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In the recent years RF Central Bank in Basic trends of Monetary and Credit Policy pays more and more attention to the importance of inflation targeting, rather than rouble exchange rate. In other words, the Bank of Russia id making a gradual transfer to the regime of inflation targeting. This regime is getting rather popular worldwide; many industrialized and developing countries reject alternative policies in favor of inflation targeting regime.(See Table 3).

Table Countries, applying Inflation Targeting Regime Inflation targeting Date of regime Inflation as of regime in Country indicator at present introduction troduction (% per year) (% per year) 1 2 3 Developing countries, economies in transition Israel Q II, 1997 8,5 1 Check Republic Q I, 1998 13,1 3 (+/ 1) Poland Q IV, 1998 9,9 2,5 (+/ 1) Brasilia Q II, 1999 3,3 4,5 (+/ 2) Chili Q III, 1999 2,9 2 Columbia Q III, 1999 9,3 5 (+/ 0,5) Republic of South Africa Q I, 2000 2,3 3 Thailand Q II, 2000 1,7 0 3,South Korea Q I, 2001 3,2 2,5 3,Mexico Q I, 2001 8,1 3 (+/ 1) Hungary Q II, 2001 10,5 3,5 (+/ 1) Peru Q I, 2002 0,8 2,5 (+/ 1) Philippines Q I, 2002 3,8 5 Slovakia Q I, 2005 3,2 3,5 (+/ 1) Indonesia Q III, 2005 7,8 5,5 (+/ 1) Romania Q III, 2005 8,8 7,5 (+/ 1) Section Monetary and budgetary spheres 1 2 3 Industrialized Countries New Zealand Q I, 1990 7 1 Canada Q I, 1991 6,2 1 Great Britain Q IV, 1992 3,6 Switzerland Q I, 1993 4,8 2 (+/ 1) Australia Q II, 1993 1,9 2 Iceland Q I, 2001 3,9 2,Norway Q I, 2001 3,7 2,Source: Inflation Targeting and the IMF (2006).

Table RF Compliance with Advisable Requirements of Introduction of Inflation Targeting Regime Requirement RF compliance Comments Institutional independence of RF Central Bank is an autonomous structure, but it is monetary and credit control au Partially compliant often under pressure of both, executive and legisla thorities tive power authorities Qualification of Experts the Highly professional analytics, Bank of Russia is sufficient for efficient inflation esti Partially compliant reliable statistics mates, but currently there is a lack of adequate sta tistics, required for reliable forecasts.

Economic situation in the RF highly depends on natu ral resources prices, some of prices are actually Diversified market economy Incompliant dependent of certain factors, and dollar equivalent in the economy is still high, though somewhat reduced.

The rates of the national financial system are rather high, but in comparison with other countries with Highly developed financial system Partially compliant transition economy, our economy is still insufficiently developed and exposed to high risks According to the point of view, dominating worldwide till recent time, the infla tion targeting is far more sensitive to institutional and macroeconomic environment factors than other regimes. Rather tough requirements to the situation, when an affective transfer to inflation targeting can be performed, made developing coun tries and economies in transition very prudent in terms of the new regime of mone tary and credit policy. However, later on it became clear that the majority of those requirements relates as much to the regime of inflation targeting, as to any other regime of monetary and credit policy. Moreover, it is confirmed by practice, that compliance with the tough technical requirements is as important in the period of regime introduction, as in further improvement of the situation during the transfer to the inflation targeting regime6. One can see from Table 4, to what extent the Rus sian Federation is compliant with those requirements.

However, in our estimates, the RF is compliant with the majority of require ments, set forth to the successful transfer to the inflation targeting (See Table 5).

Therefore, one can only welcome a gradual transfer of the Bank of Russia to the inflation targeting regime, especially basing on the results of numerous sur veys, demonstrating7 positive macroeconomic dynamics in the countries, where the inflation targeting was applied, as compared with the periods, when alternative Ref.: Survey of IMF country desk officers, 2005.

Ref. Inflation Targeting and The IMF, Prepared by Monetary and Financial Systems Department, Policy and Development Review Department and Research Department, March 2006.

RUSSIAN ECONOMY IN trends and outlooks regimes of monetary and credit policy were in effect, as well as with the countries, applying alternative regimes. Moreover, a significant result of inflation targeting re gime is a higher credibility to the monetary and credit policy of central banks on the part of economic agents and reduction of volatility of the basic macro economic in dicators, which lowers the risk of financial crisis8. A the same time, a transfer to in flation targeting regime should be supported by dismissal of the guided flexible rouble exchange rate, what can be achieved in present circumstances through a strong political decision.

