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President Vladimir Putin: The first issue relates to work on the budget for 2007. It must undergo a second reading. How would you evaluate work with the deputies?

The second issue is this year’s budget. There are certain amendments. I would like to draw your attention at once to the fact that certain things really require the government’s special attention. I am referring to inflation and other components of the real economy such as the difference in energy prices and in transport expenditures, including those within the budget. And I would like to draw your attention at once to the fact that one of the government’s priority tasks consists in fighting against inflation. And therefore when you discuss this aspect of teamwork in the 2006 budget with your colleagues, please do not forget about this.

I know that your department together with the Central Bank does a great deal to keep inflation in check. But our colleagues must exert the necessary amount of effort to resolve this problem.

The following issue is that of food allowances for military, especially as applied to retired veterans. I have made the corresponding orders. I know that you worked on this. I would like to know what has been done in this respect.

And I spoke with the head of the Central Bank both yesterday and today. And we documented a very big inflow of foreign currency, of foreign private capital. And according to tentative estimates, in the first nine months of this year this inflow amounted to 27 billion USD. This is private capital flowing in without any effort by the government. I mean, this is not state money.

Probably this inflow is the result of removing restrictions on currency transactions according to the law on currency regulation. It is perfectly clear that citizens of Russia increasingly trust their national currency. The proof is that our citizens are no longer holding such a large part of their savings in foreign currency and increasingly keeping their savings in rubles. How would you evaluate this process? What should we expect from this, what are the benefits and disadvantages here, and what do you think about this issue?

Finance Minister Aleksei Kudrin: <…> In reference to this year’s budget, I think that we are really going to make some amendments to the budget by the end of the year. In previous years we made a significant number of such amendments. We wanted to allocate all the additional income we had. But this significantly distorted the budget’s priorities. As a matter of fact, this was due to insufficient planning. In the future we must first plan the yearly budget more precisely so that we only have to make minimal changes within a given year. In other words, we must agree in advance about all the basic directions and sectors that will receive investments.

Therefore I only support modifications related to the indexation of certain parts of the budget and to unforeseeable events, for example gasoline prices or transport charges, which in turn are linked to those same gas prices. In other words, there is a small number of issues that were not given due consideration or, as a matter of fact, did not quite correspond to predictions. The remaining expenses should not be made in new projects or new construction programmes. These should all be provided for in due time, according to schedule.

In this way we will be able to avoid the so-called fourth quarter syndrome when we must change the budget in November and then this sum – which in the past has amounted to more than a 100 billion – must all be spent in December. This decreases the effectiveness of our financial resources and in January and February we suffer from inflation. Of course this year we should avoid this.

And of course this year we have higher oil prices than expected. We planned our budget based on the price of 40 USD a barrel. Then there was a new forecast for 2006, for a price of approximately 65 USD a barrel. And in practice since the beginning of the year the price has been around 63 USD. In other words, still more than the 40 USD that we planned on.

This means that if in the eight months of last year the inflow of currency was such that the Central Bank bought and increased its gold and currency reserves by 25 billion, than the total increase over the last eight months of this year was 77 billion. Of course when buying this currency the Central Bank increased the monetary supply. And for this reason our monetary mass grew by 45 percent, even more than last year.

We have a few worries. This has already created inflationary tendencies and therefore we should not increase the money supply even more with additional expenses which would just worsen inflation. On the contrary, our task consists in bringing this inflow under control. And in this respect I would like to say that in the near future the Finance Ministry and the Ministry of Economic Development are going to put forward joint proposals for additional measures to contain inflation in the last part of the year. This tendency is better than it was last year. Nevertheless, we still have anxieties and therefore we are going to take additional measures.

And now the noticeable reduction in oil prices is being compensated by additional capital inflows. 27 billion USD is the capital account balance. This is the difference between outflows and inflows in the private sector. The biggest inflow in our recent history took place in the second quarter and amounted to 17,6 billion USD.

Vladimir Putin: And you predicted outflow didn’t you?

Aleksei Kudrin: We predicted the total outflow according to the year-end results.

Vladimir Putin: Around three billion?

Aleksi Kudrin: Around three billion. At present the balance is around 27 billion USD. This inflow was reflected in general investments, including in direct investments. I can say that in this same period last year we had direct investments amounting to 18,1 billion dollars and, at present, to 20,8 billion dollars. I must say that when measured according to direct investments Russia has overtaken countries such as Japan, Canada, and other world leaders.

We now have more direct investments than several developed countries. This bears witness to the fact that our economy is modernizing as are our industrial enterprises. And of course our task consists in increasing the investment flows into processing industries, and this is something that we have recently worked on in the government. This is related to the outflow of the population’s money – what we refer to as dollars kept in stockings or in mattresses – and those dollars are becoming rubles and making a contribution to banks’ capital.

This year this outflow amounted to 10,3 billion USD and in a similar period last year amounted to only 2,9 billion dollars. In other words, trust in the new rate, in the ruble’s convertibility, and the confidence that ruble is stable with respect to other currencies are all increasing. All this will amount to the ruble becoming a more reliable investment. It will be possible to save in rubles and, in turn, this will have a positive influence with respect to holding inflation in check.

The more people trust the ruble, the more transactions will take place in rubles and the more our economy will be monetarized. This means that the quantity of money in our economy will continue to increase in the future. And today we cannot permit ourselves to have such a large amount of money in our economy as other countries can. The monetization of our economy amounts to 27 percent and represents the ratio of the monetary base over the GDP. In developed countries this indicator is larger because the economy absorbs more and processes more through its financial institutions.

Presently the monetization of our economy is growing, but growing slowly. This is linked with the fact that we must develop our financial institutions and carry out structural reforms. As a whole the liberalization of our currency as of 1 July 2006 has acted as a positive influence but this also requires that our economic and macroeconomic policy be very conservative, restrained and not give out false signals about the inflows and outflows of short-term capital. All of this would disturb the ruble’s rate and the economy as a whole. Therefore we must only engage in stable, carefully considered and balanced work.

Vladimir Putin: I hope that the strong position you have just described in reference to possible changes in the 2006 budget will help promote further stability in the Russian economy.