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Herewith, a key factor in the dynamics of the course was the dynamics in the imports of the Russian Federation. With minor changes in exports, nearly constant increase in imports caused a reduction in current account balance of payments, which, when private capital outflows from the country became the only channel of foreign currency inflow to the Russian Federation. As a result, with a relatively large current account balance (see above), in January - April there was strengthening of the ruble in nominal terms (in real terms the ruble was strengthening in January - May). Then, till the year end, ruble was continuously depreciating, both in nominal and real terms. Only a renewed rise in oil prices late in the year, which came close to the level of USD 100 per barrel, caused the ruble strengthening in nominal and in real terms as of December results.

In general, as a result of January - December, the real effective exchange rate of RUR rose by 9.6% and almost reached pre-crisis level of the mid-2008 (see Fig. 6)1. The official dollar rate against ruble in 2010 increased by 24 kopecks: by the end of December, the dollar made 30.48 rubles as compared with 30.24 rubles on December 31, 2009. Herewith, ruble strengthened against the two-currency basket2: the value of the two-currency basket has declined over the same period by 1 rub. 25 kopecks: from 36.16 rubles. up to 34.91 rubles. Within the year, there was a gradual strengthening of the US dollar to Euro at the background of the situation The level of January 2002 is accepted as 100 per cent.

Two-currency basket is the RF Central Bank operational indicator in its foreign currency policy. Currently the share of EURO in the currency basket makes 45 per cent, USD 55 per cent.

RUSSIAN ECONOMY IN trends and outlooks improvement in the US economy and worsening of the debt problems in the EU. As a result, the Euro rate against the ruble at the end of December amounted to 40.33 rubles.

50 45 40 35 30 25 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: the RF Central Bank, IEP estimates.

Fig. 6 Indicators of RUR Exchange Rate between January 2005 and December Thus, in 2010 due to favorable foreign economic situation, strengthening of the ruble was continued. We would like to recall that the rise in energy sources prices in the 2000-s before the crisis also led to a rapid increase in the surplus current account balance of payments in Russia and inspired ruble strengthening. To prevent nominal RUR strengthening, the RF Central Bank was buying foreign currency and increased monetary offer. Even the formation of the Stabilization Fund in 2004, which often helped to sterilize intervention of the Central Bank interventions in the foreign exchange market, did not allow to stop the real ruble strengthening, observed up to the crisis in 2008. Herewith, the main reason of ruble strengthening restriction to the Russian authorities was the reluctance to allow the loss of the national companies competitiveness. However, with the significant monetization of the trade balance and the lack of opportunity for the sterilization, the inflation in Russia still remained high, despite the rising monetary demand. A rise in prices, in turn, resulted in a real strengthening of the ruble (See in the insert the description of a similar situation in the foreign exchange market in China).

The issue of the Bank of Russia interest rate policy efficacy is still open. It is not excluded that in the absence of the Bank of Russia interference in the functioning of the foreign currency market ruble would be much stronger in nominal terms, but due to lower inflation the dynamics of the real exchange rate would be only slightly different from the current one. Restraining of the ruble, even in view of a partial sterilization, has inspired a rapid growth in monetary supply and inflation, still remaining at the high level in terms of the world standards. Herewith, an important role in expanding the monetary supply has played a capital inflow in 2006-2007, which, in contrast to foreign currency exchange inflows from trade operations could not be sterilized in the Stabilization Fund, which was formed through taxes. One should note, that a possibility of further sterilization, including through the emission of the RF Central Bank bonds and the accumulation of even a larger scale of the government accounts RUR May May May May May May Jan Jan Jan Jan Jan Jan Sep Sep Sep Sep Sep Sep Section 2.

Monetary-Credit and Budgetary Spheres with the RF Central Bank (i.e., in the Reserve Fund), also raises doubts as to the economic and political reasons.

At first sight, the current situation is similar. However, we believe that an important difference lies in the instability of the global economic recovery. In the event of new problems or tightening of monetary and credit policy in the US and the EU (as the economy recovers), energy prices may fall down, which will inevitably result in an outflow of capital from Russia and create conditions for the weakening of the ruble. In our opinion, under conditions of high uncertainty about the future situation in the global and Russian economies, the Bank of Russia, one should not actively intervene in the domestic foreign exchange market and should focus on reducing inflation.

