Floating Rouble could be key to inflation fight

Russia's Central bank wants to free float the rouble within two years as a more effective way to target inflation. On Thursday the regulator will present to a set of measures to hold inflation under 7 percent by 2011.

The central bank has called fighting inflation – its priority for the next three years. By 2011 inflation level should not exceed 6.8 percent annually – that's just over half the rate of last year. Chief economist at Deutsche Bank, Yaroslav Lissovolik, believes that, by making inflation its clear priority, the Central Bank is taking a step in the right direction.

“One of the problems of lowering inflation over the past several years was the contradictory nature of Central Bank policy, because at the same time it had 2 goals.  One was the exchange rate goal, the other one was the inflation goal.”

Currrently the Central Bank manages the exchange rate in order to hold down the Rouble. High oil prices means an inflow of Dollars to Russia. The bank buys excess foreign currency to take it off the market – in exchange for Roubles that are pumped into the economy, driving up inflation.

But Dmitry Pankin, the Deputy Finance Minister says the Central Bank can't allow the Rouble to float freely and intervention is inevitable.

“We cannot see a completely free float.  A completely free float means that we will substantial turbulence in the economy. The main danger is declining exports and the deterioration of our producers.”

However Yaroslav Lissovolik believes inflation is a bigger evil – for Russian producers – than a strong Rouble.

“High inflation affects virtually all Russian producers, and hence in that regard I think inflation should be viewed as a greater evil.  Rouble appreciation is in some ways good, because Rouble appreciation makes imports of capital equipment cheaper.”

Experts say the Central Bank won't be able to avoid intervening on the foreign exchange market so long as Russia has a sizable current account surplus. The inflow of petrodollars creates an imbalance of demand and supply for hard currency on the market.

Market watchers say that won't change – unless the oil price falls further – and in any event, no sooner than four years.