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Russia will curb its budget deficit as the central bank calls in emergency loans and hands the money back to the government, reducing pressure on the ruble and reining in inflation, according to UBS AG.

“There’s still plenty of government money in the banks,” Clemens Grafe, chief economist at UBS in Moscow, said in an interview. “That’s basically how they get the rubles. They don’t have to print them, they just take the money back from the banks.”

The central bank has lent Russian banks a total of about 4.2 trillion rubles ($137.4 billion) to counter the impact of the credit crisis on liquidity, according to UBS. The Moscow- based lender of last resort, Bank Rossii, can now call in the loans after bank deposits rose, reducing the need for emergency funds, Grafe said.

The world’s largest energy exporter is struggling to contain inflation as its first budget deficit in a decade swells following a record 10.9 percent economic contraction last quarter. Inflation in excess of 10 percent has held back the central bank’s ability to cut interest rates, with the benchmark refinancing rate the second highest in Europe at 10.5 percent.

Bank Rossii last week said Russian lenders owe 437 billion rubles in unsecured loans, compared with 1.9 trillion rubles in February. The government estimates this year’s budget deficit will swell to 8.9 percent of gross domestic product, or 3.4 trillion rubles.

‘More Traditional’

The repaid bank loans mean Russia won’t have to resort to printing money, or so-called monetization of the budget, a policy that threatened to spur inflation, UBS said. The government has in the past taken oil revenue in dollars, placed the money in the central bank and had the bank print the equivalent amount in rubles to fill state coffers.

Central bank Chairman Sergey Ignatiev said on Sept. 16 the bank plans to replace the emergency liquidity it provided lenders with “more traditional” loans.

Even if the government prints more money, there is sufficient demand for rubles as the currency strengthens because of rising oil prices, UBS estimates.

“To the extent that people move back into rubles, demand for rubles goes up,” Grafe said. “The prudent thing to do at that point is to increase the supply, just like with any other good.”

The Russian currency will be at about 32.5 per dollar by the end of this year, reaching 37.5 against the against the target basket of dollars and euros, according to UBS. The currency traded as strong as 30.2388 yesterday.

Oil

Russia’s budget will receive “a few hundred billion rubles” in extra revenue this year based on higher-than- expected oil prices, Arkady Dvorkovich, President Dmitry Medvedev’s chief economic adviser, said on Sept. 9.

Oil has more than doubled from this year’s low in February. The ruble gained to the highest level against the dollar this year yesterday as oil topped $72 a barrel.

Russia’s $85.7 billion Reserve Fund, one of its two sovereign wealth funds, will be drained by the end of next year, the government estimates, as the money goes toward covering the deficit and funding an “anti-crisis” program worth about 2.5 trillion rubles when tax breaks, central bank lending and other measures are included.

Some analysts have warned that the government’s plans to ramp up spending to cope with the slump may weaken the national currency as the buildup of rubles fans inflation.

Ruble

The ruble may tumble as much as 15 percent in December as consumer-price growth accelerates and Russians shift funds into foreign-currency assets, Troika Dialog, Russia’s oldest investment bank, has said.

The government aims to spend an average of 850 billion rubles to 900 billion rubles a month this year before disbursing 1.5 trillion rubles in December, Finance Minister Alexei Kudrin said on Sept. 4.

Russia has scaled back the scope of the planned deficit next year as higher commodity prices help replenish state coffers. The gap may reach 6.8 percent of GDP in 2010, down from the previous estimate of 7.5 percent, Kudrin said this week.

The government will also sell bonds for the first time since the country’s 1998 default on $40 billion of domestic debt. Borrowing will total 2.2 trillion rubles over the next three years, according to the Finance Ministry.

Russia’s budget deficit in 2009 isn’t prompting Standard & Poor’s to review its rating on the sovereign, S&P credit analyst Frank Gill said in an interview.

“What we’re looking at is not a single year’s performance, but what medium-term fiscal policy is going to be,” Gill said. “We’re looking at next year and 2011 to see how they start to take back the fiscal stimulus.”

S&P rates Russia’s long-term foreign-currency debt BBB, its second-lowest investment-grade ranking, with a negative outlook.

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