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Fourthly, comparatively higher growth of expenses over the revenues has led to both, the reduction of the federal budget surplus in absolute terms in 2007, and its share in the GDP as compared to the forecasted results of performance in 2006. Making an analysis of financial sources for the budget deficit recovery, one should note that in 2007 the amount of assets, addressed to cover the external debt of the RF will be decreased due to extensive repayments made in 20052006. The government maintains the policy of extension of the internal and reduction of the external government debt.

Basing on the above arguments, the draft federal budget for 2007 can be defined in general as a rather conservative due to minor changes in the structure of its revenues and expenses. Nevertheless, one can observe stabilization of the income level in the situation, when the non-interest expenses are growing. Further implementation of policy of increase of non-interest expenses at a higher rate than the rate of GDP growth may result in excessive inflation pressure. This might hinder the measures taken by Central Bank to curb the growth of prices within the preset limits. On top of that, stabilization of the situation in the world market of raw products along with innovations in tax and budget area can increase the risks of a decline of the share of revenues, dependant on the market situation, and reduction of tax proceeds. It should be also noted that forecasted amount of federal budget revenues (either in terms of the share in GDP, or in nominal terms) is close to the indicators estimated on the basis of medium-term macroeconomic structural model, developed in IET D. Polevoy Monetary Policy in the Russian Federation in August The consumer price index parameter grew again in August 2006 against the previous year: prices of consumer goods grew up by an average of 0.2% in the country. Money supply also kept growing at faster rates: monetary base (narrow definition) grew by 3.9%. The volume of golden and foreign exchange reserves of the Russian Federation reduced by 2.3% in the same period due to payments made in repayment of the Russias foreign debt due to the Paris Club of Creditors.

The value of consumer price index accounted for 0,2% in August 2006 (as opposed to -0.1% in August 2005 ( see Figure 1 )). This means that no deflation took place as it was expected as a result of cheaper prices of fruits and vegetables, though the parameter of consumer price index in August was lower than that in July 2006. The reason behind it was substantial growth of price rates of non-food products ( + 0.8% ) and fee based services provided to the general public ( + 0.8% ).

Considerable growth in prices of non-food products was caused by growing prices of motor gasoline ( + 5.4% ) and building materials ( + 1.7% ). In addition, prices of TV and radio goods ( - 0.2% ).

Sharp increase in prices of gasoline resulted in that the Government of the Russian Federation again, as in the previous year, arranged for a meeting with representatives of Russian major oil companies, at which agreements were achieved to force gasoline price growth rates to reduce until the end of the year. However, there is a seasonal character in reduced demand for gasoline in the period between fall and winter. Therefore, prices of gasoline are likely to increase at slower rates in the nearest future.

Regarding fee-based services to the general population in August, prices of educational services and passenger transport grew most by + 1.9% and + 1.1% respectively. It should be noted that such a significant growth in prices of educational services is of seasonal character featuring growing demand for such services, while growth in prices of passenger transport is due to the growth in prices of gasoline.

Prices of food products in August 2006 fell by an average of 0.5% in the country. Prices of fruits and vegetables fell most ( - 10% ), as was expected. In addition, prices of sunflower oil ( - 0.1% ) reduced slightly. Prices of alcoholic beverages kept growing due to reduced supply and increased suppliers costs as a result of introduction of the Unified State Automated Information System of Accounting of Production and Trade of Ethanol and Alcoholic Beverages.

The value of the reference consumer price index 2 grew by 0.6% in August 2006 (as opposed to 0.% over the corresponding period of the previous year ). Therefore, underlying inflation continued to boost in August 2006 due to rapid growth in money supply in the current year. The upward trend in the underlying inflation cannot but alert given that over the first three month of the current year the monetary base (broad definition) almost tripled against that in the previous year. In our opinion, the underlying inflation is expected to keep growing in fall thus creating additional inflation risks.

The value of the consumer price index is estimated to account for 0.4 % in September and 0.5 % in October 2006, according to the IETs bulletin of model analysis of socio-economic performance forecasts in the Russian Federation.

