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In other words, the choice between austerity and stimulus is not reduced to the question of whether preference should be given to an expansionist or conservative budgetary policy. The case in point is what signal should be sent to economic agents to remain as they are, or to modernize. However socially and politically problematic they might be, tough budget constraints create conditions for innovation, while soft budget constraints that can mitigate many Section 1.

The Socio-Political Context current problems will lead to a severe structural crisis in the future. In the mid-1980s, the Soviet Union gave preference to stimuli, and the consequences of that choice are well known.

In contemporary Russia, the situation is aggravated by the countrys half-century-long dependence on the inflow of cheap money. Resource dependence is extremely dangerous, because it leads to a gradual degradation of social (political and economic) institutions and the education system, thus creating barriers to modernization. This resource dependence is quantitatively different from the raw-material character of the Russian economy of bygone days, when agricultural products accounted for the lions share of Russias exports. The core issue of how this dependence can be neutralized thus stimulating demand for modernization must clearly become the focal point of the ongoing political and economic discourse.

Section 2. Monetary-Credit and Budgetary Spheres 2.1. The Monetary and Credit Policy A major trend in the monetary and credit sphere of the Russian Federation in 2010 was the cutting-down of support to anti-crisis Russian financial system by the Bank of Russia in the course of the gradual recovery of the Russian economy. Herewith, the resumption of monetary supply growth by monetizing the total balance of payments, as well as a significant negative shock of aggregate supply in summer (as a result of the drought) again caused an acceleration of inflation in autumn. Reduced dependence of the banks of the RF Central Bank and the sustained net flow of currency to the country once again bring the Bank of Russia at a choice between reducing inflation and managing the exchange rate. At the same time, representatives of the Central Bank of Russia declare the inflation reduction as their priority goal.

2.1.1. The Monetary Market During 2010, there was again observed a substantial increase in the RF international reserves (Fig. 1). The main factor of growth were relatively high prices for Russia main exports, primarily oil, gas and metals. Furthermore, the reduction for the year Euro against the USD in the global currency markets brought about a decline in the dollar value of the reserves denominated in Euro. As a result, there was a trade surplus of the Russian Federation, and the national international reserves were growing, as the Bank of Russia bought foreign currency to slow down the growth of the nominal exchange rate.

By the end of the volume of international reserves amounted to 479.4 billion dollars, while at the beginning of the year they accounted for 439.5 billion dollars, i.e., during the year reserves grew by 9.1%. The volume of the RF international reserves remains sufficiently large by international standards: they are in the third place in the world in absolute value after the reserves of China and Japan. However, the experience of winter 2008/2009 showed that the sharp deterioration in external economic conditions and massive capital outflows, even such large reserves can be quickly spent in case of maintenance of the RF Central Bank rate. In addition, the rapid growth of imports, while maintaining net capital outflows from Russia caused by the persistence of high economic and political risks of investments in Russia, as well as the need to service a large external debt, reducing the supply of currency in Russia.

Therefore, with the stable energy prices in 2011, international reserves will probably grow more slowly than in 2010.

RUSSIAN ECONOMY IN trends and outlooks 100 Monetary Base International reserves (right scale) Source: RF Central Bank.

Fig. 1. The Dynamics of the Monetary Base and Foreign Reserves in 2000-As one can see from Fig. 1, after the crisis, the monetary base was growing at progressive rate as compared to international reserves. An important source of monetary supply growth in 2010, in addition to the operations of the Central Bank of Russia in the foreign exchange market was the use of the Reserve Fund to finance the budget deficit. During 2010, the accounts of the Ministry of Finance of Russia declined by 1.7 trillion rubles. In fact, the monetization of fiscal deficits causes expansion of monetary supply to Russia Herewith, the constraint of the growth of the monetary base at the beginning of the year was the reduction of the net debt of credit institutions to the RF Central Bank (see Table. and Fig. 2). However, already in summer of 2010 credit to the banks on the part of the RF Central Bank has been reduced to the pre-crisis level and further had no significant effect on the balance sheet of monetary regulation. Therefore, in case of continued balance of payments and budget deficit of 2011, one can expect a significantly higher rate of growth of money supply, which increases the risk of inflation.

