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During the 20082009 crisis and the post-crisis period, operations of the Central Bank of the Russian Federation as regards provision of funds to commercial banks had a considerable effect on the money supply (see Fig. 4). In autumn 2011, when credit institutions were in need of liquid resources again the Bank of Russia increased the volume of funds extended to commercial banks and that situation became the main factor behind the growth in the monetary base. It is to be noted that on a year on year basis the monetary base increased by the mere Rb 0.5 trillion (+5.5%) with the December growth in the monetary base amounting to Rb 1.2 trillion. In 2010, the monetary base grew by Rb 1.7 trillion (+26.6%).

Source: The Central Bank of the Russian Federation, the IEP calculations.

Fig. 3. The main factors behind the change in the monetary base (in the broad definition) in the 20082011 period The period under review in 2008 and 2011 is determined by availability of the data on the currency interventions by the Bank of Russia and the balance of the Bank of Russia as of the date of preparation of this review.

RUSSIAN ECONOMY IN trends and outlooks Table The balance of the Bank of Russia in the 20102011 period 01.01.2010 01.01.2011 01.12. Billion % of assets/ Billion % of assets/ Billion % assets/ rubles liabilities rubles liabilities rubles liabilities Funds deposited with non-residents and securi- 12383.3 80.3 13272 85.5 14142 76,ties of foreign issuers Loans and deposits 1705.8 11.1 514 3,3 1657 8.Precious metals 764.6 5.0 1 201 7.7 1602 8.Securities 465.9 3.0 441 2.8 421 2.Other assets 100.3 0.7 99 0.6 697 3.Total assets 15420 100 15526 100 18519 Cash in circulation 4629.9 30 5792 37.3 6150 33.Funds in accounts with the Bank of Russia 7979.7 51.7 6431 41.4 8532 46. Including those of the Government of Russia 4980.2 32.3 3270 21.1 5263 28.Resident-credit institutions 1731.3 11.2 1817 11.7 1328 7.Funds in settlements 8.4 0.1 7 0.0 33 0.Issued securities 283.1 1.8 589 3.8 0 0.Other liabilities 168.3 1.1 145 0.9 1397 7.Capital 2099.1 13.6 2359 15.2 2407 13.Profit of the reporting year 251.4 1.6 204 1.3 0 0.Total liabilities 15420 100 15526 100 18519 The source: The Bank of Russia.

Unsecured loans Other loans Lombard loans and overnight loans Debt on direct REPO operations Source: The Central Bank of the Russian Federation, the IEP calculations.

Fig. 4. The commercial banks debt to the Central Bank of the Russian Federation on individual instruments of refinancing in the 20082011 period Here is a more detailed analysis of the structure of the monetary base in the broad definition (see Table 2). In 2011, the growing components of the monetary base were the cash funds and mandatory reserves. Growth in the mandatory reserves was related to a threefold increase by the Central Bank of the Russian Federation of mandatory reserve requirements in the first six months within the frameworks of return of such requirements to the pre-crisis level. At the same time, lack of channels for such a sustained expansion of the monetary base as was stated Billion rubles 09.01.12.03.14.05.16.07.17.09.19.11.21.01.25.03.27.05.29.07.30.09.02.12.03.02.07.04.09.06.11.08.13.10.15.12.16.02.20.04.22.06.24.08.26.10.28.12.Section The Monetary and Budget Spheres above, as well as problems in the global economy which resulted in the capital outflow and difficulties in refinancing of Russian companies caused a reduction in liquidity in the banking sector. As a result, banks excessive reserves fell within a year: correspondent accounts of commercial banks with the Central Bank of the Russian Federation remained virtually unchanged at on a year-on-year basis (1.3%), however, banks deposits decreased by 38.7%, while credit institutions investments into bonds of the Central Bank of the Russian Federation dropped from nearly Rb 600bn as of the beginning of the year to zero.

Table The dynamics of the monetary base in the broad definition in 2011 (billion rubles) 01.01.2011 01.04.2011 01.07.2011 01.10.2011 01.01.Monetary base (in broad definition) 8 190.3 7 514.2 7 410.3 7 407.9 8644. - cash funds in circulation with cash 5 785.2 5 482.7 5 787.8 6 059.5 6895.balances at cashers offices of credit institutions taken into account - correspondent accounts of credit 994.7 597.2 786.5 781.6 981.institutions with the Bank of Russia - mandatory reserves 188.4 244.1 331.3 347 378. - deposits of credit institutions with 633.2 786.7 486.4 209.5 388.the Bank of Russia - bonds of the Bank of Russia with 588.9 403.4 18.3 10.3 credit institutions Source: The Central Bank of the Russian Federation.

