By Jason Bush
MOSCOW, July - Russia needs to adopt both a tougher budget and tighter monetary policy to guard against the risk of overheating and to bear down on inflation, the International Monetary Fund said in a statement on Thursday.
The statement follows a meeting of the IMF's Executive Board to discuss the results of annual consultations between the Fund and the Russian government.
IMF directors "recommended an ambitious fiscal consolidation path to reduce overheating pressures and vulnerabilities and ensure intergenerational equity," it said.
They also "generally recommended a gradual further tightening of monetary policy to contain underlying pressures and anchor expectations."
The IMF has warned repeatedly in recent months that it fears Russia's economy is in danger of overheating - implying that demand is growing faster than potential output, leading to higher inflation.
In its latest statement, the IMF predicted that Russia's economy would grow by around 4 percent in both 2012 and 2013, slightly above its assessment of the underlying growth potential.
The IMF said that although inflation has come down in recent months, the fund's measure of core inflation remains high at around 6 percent.
It forecast that inflation would rebound to 6.5 percent by the end of the year, compared with 4.3 percent in June.
The forecast implies that Russia's central bank will miss its 5-6 percent inflation target for 2012, increasing pressure on the central bank to raise interest rates.
SCOPE FOR IMPROVEMENTS
The IMF's call for fiscal consolidation also reflects its long-standing concerns about Russia's high non-oil deficit - a measure of the underlying budget stance that excludes oil taxes.
The statement noted that although the non-oil deficit declined to 9.8 percent of GDP in 2011, from 12.7 percent in 2010, the deficit is set to rise by around 1 percent of gross domestic product this year.
The IMF commended Russia for adopting a new fiscal rule that will base government expenditures on the long-term average oil price. But it also said that it "saw scope for further improvements to allow for the effective rebuilding of the Reserve Fund."
The Reserve Fund, which is designed to protect the federal budget against a fall in oil prices, is at present worth some $60 billion (3.2 percent of GDP), down from $143 billion in 2008.
The IMF said that effective fiscal consolidation would also need to be underpinned by structural reforms, including pension reform.
Structural reforms are also needed to improve the country's investment climate and long-term economic growth, the IMF said, recommending that Russia improve the rule of law, reduce corruption, and privatize state-owned companies.
"The challenge in the short term is to manage domestic demand in order to avoid overheating and in the medium term to fully realize Russia's significant growth potential," the IMF said.
(Reporting by Jason Bush; editing by Stephen Nisbet)