RUR bn USD bn Jul-Jul-Jan-Jan-Jun-Oct-Oct-Feb-Sep-Apr-Dec-Dec-Mar-Mar-Aug-Nov-Aug-May-May-Section 2.

Monetary-Credit and Budgetary Spheres Table Bank of Russia Balance, 2009 01.01.2009 01.01.2010 01.12.% assets/ % assets/ % assets/ RUR. bn. RUR. bn. RUR. bn.

liabilities liabilities liabilities Funds placed with non-residents and 12091.1 71.3 12383.3 80.3 13752.2 85.foreign issuers securities Credits and deposits 3871.3 22.8 1705.8 11.1 551.4 3.Precious metals 450.3 2.7 764.6 5.0 1172.0 7.Securities 441 2.6 465.9 3.0 446.6 2.Other assets 110 0.6 100.3 0.7 105.1 0.Assets, total 16963.7 100 15420 100 16027 Cash in circulation 4378.2 25.8 4629.9 30 5153.0 32.Cash on accounts with the Bank of 10237.6 60.4 7979.7 51.7 6978.7 43.Russia Including the government of Russia 7093.9 41.8 4980.2 32.3 4434.2 27. Those of resident-credit institutions 2010.1 11.8 1731.3 11.2 934.2 5.Cash in settlements 16.1 0.1 8.4 0.1 44.8 0.Securities issued 12.5 0.1 283.1 1.8 870.8 5.Other liabilities 319.2 1.9 168.3 1.1 818.8 5.Capita 1902.4 11.2 2099.1 13.6 2161.1 13.Profit by the reported year 97.8 0.6 251.4 1.6 0 0.Profit by the reported year 16963.7 100 15420 100 16027.3 Source: the Bank of Russia.

Unsecured credit Other credits Lombard, Day-time credit, Overnight credit Source: the Bank of Russia.

Fig. 2. Debts of credit institutions under the loans of the Bank of Russia in 2009-2010. "Other" credits include loans secured by the Bank of Russia under promissory notes, rights of claim under loan agreements with organizations or guarantees of credit institutions.

RUR bn ECONOMY IN trends and outlooks Dynamics of the assets of the Central Bank of Russia has led to the expansion of the monetary base during 2010 the monetary base (in wide terms1) increased by 1.7 trillion rubles - up to 8.2 trillion rubles (26.6%) (Table 2). Recall that in 2009, this figure rose by 15.9%. Cash in circulation, with the account of credit institutions cash balances accounted on January 1, 2011 amounted to 5.8 trillion rubles (25.1% as compared with January 1, 2010), the correspondent accounts of credit institutions with the Bank of Russia - 1 trillion rubles (10.5%), compulsory reserves - 188 billion rubles (+24.4%), deposits of credit institutions with the Bank of Russia - 633.2 billion rubles (+24.4%), the value of Bank of Russia bonds with credit institutions - 588.9 billion rubles (grown in 2010 by 2.1 times).

Table The Dynamic of the Monetary Base in Broad Terms in 2010 (RUR. Bn.) 01.01.2010 01.04.2010 01.07.2010 01.10.2010 01.01.Monetary base (in broad terms) 6467.3 6 363.90 7 195.00 7 126.00 8190.Including:

Cash in circulation, with account of credit organiza- 4622.9 4 411.20 4 828.10 5 024.50 5785.tions cash balances Credit organizations corresponding accounts with 900.3 579.5 603.6 590 994.the Bank of Russia Compulsory reserves 151.4 167.7 175.5 182.2 188.Credit organizations deposits with the Bank of 509 469.6 637 519.4 633.Russia The bonds of the Bank of Russia held by credit 283.7 735.9 950.8 810 588.organizations Source: the Bank of Russia Monetary supply M2 in national terms has increased over the 2010 by 28.5% and amounted on January 1, 2011 to RUR 20173.5 bn or 45.3% of GDP (on January 1, monetary aggregate M2 amounted to RUR15,697.7 billion (40.5% of GDP). Consequently, in 2010, the monetization of the Russian GDP was growing due to a rapid increase in the monetary base and expanded lending to the economy from commercial banks. In the conditions of high uncertainty about the RF future prospects of economic development, the monetary growth in the medium term will be largely determined by foreign economic situation, as well as the volume of the budget deficit, on the one hand, and speed economic recovery and credit activity of the banking sector on the other hand.