In 2011, the M2 money supply in the national definition increased by 22.6% and amounted to Rb 24.5 trillion as of January 1, 2012 or 45.1% of the GDP. In 2011, monetization of the GDP rose by 0.8%. In 2011, as the financial system of Russia developed the growth of the money multiplier continued; within a year it grew by 16% and was equal to 2.8 as of January 1, 2012 as compared to 2.4 as of January 1, 2011.

Thus, in 2011 the main factors behind slow growth in the money supply became insignificant interventions by the Central Bank of the Russian Federation on the foreign exchange market; the stable and positive balance of payments which was formed as a result of a positive current account balance and negative capital and financial instruments account balance (see the relevant section of the review) contributed to limitation of such interventions. It is to be noted that the Reserve Fund was not spent, but replenished. In such a situation, the main sources of the money supply growth became the Russian Central Banks operations related to refinancing of the banking sector. At present, it can be asserted that the existing trends are likely to continue in 2012 which factor results in a slow expansion of the money supply in case of absence of external shocks.

2.1.2. Inflationary Developments At year-end 2011, the inflation rate in the Russian Federation turned out to be the minimum one in the entire latest history of the Russian Federation. Such a result became feasible thanks to a good combination of both monetary and non-monetary factors. It is to be noted that judging by the inflation rate in January-May it was difficult to predict such a slowdown of the growth rates of prices because the growth in prices in that period in general was the same as in the corresponding period of 2010. A drop in the inflation rate against 2010 was achieved in the second half of the year.

As seen from Fig. 4, the growth rates of the money supply began to fall from autumn which situation could not but have an impact on inflationary developments in 2011. Non RUSSIAN ECONOMY IN trends and outlooks monetary factors behind the rate of inflation include, among other things, the stable exchange rate of the ruble (see the section which deals with the analysis of the balance of payments of the Russian Federation), slow economic growth and a good yield of agricultural products. It is to be noted that despite some weakening of the ruble at the end of summer and in autumn the nominal effective rate of the ruble on a year on year basis did not change much (+2.4%) which situation means that with all other things being equal ruble prices on imported goods remain stable.

Source: Rosstat, the Central Bank of the Russian Federation and the IEP calculations Fig. 5. Growth rates of consumer prices and M2 money supply in the Russian Federation in 20082011 (on a year-on year basis) Here is a more detailed analysis of the dynamics of inflationary developments in 2011. As seen from Table 3, the main factor behind the slowdown of the inflation rate was the fact that growth rates of prices on food products were slower as compared to the previous years. Price rises on meat and fowl (+9.2%), fish and seafood (+10.3%), as well as bread and bakery products (+8.9%) made the main contribution to the growth in prices on food products.

Prices on housing and utilities services continued to grow (+11.7%), but at a slower rate than in 2010. A noticeable growth in prices on pre-school education services (+11.3%), health and recreation services (+9.1%) and services rendered by entities of culture (+11.3%) was observed.

In 2011, prices on non-food products grew at a higher rate than in 2010. It can be partly explained by the growth in prices on gasoline (14.9%), tobacco products (21.1%) and building materials (7.9%).

It is to be reminded that in 2012 the annual raising of the tariffs (regulated by the government) on paid services to the households was postponed from January 1 to July 1. Due to the above, in the first six months the inflation rate on a year on year basis is likely to go down. If the Central Bank of the Russian Federation goes ahead with its policy of limited interference into functioning of the foreign exchange market provided that no serious external shocks take Section The Monetary and Budget Spheres place and a reasonable budget policy is carried out a further drop in the inflation rate may be expected in the Russian Federation by the year-end 2012.

