Central Bank to Raise Reserve Requirements to Cut Inflation

The Central Bank, worried about galloping inflation and fast lending growth, said Monday that it would aggressively raise bank reserve requirements from July 1 to curb inflation.

The Central Bank said the requirements on liabilities in foreign currency would rise to 7 percent from 5.5 percent, requirements on retail deposits to 5 percent from 4.5 percent and on other liabilities to 5.5 percent from 5 percent.

It will also set an averaging ratio, which allows banks to spread their reserves over time and even out periods of excess and scarce liquidity, at 0.5 percent compared with 0.4 percent before.

"It was a timely decision. The rise is significant, I think there will be an impact," Alfa Bank's Natalya Orlova said. The Central Bank said the rise of the averaging ratio would smooth the impact of the measure.

Annualized inflation may exceed 15 percent in May, well above the government's target of 10 percent. Mandatory reserve requirements are the money the banks should set aside, and a rise in requirements slows lending growth.

Orlova expects the measure to bring down the annual inflation rate by 0.3 percentage points and said it was equivalent to slowing expected 48 percent corporate lending growth in 2008 by about 2 percentage points.

Corporate lending grew by 70 percent in the first quarter, and Central Bank deputy chairman Gennady Melikyan said last week that he was worried about Russian banks growing too fast and lending too much despite the global economic slowdown.

The country's top banks, Sberbank and VTB, reported healthy results for 2007 but warned of an imminent slowdown later this year. Both banks lobby for access to cheap government cash.

The rise in reserve requirements came as the largest Russian banks and corporations have returned to capital markets after a pause caused by the global credit crunch, with banks like VTB issuing a $2 billion eurobond last week.

The banks have made a lucrative business of borrowing cash at low interest rates abroad and lending it at home at effective interest rates that have in the past reached as much as 50 to 70 percent per year.

The requirements are the Central Bank's second most powerful anti-inflation monetary policy tool after the ruble exchange rate, but the Central Bank has so far been reluctant to revalue the ruble because of speculative capital inflow fears.

A number of large Western investment banks advised their clients to go long on the ruble in anticipation of a revaluation after the inauguration of President Dmitry Medvedev.