The Growth Rate of the CPI in 2002 - 2006 (% per month).

3,5% 3,0% 2,5% 2,0% 1,5% 1,0% 0,5% 0,0% -0,5% Data source : the Federal State Statistics Service.

The monetary base ( broad definition )3 grew by Rb 177,2 billion to reach Rb 3.48 trillions ( + 0.% ) in August 2006. The volume of monetary base ( broad definition ) equaled Rb 3.31 trillion as of August 1, 2006. Let us consider the movement of the monetary base ( broad definition ) by component..

Active cash money including cash balances at credit organizations accounted for 2.51 trillion rubles as of September 1, 2006 ( as opposed to + 2.4 % on August 1 of the same year ), correspondent accounts of credit organizations with the Bank of Russia amounted to Rb 368.3 billion ( + 1.2 % ), mandatory reserves amounted to Rb 204.2 billion rubles ( + 5.3 % ), banks deposits with the Bank of Russia accounted for 229.1 billion ( + 83.1 % ), the value of the bonds of the Bank of Russia held by credit organizations was Rb 168,1 billion ( + 0.5 % ), and currency transactions reserves deposited with the Bank of Russia amounted to Rb 0.3 billion ( - 40 % ). It should be noted that deposits with the Bank of Russia grew significantly in August 2006 due to increased deposit rates. It is to recall that rates of fund raising instruments were increased at credit organizations since August 7, 2006, namely The consumer price index is an indicator which reflects inflation level in the consumer market without consideration of a seasonal ( prices of food products ) and administrative ( tariffs of regulated types of services, etc. ) factors. The reference consumer price index is normally calculated by the Federal Sate Statistics Service of the Russian Federation.

The monetary base ( broad definition ) of the Russian Federation includes correspondent account balances deposited by credit organizations and banks with the Bank of Russia as well as active cash money issued by the Bank of Russia and account balances of compulsory reserves deposited with the Bank of Russia by credit organizations in borrowing funds in national currency.

Jul Jul Jul Jul Jul Jan Jan Jan Jan Jan Oct Oct Oct Oct Apr Apr Apr Apr Apr deposits on standard terms and conditions tom-next, spot/next and on demand ( from 1.5% to 2% per annum ), first week and spot-week ( from 2% to 2.5% per annum ). It was the third time since the beginning of 2006 that the said rates were increased in order to sterilize the excess liquidity in the country.

In August 2006, growth in the volume of active cash money ( + 2.4 % ) with simultaneous increase in mandatory reserves ( + 5.3 % ) resulted in that the monetary base (narrow definition ) ( cash money + compulsory reserves )4 widened by 3.9 % ( see Figure 2). In addition, the RF gold and foreign exchange reserves of the Central Bank of the Russian Federation reduced in August 2006 ( - 2.3 % ) to $265.7 billion US dollars as of September 1, 2006. The reserves reduced by another 2.5 % to total $259 billion US dollars over the first three weeks in September 2006. Such a considerable reduction in the RF gold and foreign exchange reserves of the Central Bank of the Russian Federation is explained by two reasons. First, in August 2006 Russia repaid its foreign debt due to the Paris Club of Creditors to the amount of about $23 billion US dollars. Second, prices of energy sources in the global market began to fall in September 2006, which aggravated foreign economic situation and resulted in reduction of currency inflow rate into the Russian Federation. A the same time the Bank of Russia continued to support gaining exchange rate of the national currency in order to reduce inflation rate. The repayment of the Russias foreign debt also resulted in reduction of the stabilization fund which totaled Rb 1730,6 billion in volume as of August 1, 2006 ( - Rb 475,4 billion as compared to August 1, 2006 ).

It should be noted that the amount of golden and foreign exchange reserves of the Russian Federation by the end of October 2006 is expected to exceed the amount of $275 billion US dollars, according to the IETs bulletin of model analysis of socio-economic performance forecasts in the Russian Federation.

Changes in the Monetary Base and in the Gold and Foreign Currency Reserves in 2005 - 2006.

2730 1850 Monetary Base (billion rubles) Gold and Foreign Currency Reserves (billion dollars) Data source : the Central Bank of the Russian Federation.

