“There are strong signals that the Russian economy is overheating. We indeed think that monetary policy is loose and needs some tightening,” Neven Mates told a briefing.

Russia’s $1.3 billion economy grew by 8.0% in the Q1, according to the Economy Ministry estimates, with the global credit crunch failing to dent the oil-fuelled bonanza Russia enjoyed in the last decade.  The latest batch of statistical data released this week showed Russian wages were up almost 30% year-on-year in March, retail sales up 16.5% and capital investment up 20.2%, with unemployment at 4.8%. The robust data puzzled the analysts who expected a lending slowdown and cooling of demand to dampen price growth, pushed up by higher food prices and loose fiscal policy.

The IMF expects consumer price growth to stay at about the same level as last year provided there is no substantial policy change. Consumer price growth returned to double digits in 2007, hitting 11.9%, and became the biggest economic policy challenge for the government. The central bank raised all its interest rates last February, with the one-day repo rate rising by 25 basis points to 6.25%, in a bid to curb money supply growth and inflation but in a controlled exchange rate environment the interest rate policy has limited effect.

 
LIMITED EFFECT
Mates said the February rate rise was only the first step in the central bank’s tightening cycle. “We should expect a further increase in interest rates,” he added. Mates called on Russia to allow more ruble exchange rate flexibility and gradually move to an inflation targeting regime, which would enable Russia to steer the economy with interest rates policy. The central bank keeps the ruble within a flexible band against the dual currency basket, made of $0.55 and €0.45. Exchange rate appreciation is the country’s most powerful weapon against inflation.

Russia does not owe money to the IMF and has no obligations to follow its advice but Mates’ statement will play in favor of the fiscal and monetary hawks’ camp in the government, headed by Finance Minister Alexei Kudrin. Kudrin and his supporters at the central bank have also argued the economy is overheating, opposing plans to cut taxes and boost economic growth brought forward by some Kremlin economists backed by industrial lobbies. The outcome of the overheating debate is likely to shape up the course of the next government, which will be led by outgoing President Vladimir Putin, who takes over as Prime Minister after the inauguration of president-elect Dmitry Medvedev. (Reuters)