The dynamics of the National Currency of China We would like to note that the problem of yuan exchange rate, which is recently under discussion, is relevant to our country as well, because Russia, like China, is heavily dependent on commodity exports. Herewith, the sharp devaluation of the ruble after the 1998 crisis along with rising energy prices and a recovery growth has caused the process of import substitution, which was an important factor in rapid economic growth in Russia in the early 2000's. It is considered that China also supports the competitiveness of their exports by an undervalued yuan.

However, as we have seen above, during the 2000-s and until the crisis ruble was strengthening in real terms, whereas it can be seen in Figs. 7 and 8, that the real effective exchange rate of the yuan over the past years has not changed. With control over the nominal exchange rate by the People's Bank of China, a stable real effective exchange rate means similar inflation in the USA (the main trading partner of China) and China.

140 10 --0 -Yuan real effective exchange rate (left IPC M1 MCPI in China (% to the relevant period CPI in the USA (% to the relevant peri Fig. 7. The monetary instruments growth rate and CPI in China in 19992010 (% to the relevant period Fig. 8. Yuan real effective exchange rate of preceding year1) (01.1999=100) CPI in China and US in 19992010.

Achievement of a moderate level of inflation in China was made possible by a large sterilization through purchased by the Central Bank reserves, accumulated not only in the government accounts in the People's Bank of China, but also (to a much larger scale) by selling bonds of the Central Bank to credit institutions (see Figs. and 10). Such policy, coupled with the rapid economic growth, as well as restrictions in capital inflows, limiting further inflow of foreign currency to China, has allowed the Chinese authorities to curb monetary supply growth and inflation.

The same period last year.

% per year 2001M2002M2003M2004M2005M2006M2007M2008M2009M2002M2003M2004M2005M2006M2007M2008M2009M2010M1999M1999M2000M2001MRUSSIAN ECONOMY IN trends and outlooks 250 200 Reserves Central Bank bonds Other Requirements to non-financial sector Foreign liabilities Government deposits Requirements to financial sector Requirements to the Government Foreign assets Capital Other Fig. 10. People's Bank of China liabilities dynamics Fig. 9. People's Bank of China assets dynamics in 2002in 2002One of the major trends in the dynamics of balance of payments in 2010 was the dynamics of net capital outflows from non-financial sector, which reached USD 37.9 billion as of the year results (in 2009, due to the crisis, the outflow amounted to USD 58.7 billion) (See Fig. 11). After the outflow of capital in the I quarter in the amount of USD 13.8 billion, in II quarter the inflow (USD 2.6 billion) was recorded. However, in the second half of the year the outflow of capital has accelerated (USD 3.8 billion and 22.8 billion in the III and IV quarters, respectively). At first glance, it might seem that the outflow of capital is gradually decreasing at the background of the Russian economy recovery from the crisis.

However, a comparative analysis shows that while private capital inflows were growing to many developing countries, where investors were ready to run the risk and where low interest rates were sustained, private capital is still flowing away from Russia. The reasons for this situation, apparently, is the maintained strong economic and political risks of investments in the RF with the level of profitability comparable to other developing countries.

Another evidence of the unfortunate situation with the inflow of capital is acceleration of the so-called capital flight1 in 2010. As a result of capital flight in 2010 (Fig. 12) reached, according to our estimates, 35.8 billion dollars, which is by 11.6 billion dollars more than in 2009. In 2010, respectively, an increase was recorded in the share of capital flight in foreign trade turnover from 4.9% in 2009 to 5.5%.

We estimate the capital flight by the methodology of the IMF, which represents the sum of "commercial loans and advances", "delayed receivable export revenue and receivable goods and services on the account of remittances under import contracts" and "net errors and omissions".

Yuan 100 bn Yuan 100 bn 2002,2002,2003,2004,2005,2005,2006,2007,2008,2008,2009,2010,2002,2002,2003,2004,2005,2006,2007,2008,2009,2010,Section 2.