According to the information from the Federal Treasury, in July 2006, the Russian Federations expenditures on repayment of its foreign debt amounted to $24 million US dollars, of which $23.3 million US dollar were paid in repayment of the foreign debt, and $0.7 million US dollars were paid for It will be recalled that monetary base ( broad definition ) represents national currency liabilities of the Bank of Russia rather than a monetary aggregate. The monetary base is a monetary aggregate ( one of the parameters representing money supply volume ) which is fully controlled by the RF Central Bank.

billion rubles billion dollars 1-7.12.3-9.02.1-7.09.8-14.09.7-13.04.9-15.06.18-24.08.20-26.10.10-16.11.22-28.12.13-19.01.17-23.03.19-25.05.21-27.07.11- service. The biggest amounts were paid in repayment of Russias debt due to the Paris Club of Creditors ( $23.9 US dollars ), debts on loans extended by the IBRD and the EBRD ( $38.7 million US dollars ), and loans raised upon bonds ( $0.1 million US dollars ).

Trunin P.

Financial MarketsOn the whole, the situation in the Russian financial market in September slightly deteriorated as compared to the previous month. Russian eurobonds remained more or less stable: by the end of the month they either grew a little or remained at the August level. In the first half of September the rouble debt market also showed a stable growth, however in mid-September it went down against the backdrop of the roubles drop against the dollar, a downturn in the rouble liquidity, high initial supply and a number of other external economic factors. The situation in the Russian equity market was the worst: following a drop in the world oil and metal prices, it was falling throughout the month.

Fixed income market The situation in Russias foreign currency debt market in September remained favourable. The yield on traded issues either dropped further or remained at levels comparable to the August figures. In early September, despite a certain fall on the US debt market caused by a rise in the cost of labour, Russian bonds appeared quite stable, having suffered an insignificant drop. That was followed by an aggravation in external factors. Political instability in a number of developing countries as well as Ecuador's announcement of a revision of its external debt payments had a negative effect on western investors' demand for these countries' securities. At the same time the Russian market again demonstrated a relatively lower rate of fall. Moreover, several issues showed a minor growth by the end of the first week.

The beginning of the second half of the month did not bring any considerable changes. World factors continued to have a negative impact: investors were wary of a slowdown in the US economy; oil prices continued to fall and nearly reached $60 dollars per barrel; western funds were withdrawing money from emerging markets. All of the above given the lack of significant domestic news contributed to a continued downward trend on the Russian share market. The third week in September was marked by a lower activity on the market as a result of which quotations on the whole stayed at the same level or slightly dropped. A falling oil price did bring about a certain drop in the prices of some issues. At the same time the risk of a rising yield on US government bonds, which are at present being traded below the basic interest rate, remains rather high. If this risk proves true, it will have a negative effect on the Russian foreign currency debt market.

As of 27 September, Russian eurobonds RUS 30 yield to maturity was 5.67% per annum; RUS-18, 5.81%. On the same date the yields on Russian eurobonds stood at: Minfin bonds (OVVZ, internal foreign currency bonds) tranche 8 4.47%, tranche 7 5.43%; tranche 5 5.54%; and RUS-07 5.37%.

The situation on the rouble government bond market remained quite stable, too. Early in September quotations were on the rise despite a fall on the US market, a weaker rouble against the dollar and a certain rise in the initial supply. During the second week a moderate growth continued against the backdrop of a relatively stable dynamics of the Russian foreign currency debt and a certain strengthening of the rouble against the dollar. At the same time, a drop in the banking sector liquidity put pressure on the market. In mid-September quotations finally stopped to grow and began a moderate fall.

That was brought about by a stabilisation of the external market, a stronger dollar against the rouble as well as the risk of higher interest rates on the US government bond market.

From 1 to 30 August the total volume of the GKO-OFZ secondary market amounted to approximately 70.9bln roubles at an average daily turnover of 3.22mln roubles (about 41.7bln roubles at an average daily turnover of 2.6bln roubles in July). Thus trading activity in rouble government bonds in August was much higher than in July.

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