Table RF Compliance with Necessary Requirements of Introduction of Inflation Targeting Regime Requirement RF compliance Comments RF economy id under sustained development. GDP is Relatively large scale economy Compliant relatively high Hough the RF economy is highly dependent on ex Prices are established on the ternal markets, basically the dynamics of prices in Compliant national level the national market is determined by domestic fac tors Inflation rate is less than 10% Compliant As of 2006 results, the CPI made 9% Currently the task of inflation reduction is a priority to Support to the transfer of inflation the government of the country, and the inflation tar targeting on the part of govern Compliant geting regime is the best instrument for achievement ment authorities of that target Monetary and credit control bod RF CB representatives repeatedly make statements ies firmly adhere to the declared Partially compliant on sustainability of their objectives, but they are far targets from reaching all the those target objectives At the end of this section, let us compare the growth rates of consumer prices in the RF and other CIS countries (See Table 6).

Table Indices of Consumer Price Growth in CIS in 2000 2006, as % 2000 2001 2002 2003 2004 2005 Azerbaijan 2 2 3 2 7 10 8,Armenia 1 3 1 5 7 1 3,Belarus 169 61 43 28 18 10 5,Georgia 4 5 6 5 6 8 7,Kazakhstan 13 8 6 6 7 8 7,Kyrgyzstan 19 7 2 3 4 4 3,Moldova 31 10 5 12 12 12 12,Russia 20 19 15 12 12 11 Tajikistan 24 37 10 17 7 8 11,Urraine 28 12 1 5 9 14 10,Source: CIS Interstate Statistical Committee. (http://www.cisstat.com/).

One can notice that the inflation rates in Russia are still high in comparison with other CIS countries. As mentioned above, the reasons for sustained high rates of consumer prices in RF might be both, high growth rates of money supply (See Fig. 2), caused by a tendency to maintain a stable rouble rate, and non monetary Ref. Masson P., M. Savastano and S. Sharma, The Scope for Inflation Targeting in Developing Countries, IMF Working Paper 97/130, Washington, IMF, 1997.

The basic information on the RF is provided as of 2006, on other countries as of January November.

Section Monetary and budgetary spheres factors, like high market monopolization, accelerated growth of commercial ser vices (See Table 2),a as well as other reasons, not quite clear at this point.

2.1.3. State of Balance of PaymentsThe RF stable situation with the balance of payments in 2006 as in years be fore was due largely to the peak volumes of the Russian main exports, first and foremost its energy sector. At the background of raising oil prices, the value of Russian exports has grown by 24 per cent. However, the rates of export sales growth have been reduced times 1.5 versus the preceding year of 2005, which re sulted in some decline of oil prices in 2006. At the same time, the RF Central Bank has been accumulating gold and foreign currency reserves. Moreover, 2006 was also remarkable in terms of large amount of net capital inflow, which increased fold as compared with the relevant indicator of preceding year, when the inflow capital to the RF has exceeded the outflow for the first time.

350 300 250 200 150 100 50 0 1999 2000 2001 2002 2003 2004 2005 Export Share of oil, oil products and gas in export Source: RF Central Bank Fig. 5. Dynamics of Export Sales and Share of Energy Sector in Exports in 1999 According to the tentative estimates of the RF balance of payments in 2006, published by the Bank of Russia, the surplus balance of current account surplus stood at USD 95.6 bln, i.e., has grown by 14.7 per cent versus the level of (See Table 7). Trading surplus in particular rose by 18 per cent (from USD 118.bln to USD 139.6 bln), with growth in exports at 24.1 per cent (from 243.6 bln to USD 302.3 bln) and imports also grew by 29.8 per cent (from USD 125.3 bln to USD162.7 bln). The share of products from the oil and gas segment of the econ omy made 63.4 per cent of total exports (versus 54.7 per cent in 2004, 61.1 per cent in 2005) (See Fig. 5).Therefore, as in the years before, status of Russias cur The analysis of the state of balance is made on tentative data of the RF Central Bank.

% bln dollars RUSSIAN ECONOMY IN trends and outlooks rent account depends largely on its trade component, which in its turn is mostly de termined by changes in prices for energy products and other major Russian export commodities, brought out to the world market. The data presented in Fig. 6 dem onstrates that the correlation between the Russian trade account balance and the world market energy prices observed within 2002 2005, continued in 2006 as well.

Deficit in services account made USD 15.8 bln and has grown by 7.3 per cent as compared with 2005. Russian exported services amounted to USD 30.1 bln, USD 5.5 bln (or 22.2 per cent) more than the level of preceding year. At the same time, value of imported services also grew by 16.6 per cent in 2006 versus the level of 2005 and reached USD 46 bln.