Monetary-Credit and Budgetary Spheres 100 60% 53,40% 39,20,21,8,15,20% 7,8,1,2,3,-6,-37,0% -5,1 -2,0-6,3 -6,6 -3,11,8 13,-4,-7,1 -20% -13,8 -22,-19,-24,--33,-40% -60% --80% -130,-150 -100% 2004 2005 2006 2007 2008 2009 Capital net outflow (USD bn) Capital net outflow/external trade turnover (%) Source: the RF Central Bank, IEP estimates.

Fig. 11. Capital net outflow dynamics in 20042010.

5 4% 2% 0,1 2,0% -2,-3,-4,-5,-7,4 -7,-8,3-8,0-7,0-9,3-7,0 -9,3 -9,6 -8,0-8,1 -2% -8,--10,8 -10,-11,-13,-13,7 -14,2 -14,0 -4% -15,-18,-19,-10 -6% -8% --10% -12% --14% -25 -16% 2004 2005 2006 2007 2008 2009 Capital flight(USD bn) Capital flight/ external trade turnover (%) Source: the RF Central Bank, IEP estimates.

Fig. 12. Capital flight dynamics in 20042010.

USD bn Quarter I Quarter I Quarter I Quarter I Quarter I Quarter I Quarter I Quarter II Quarter II Quarter II Quarter II Quarter II Quarter II Quarter II Quarter III Quarter III Quarter III Quarter III Quarter III Quarter III Quarter III Quarter IV Quarter IV Quarter IV Quarter IV Quarter IV Quarter IV Quarter IV USD bn Quarter I Quarter I Quarter I Quarter I Quarter I Quarter I Quarter I Quarter II Quarter II Quarter II Quarter II Quarter II Quarter II Quarter II Quarter III Quarter III Quarter III Quarter III Quarter III Quarter III Quarter III Quarter IV Quarter IV Quarter IV Quarter IV Quarter IV Quarter IV Quarter IV RUSSIAN ECONOMY IN trends and outlooks Summarizing the analysis of the balance of payments, we should note that the decline in energy prices during the crisis has demonstrated the vulnerability of the domestic balance of payments. Restoration of oil prices in 2009-2010 helped to stabilize the balance of payments.

However, with improvement of the Russian economy, imports began to recover. In addition, if during the III quarter of 2009 - II quarter of 2010 the restoration of imports was slower than exports, in the second half of 2010 the growth rate of imports has nearly twice exceeded the growth rate of exports. As a result, despite the continued rise in oil prices, late in the year, at the background of accelerating capital flight, in order to stabilize the balance of payments, it was needed to reduce Russia's international reserves amounting by 8.6 billion dollars. In the case of preservation of this trend, declining in the current account balance will continue, which will create downward pressure on the ruble.

As for balance of capital operations account and financial instruments, the capital flows apparently will remain quite volatile. However, with other terms being equal (especially in the case of stability in energy prices), in the absence of efforts on the part of the Russian government to reduce the risks of investments in Russia, one can hardly expect private capital inflows into the country as per 2011 results.

2.1.4. Main Measures in the Monetary and Credit Policy Area Measures taken by the Bank of of Russia in order to ensure the stability of the financial system can be divided into two groups: the interest rate policy and other measures.

If we talk about interest rate policy of the RF Central Bank in 2010, then in the first half of the Bank of Russia continued the policy of 2009 addressed to mitigate the monetary and credit policy. In particular, in January May, the RF Central Bank reduced interest rates four times. During this period, the refinancing rate (together with the rates on Bank of Russia) was reduced from 8.75 to 7.75% per annum. The reason for such action of the RF Central Bank was that lending to the real sector of the economy has been dramatically slowed down with the reducing inflation. Slowing inflation enabled the Bank of Russia to reduce the cost of resources provided to commercial banks, slightly amending the interest rate in real terms, as nominal rates were maintained at the level of inflation. The reasons to reduce the rates, published in the RF CB press release, were in all cases approximately the same. In particular, among the reasons for lower rates there were mentioned the decline in inflation and the need to promote the recovery of the unstable economic growth.

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