Central Bank, the authors estimates. a result, given the existing favorable external market Figure 3. Indicators of the rubles exchange rate behavior situation, profiteers get an in January 2005 March 20101.

opportunity to make a lot 1 The January 2002 level is taken as 100.

billion rubles billion dollars 9-15.08.4-10.10.5-11.09.23-29.02.19-25.04.14-20.06.24-30.01.21-27.03.16-22.05.11-17.07.25-31.12.19-25.02.29.11-5.12.30.10-5.11.29.12.07-4.01.RUR May May May May May Jan Jan Jan Jan Jan Jan Sep Sep Sep Sep Sep INFLATION AND MONETARY POLICY of money from the ruble upward trend and the interest rate differentials. In our opinion, this exchange-rate policy mechanism does not contribute to increasing the independence of the RF Central Banks monetary policy and to a switch-over to inflation targeting.

On 19 March, the Bank of Russia announced that the credit risk limits set for credit institutions for the purpose of granting unsecured credits would be reduced from 1 May. In other words, the Bank of Russia is going to lower the upper limit of its unsecured credits to credit institutions. This step is aimed at gradually rolling back the anti-crisis measures designed to assist the banking sector. It should be noted that in the course of stabilization of the economic situation in the country, the indebtedness of credit institutions against unsecured credits has already reduced from almost 2 trillion Rb at the beginning of 2009 to 75 bn Rb in March 2010. Most credit institutions have done their best to repay their unsecured credits as soon as possible because of their high cost and the possibility to attract credits at better terms. Thus, it can be assumed that most of the remaining payables are accounted for by the banks whose situation remains strained. Given the RF Central Banks course towards banking sector consolidation, it can be expected that the recently adopted measures will contribute to ousting non-effective banks from the market.

RUSSIAN ECONOMY: TRENDS AND PERSPECTIVES FINANCIAL MARKETSN.Burkova, E.Khudko In April there was volatile dynamics in the Russian financial market under the impact of both, external and internal factors. The1 RF involvement of the new loans in foreign markets, the volatility of the global economy, fears about the financial sustainability of Greece, the closing air transportation in Europe, increased domestic and external debt of Russia up to the I quarter of 2010 contributed to the decreased trading volume in the market of public securities by 2.7fold. However, the positive financial results of several major international companies for the I quarter of 2010, upgrading of the Standard & Poors longterm credit ratings of 14 Russian banks, the IMF amendment of the forecast of GDP growth in Russia for 2010 from 3.6 per cent to 4 per cent, growth of the Russian international reserves have contributed to the support of the corporate securities market and an increase in average daily turnover by 5 per cent. In the corporate bond market April was a period of stabilization. Among the most positive developments there should be noted the growth of IPOs. However, the major problem in the bond market is the failure of the issuers to perform their obligations to the bondholders.

Government securities market In April, Russian Eurobonds have demonstrated general volatile trends at the background of volatility in the global financial markets, Russia appearance at the external debt market after the twelveyear interval with the aim to raise new loans through the placement of government Eurobonds and decreased rates of the Central Bank interest. Activity in the secondary markets has decreased by 2.7 times as compared with the preceding month.

As of April 25, the Russian Eurobonds RUS28 yield to maturity has decreased as compared with the level of March 28 from 5.81 to 5.73 per cent per annum (by 1.41 per cent), RUS18 from 4.76 to 4.69 per cent per annum (by 1.37 per cent), and RUS30, on the contrary has grown from 4.99 to 4.69 per cent per annum (by 0.34 per cent). Eurobond RUS10 was redeemed on March 31, 2010, the amount of 3,00% redemption made 341.2,90% million dollars.

2,80% In addition, on April Tranche 2,70% there were placed the RF Eurobonds by fiveyear and 2,60% tenyear tranches RUS2,50% and RUS20: the amount of 2,40% placements were 2 and 3.2,30% billion dollars, the average weighted yield were 3.2,20% per cent and 5.08 per cent 2,10% per annum, the price of 2,00% placement 99.48 per cent and 99.36 per cent, the coupon scope 3.63 per cent and per cent per annum, maturity date April 29, 2015 and Source: Finmarket Information Agency data 2020, accordingly. According to the international rating Fig. 1. Minfi n bonds yields to maturity in February April agencies Fitch Ratings and 1 In the course of preparation of the survey, there were used analytical materials and surveys published by the Interval, MICEX, RTS, RF Central Bank and the materials presented at web sites of Russian issuing companies.

01.02.04.02.09.02.12.02.17.02.24.02.01.03.04.03.09.03.12.03.17.03.22.03.25.03.30.03.02.04.07.04.12.04.15.04.20.04.23.04.FINANCIAL MARKETS Standard & Poors, those 8,00% Russian Eurobonds are 6,00% rated as BBB.

4,00% As of April 25, the yield 2,00% to redemption of RUS0,00% made 4.06 per cent, and -2,00% RUS20 5.25 per cent. As -4,00% of the same date, an upward -6,00% trend was observed in the -8,00% yields of external currency RUS-2030 RUS-2010 RUS-debt bonds. Thus, the yield -10,00% RUS-2028 RUS-2015 RUS-to redemption of the seventh -12,00% tranche of external currency -14,00% debt bonds has increased from 2.30 to 2.37 per cent per annum (by 3.4 per cent) (see Figs 12) Within the period from Source: Finmarket Information Agency data March 29 to April 25 the total Fig. 2. Yields to maturity of the Russian Eurobonds with maturity in 2010, 2015, turnover of the secondary 2018, 2020, 2028 and 2030 in February April market of government bonds amounted to approximately RUR 139.86 billion with an average daily turnover of RUR 6.99 billion (about RUR 433 billion with an average daily turnover of RUR 18.83 billion in March), which means the downgrading of an average monthly turnover by 2.7 times.

In the period from March 29 through April 25, like in preceding month, there were no auctions on government bonds placement at the primary government bonds market. However, in the period under review there were two auctions for government bonds additional placement in the secondary market (four auctions a month before). Thus, on April 14, there was an auction for government bonds additional placement series 25072 for the amount of RUR 6 042.42 mln. Actual placement volume was RUR 2 036.73 mln with an average weighted yield of 5.98 per cent per annum. On April 21, there was an auction for government bonds additional placement series 25073 for the amount of RUR 11 132.37 mln, with an average weighted yield of 5.97 per cent per cent per annum.

Therefore, the actual volume of placement for the period under review was 22 per cent versus the estimated level (52.63 per cent a month earlier), which demonstrates a decreased interest of the investors to additional placements in the government bonds market in April. This trend reflects a downgrading dynamics in the government bonds market.

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