Labor costs in 2006 continued to decline and made USD 4.3 bln.(In 2005 that figure was USD 1.2 bln).

Deficit of the RF investment income in the balance of payments in 2006 as compared to its 2005 level rose by 27 per cent (to USD 22.7 bln). The investment income increased from USD 15.7 bln to USD 25.4 bln due to considerable growth of the indicators of monetary and credit supervision authorities (from USD 4 bln to USD 10.7 bln.11) and non financial organizations (from USD 8.4 bln to USD 10.bln). Similar growth of investment income payments at the non financial sector (from USD 25.9 bln to USD 39.5 bln) has contributed to larger overall income pay ments (from USD 33.5bln to USD 48.1 bln).

The balance of current transfers in 2006 changed insignificantly as compared with 2005; that value was estimated at USD 1.2 bln.

Table Major Components of the RF Balance of Payments and Dynamics of External Debt in 20042006 (USD bln) 2004 2005 Balance items I Q II Q III Q IV Q Year I Q II Q III Q IV Q Year I Q II Q III Q IV Q Year* 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Current Account 12,7 13,5 15 17,9 59,1 20 22,1 19,7 21,7 83,5 29,5 24,9 23,6 17,6 95,Transac tions Capital Account 3,1 8 8,1 11,9 7,3 1,4 1,8 10,6 3,4 10,4 6,3 17,4 12,9 16,4 14,Transac tions Changes in Gold and Foreign Currency Reserves ( 6,8 5 6,5 26,9 45,2 14,4 18 8,1 21 61,5 21,4 40,9 13,8 31,3 107,+ a decrease, growth of re serves) The high level of income of monetary and credit control authorities is based on the beginning of investments to the RF Stabilization Fund.

Tentative estimates.

Minus changes in foreign currency reserves.

Section Monetary and budgetary spheres 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Net Errors & 2,8 0,5 0,3 2,9 6,5 4,1 2,2 1 4,1 11,4 1,7 1,4 3,2 2,7 2,Omissions Changes in the RF external debt (+ 27,5 6,0 8,4 1,1 30,6 43,9 16,1 14,9 19,8 growth, decrease of external debt) Changes in the RF external 0,6 4,8 0,6 18,9 1,2 23,1 4 7,1 24,5 govern ment debt Changes in the external debt of the 28,0 10,8 9,1 17,8 29,4 67,1 12,1 22,0 4,8 RF private sector * Estimates.

Source: Bank of Russia.

For the first time since 1998, a surplus was achieved in 2006 in terms of capital accounts transactions and financial instruments, which has reached USD 14.5 bln.

Herewith, if the basic input in the above surplus in 1998 was made through increased loans of government sector, in 2006 the surplus of capital account transactions was formed primarily due to increased inflow of investments in private sector.

The balance of capital transfers was insignificant in 2006 and made USD 0.bln. Therefore, regardless capital transfers, made in 2006, the surplus of capital account was noted in the amount of USD 14 bln.

Source: RF Central bank, IET assessments.

Fig. 6. RF Balance of Trade and Index of World Oil Prices for 2003 RUSSIAN ECONOMY IN trends and outlooks Growth of the RF external liabilities in 2006 stood at USD 69.8 bln, i.e., 26.per cent higher than in preceding year (USD 55.3 bln).

As a year ago, federal government was still a net borrower to non residents.

Its external liabilities have been declined by USD 28.9 bln, basically due to pre scheduled repayment of the RF external debt to Paris Club creditors. The external liabilities of the RF Subjects made USD 0.2 bln. Reduction of liabilities of monetary and credit control organizations has reached USD 7.1 bln. The expansion of activi ties of banking sector in terms of foreign capital involvement has resulted in the growth of liabilities of this sector (+ USD 48.5 bln). That indicator has been raised times 2.5 as compared with the relevant indicator of 2005. As per methodology of balance of payments, non residents investments in the real sector made USD 57.bln (USD 54.4 bln in 2004 .). It should be noted, that despite an insignificant growth of investments in the real sector, their structure in 2006 has greatly changed: if in 2005 more than 75 per cent of investments were made in the form of loans and credits, in 2006 about 54 per cent of assets, involved by non financial organizations, were made in the form of direct investments.

Foreign assets held by Russian residents have been increased in 2006 for USD 55.8 bln (in 2005 that indicator was USD 53 bln.). Practically all surplus is de rived from the operations in private sector.

Foreign assets held by the RF federal government increased by USD 1.4 bln.

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