2.1.2. Inflationary Processes One of the important consequences of the 2008-2009 economic crisis for the Russian economy as a significant slowdown of inflation due to the decline in aggregate demand and due to the reduced monetary supply (within September 2008 - February 2009 M2 monetary supply decreased by 17.3%). In the first half of 2010 inflation continued to reduce, but in the According to the RF Central Bank methodology, the monetary base in wide terms characterizes the Bank of Russias monetary and credit liabilities denominated in the national currency, which determine growth in money supply. The monetary base in wide terms comprises cash the RF Central Bank issued in circulation (with account of credit institutions cash balances), balances of the compulsory reserves accounts which credit organizations deposit with the Bank of Russia, monies on correspondent accounts (including averaged balances of compulsory reserves) and deposit accounts the credit organizations have with the Bank of Russia, their investments in the Bank of Russias bonds, backup funds by forex transactions deposited with the RF Central Bank, as well as the Bank of Russias other liabilities bywith respect to operations with credit organizations in the currency of the Russian Federation.

Section 2.

Monetary-Credit and Budgetary Spheres beginning of the year conditions were created for the acceleration of inflation in the form of rapid monetary supply growth (see previous section) (Fig. 3). A drought, which hit Russia in summer of 2010, has made practically inevitable the acceleration of inflation in autumn. Let us consider inflation in 2010 in more detail.

3,0% 2,5% 2,0% 1,5% 1,0% 0,5% 0,0% 2009 Source: Russian State Statistical Service.

Fig. 3. The Dynamics of CPI of the RF in 2009In January - December 2010 food prices grew on average across the country by 12.9% (versus 6.1% in 2009) (Table 3). The main contribution to the growth of food prices has made a rise in cereals and beans (+58.8%), fruit and vegetables (+45.6%), sunflower oil (+ 27.6%), butter (+23.3%) and sugar (+22.5%). The rapid increase in food prices has made the most significant contribution to the CPI growth in 2010. Prices for commercial services have grown in 2010 by 8.1% (against 11.6% in 2009). During January - December the utmost growth in prices were observed in housing and utilities (+13%) for passenger transport services (+8.7%), services of cultural organizations (+8.6%) for medical services (+8. 4%). Non-food products have increased in price in 2010 by 5% on average (against 9.7% in 2009). During the year the utmost growth took place in the price of tobacco products (+19.5%) for knitwear (+7.8%), clothing and underwear (+7.1%) and motor gasoline (+6.5%). The rate of increase basic consumer price index for 2010 made 6.6% (against 8.3% for the same period of the last year). Therefore, the main factors of inflation dynamics in 2010 were the effect of a low base in 2009, on the one hand1 and monetary supply growth against the background of a slow recovery of economic activity and aggregate supply shock in the summer - on the other hand.

From the Table 3 one can see that the major component of inflation in 2007-2010 was the growth in food prices, the expenses for which are the substantial share of household expenditures. At the same time, in 2010 food expenses growth was twice faster than in 2009. The In early 2009 accelerated inflation was recorded in Russia.

jul oct jan feb apr jun sep dec aug nov mar may RUSSIAN ECONOMY IN trends and outlooks main reason for this was the summer drought. Such a conclusion can be drawn basing on the fact that a significant acceleration of growth in food prices began in the fall, while the growth in price was faster for the products, affected by the drought. At the same time, we would like to note that the rapid rise in food prices in 2010 took place all over in the world, but the CPI in the most developed countries remained at a low level. This may indicate either the great possibilities of Russian companies to raise prices due to low competition, and the effects of faster growth in monetary supply in late 2009 - early 2010, as well as the mature high inflationary expectations.

In the sector of commercial services sector one should note the continued growth in prices for housing services. At the same time, in 2010 housing services rose much less than in 2009, whereas in 2008-2009 accelerated pace of appreciation of service were observed. A further slowdown in price increases for housing and communal services in view of the alignment of their prices for population and industrial enterprises, as well as reducing the level of subsidy rates for utility services from the state will decrease the contribution of higher prices of housing services in inflationary pressures.

Non-food products in 2010 rose in price more slowly. Herewith, a rapid increase in tobacco prices was due to primarily an increase excise taxes on them, and the price for knitwear, clothing and underwear - rise in price for cotton due to low yield.

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