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WASHINGTON, Dec 14 (Reuters) - Russia's economy will stage a modest recovery next year, with growth reaching 3.5 percent, the International Monetary Fund said on Monday while warning that bad bank loans will weigh on credit expansion.
In a statement at the end of a staff visit this month, the IMF said while the banking system had stabilized, generous liquidity support could mask more severe underlying problems.
Russia emerged from recession in the third quarter with a quarter-on-quarter growth pace of 0.6 percent.
"We are concerned that, absent more forceful policy action, significant problems in the banking system could emerge once a normalization of cyclical conditions forces the Central Bank of Russia to tighten monetary policy," the IMF said.
"Given these concerns, the CBR should take advantage of the current stable environment to restore more stringent regulatory requirements by not extending the forbearance framework that is due to expire at the end of the year."
Russia's banks have been hurt by the global credit crunch and falls in asset values. The IMF said it was concerned that the higher spending contained in the 2009 and 2010 budgets would become entrenched and fuel inflation in the future.
It noted that expenditures were set to rise by 7 percentage points of GDP compared with 2007 levels, with half of that representing increased statutory obligations.
"This points to the risk that the sizable fiscal expansion will not be reversed, eventually leading to a highly procyclical fiscal stance, inflation, rapid real ruble appreciation and increased dependence on oil," the fund said.
The IMF said the monetization of large fiscal deficits would significantly circumscribe monetary policy in the near term and warned such a step risked putting the ruble under pressure to weaken and stoke inflation.
"While Russia's ample foreign reserves would provide scope to cushion sharp movements in the exchange rate, liquidity conditions would need to gradually be tightened through the placement of CBR paper or other means," it said.
The fund also criticized the Central Bank of Russia's inflation goals for next year for being "unambitious" and urged it to take advantage of the current disinflationary environment to bring inflation down to below 5 percent by the end of 2010.
The IMF cautioned against further interest rate cuts until the monetary implications of the large end-year liquidity injection associated with the fiscal deficit become clear.
The CBR cut interest rates for the ninth time last month in an attempt to slow appreciation of the ruble and support the economy's still-fragile recovery from recession.
The IMF said it believed the appreciation of the ruble associated with capital inflows was likely to be temporary. (Reporting by Lucia Mutikani; Editing by Dan Grebler)