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Russia May Favor Ruble Gains Over Rate Increase

Russia’s central bank may let the ruble appreciate and tighten reserve requirements before considering a rate increase as a nascent credit expansion buoys the recovery, Citigroup Inc. said.

Bank Rossii yesterday ended a 14-month easing cycle to keep the refinancing rate at a record-low 7.75 percent and signaled it will keep rates unchanged in the coming months. The rate differential with developed economies may deter investors chasing higher returns, according to HSBC Holdings Plc.

The regulator, which previously said it may start raising rates this half, may delay increases until next year as inflation remains at the lowest level in 12 years and capital flows subside. There will be no net inflow this year after $10 billion flowed in from March through May, the bank’s First Deputy Chairman Alexei Ulyukayev said on June 29.

“Further rate cuts are unlikely as inflationary risks are expected to grow at the end of 2010,” Elina Ribakova and Natalia Novikova, Citigroup economists in Moscow, said by e-mail. “We expect monetary policy tightening in the first place will take the form of higher reserve requirements or ruble appreciation, with rate hikes postponed until late 2011.”

The Russian currency gained against the dollar for the fourth day in five, advancing 0.2 percent to 31.1950 at the close of trading in Moscow. It retreated 1 percent to 38.6650 per euro.

Program Halt

The central bank said today it will stop its unsecured loan program for commercial banks on Jan. 1. The credit facility was introduced at the height of the financial crisis as an emergency measure to boost liquidity in the industry.

Bank Rossii called the current level of interest rates “neutral in terms of cross-border capital flows,” according to the statement accompanying yesterday’s decision. Its policy “balances” inflationary risks and access to credit, it said.

The ruble is heading for a period of exchange-rate volatility and the recent period of “rapid strengthening” is over, Ulyukayev said on June 29.

The disparity in interest rates between emerging and developed economies boosts “carry trades” and complicates efforts to battle “hot money inflows,” Ulyukayev said at a conference in Moscow. Carry trades allow investors to make money by borrowing in countries with low interest rates and investing where rates are higher.

Not Appealing

“The rate differential has reached the point when investments into ruble assets aren’t as appealing for non-residents,” Alexander Morozov, chief economist at HSBC in Moscow, said in an interview. “As inflationary risks build, there are grounds to shift to a policy of raising rates.”

The inflation rate remained at the lowest level in 12 years in May, reaching an annual 6 percent and matching the rate in April. Consumer-price growth reached 4.4 percent in the year to date through June 28, the Federal Statistics Service says.

The central bank, which steers the ruble against its target euro-dollar basket, may have to end its purchases of “excess” amounts of foreign currency if high oil prices swell the trade surplus, VTB Capital said by e-mail today. The ruble may be allowed to appreciate because continued interventions on currency markets will have an inflationary effect, the bank said.

“The Russian central bank would have to abandon this policy at the first signs of inflation,” said , Aleksandra Evtifyeva and Dmitri Fedotkin, Moscow-based economists at VTB Capital. “Were oil prices to remain at elevated levels and capital inflows to continue, this would lead to a stronger ruble.”

Offsetting Rates

The regulator may also seek to offset record-low rates by requiring banks to increase reserves after the financial industry showed signs of sustained revival in recent months.

Corporate lending grew in May at the fastest pace since January 2009 while retail loans advanced the most since October 2008 for a third straight monthly rise, central bank data show

Further gains in lending growth should be achieved via a “revaluation of credit risks” as the economy gathers speed and “market expectations” stabilize, Bank Rossii said yesterday.

Stronger consumer demand and growing bank lending will increase the risk of faster inflation and a rate increase at the end of 2010, said Vladimir Osakovsky, economist at UniCredit SpA in Moscow.

“Inflation will quicken at the end of the year on the back of a recovery in lending and broader economic activity,” he said. “This will bring up the question of raising interest rates at the end of the year.”

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