Nov. 10 (Bloomberg) -- Russia’s economy will suffer a deeper contraction this year than previously estimated after a series of central bank interest rate cuts failed to ease a “prolonged” credit drought, the World Bank said.

Output in the world’s biggest energy producer will contract 8.7 percent this year, compared with a June forecast for a 7.9 percent decline, the bank said in a report released today. The government predicts the economy will shrink 8.5 percent this year and grow 1.6 percent next year.

“We expect that the central bank will continue lowering its policy rate in the near future to facilitate credit to the real sector,” the World Bank said. “The impact, however, appears to be limited. The policy rates are mostly indicative, while the cost of credit remains very high.”

The central bank has cut rates eight times since April in a bid to unlock credit and underpin the first signs of a fledgling recovery as inflation slowed. Russia’s commodity-reliant economy shrank a record 10.9 percent in the second quarter after demand for the country’s oil, gas and metals fell and lending dried up.

“Risks associated with high volatility of oil prices and global demand” remain even as the economy recovers in the second half on higher commodities prices, the bank said.

Lending failed to show a “significant” increase last month, Alexei Ulyukayev, a first deputy central bank head, said yesterday.

Non-Performing Loans

Lenders’ corporate loan books fell 0.7 percent in September from August after staying unchanged the previous month, according to central bank data. Lending to consumers dropped 1.1 percent for an eighth consecutive monthly decline and delinquent retail loans climbed to 6.4 percent from 6.2 percent.

“We expect the balance sheets of many banks will continue deteriorating as the share of non-performing loans increases,” the World Bank said. “In the environment of increasing credit risks, lending activities by the banks have remained limited despite improving liquidity conditions in the economy and continuing monetary loosening.”

Delinquent debts in the banking industry may reach an average of 10 percent by the end of the year, the bank said. Bad loans for the financial industry were unchanged in September at 5.8 percent of the total, Bank Rossii said this month.

Even so, systemic risks to the bank industry are “well contained,” World Bank Russia Director Klaus Rohland told reporters in Moscow today.

Excess Liquidity?

The bank doesn’t expect “major defaults” for lenders of corporates this year, World Bank economist Sergei Ulatov said. There is a risk that bad debts will increase, “but with time they will become smaller and smaller,” he said.

Lower rates and the need to tap the country’s Reserve Fund to cover the budget deficit may lead to “excess liquidity,” spurring price growth at the end of the second quarter next year, according to the report.

Inflation will be slower than forecast at 9 percent to 10 percent this year, “reflecting sharply slowing domestic demand and the continuing credit crunch,” the bank said.

While the economy will show a “modest” recovery in the second half of 2009, this is “unlikely to have significant impact on social indicators,” according to the World Bank.

Unemployment will increase to 9 percent “as seasonal factors wane” from 7.6 percent in September and it may take three years before the number of Russians living in poverty falls to pre-crisis levels, the World Bank estimates. Real incomes are “likely to fall further,” it said.

Oil Assumptions

By the end of the year, 17.7 percent of the population, or about 24 million people, may be living on incomes lower than about $169 a month, according to the report. That proportion may decline to 14.6 percent by the end of 2011, the bank said.

The economy may grow 3.2 percent next year “from a low base,” bolstered by a rebound in prices for Russia’s commodity exports, according to the report. The ruble may appreciate “slightly” assuming the price of oil meets the bank’s target of $61.4 per barrel in 2009 and $75.3 a barrel next year, Ulatov said. That compares with the government’s forecast of $58 a barrel on which it bases it 2010 budget.

The economy, “aided by higher oil prices and stronger global demand, is starting to turn around -- very slowly,” the bank said.

To contact the reporter on this story: Alex Nicholson in Moscow at anicholson6@bloomberg.net.

Last Updated: November 10, 2009 07:08 EST