Table The annual growth rates on individual types of goods and services in the 20082011 period (% of December of the previous year) 2008 2009 2010 2011 2008 CPI 13.3 8.8 8.8 6.1 42.Food products 16.5 6.1 12.9 3.9 45.Cereals and bean products 25.8 -2.5 58.8 -8.0 79.Butter 10.5 7.9 23.3 6.6 56.Sunflower oil 22.1 -19.8 27.6 4.6 30.Pasta 33.8 1.6 4.7 3.4 47.Milk and dairy products 12.2 2.3 16.7 6.3 42.Bread and bakery products 25.9 2.4 7.6 8.9 51.Meat and fowl 22.2 5.0 5.3 9.2 47.Fish and sea products 15.1 10.6 4.8 10.3 47.Non-food products 8.0 9.7 5.0 6.7 32.Building materials 11.3 2.1 4.6 7.9 28.Motor gasoline 1.2 8.0 6.5 14.9 33.Services 15.9 11.6 8.1 8.7 52.Housing and utilities services 16.4 19.6 13.0 11.7 75.Pre-school education services 20.7 16.2 7.7 11.3 68.Health and recreation services 21.2 9.5 5.4 9.0 52.Passenger transport services 22.5 6.5 8.7 9.1 54.Services of entities of culture 15.5 11.3 8.6 11.3 55.Source: Rosstat.

2.1.3. The main measures in the sphere of the monetary and credit policy Early in 2011, after numerous cuts in the interest rate on its instruments during and after the crisis the Bank of Russia made its monetary and credit policy tough again. Last year, the rate of refinancing was raised twice. It is to be noted that it took place in the first six months (on February 28 and May 3); within that period the rate of refinancing rose from 7.75% to 8.25%. Simultaneously, with raising of the rate of refinancing by a comparable value the interest rates on operations related both to absorption and provision of liquidity increased. Late in May, the rates on deposit operations of the Central Bank of the Russian Federation were raised by 0.25% with other rates (including the rate of refinancing) remaining unchanged.

In the same period, the Central Bank of the Russian Federation raised three times the mandatory reserve requirements. Starting from February, for three months running the Bank of Russia declared about toughening of the reserve requirements: as regards ruble and foreign currency liabilities of credit institutions to non-resident-legal entities the reserve requirements were raised from 2.5% to 3.5% from February 1, then, from 3.5% to 4.5% from March 1 and, for the third time, from 4.5% to 5.5% from April 1; as regards liabilities to individuals and other ruble and foreign currency liabilities of credit institutions the reserve requirements were raised from 2.5% to 3% from February 1, then, from 3% to 3.5% from March 1 and, for the third time, from 3.5 % to 4% from April 1. It is to be noted that reserve requirements as regards liabilities to non-residents were raised to a greater extent which factor reflects the intentions of the Bank of Russia to discourage borrowings from abroad in a situation of financial instability in order to reduce foreign exchange risks. As a result of raising of the reserve requirements, they returned to the level of the first half of 2008.

RUSSIAN ECONOMY IN trends and outlooks Additional efforts as regards toughening of the monetary and credit policy and scaling down of anti-crisis measures included the following:

On January 31, 2011, the Central Bank of Russia made a decision to raise requirements to the ratings of issuers whose securities were included in the Lombard list of the Bank of Russia. From April 1, 2011, the minimum rating was raised from -/ to /2, while from July 1, 2011, from /2 to +/1 according to the classification of rating agencies Standard & Poor's, Fitch Rating and Moody's Investors Service.

From February 10, 2011, the Bank of Russia suspended operations as regards extension to credit institutions of loans (secured with assets or sureties) for the period from 91 days to 180 days, as well as Lombard loans at a fixed interest rate for the period of 30 days.

From July 1, the Bank of Russia suspended conclusion of direct REPO deals with credit institutions in which deals equities of Russian companies were used as a collateral.

The main reason for toughening of the monetary and credit policy was a speed-up of the inflation rate in the beginning of the year. In addition to that, the above decision was aimed at sterilization of such an accumulated excessive liquidity in the banking system as was formed due to banks huge profits which were received as a result of reduction of loan loss reserves, growth in the value of investments in securities as a result of the post-crisis recovery of stock markets and increase in the interest margin. To attract banks available funds into deposits with the Central Bank of Russia, the latter kept raising interest rates on such deposits. It is to be noted that the Central Bank of the Russian Federation narrowed the spread between the rates on provision and absorption of liquidity (see Fig. 6). Such a policy contributed to greater role of interest rates as PSA instruments within the frameworks of a switchover to the inflation targeting regime. It is to be noted that in a situation of excessive liquidity the market interest rates were primarily influenced by the rates on deposits with the Bank of Russia (for instance, in 2010), while in the periods of a shortage of liquidity (autumn winter 2011), by the rates on the Russian Central Banks liquidity provision instruments. Thus, by changing interest rates and setting limits on provision of loans to commercial banks, the Bank of Russia has a significant impact on the situation on the money market and actually determines both the volume of the supply and the cost of money.

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