The Central Bank's "protectionist" ruble policy is causing the stock market to overheat and is threatening to create an asset bubble, the nation's top financial regulator warned Thursday.

The Central Bank is reacting wrongly to the U.S. Federal Reserve's decision to "pump the world economy full of cheap dollars," Oleg Vyugin told Vedomosti. Instead of intervening in the currency market to keep the ruble from strengthening against the greenback, the Central Bank should let the market decide what the currency is worth, said Vyugin, who ran monetary policy at the bank before moving to head the new Federal Service for Financial Markets last month.

A massive inflow of weakening dollars from record oil and gas exports is encouraging Russians to convert their savings into rubles, much of which is being invested in equities -- either directly or via bank deposits, he said.

President Vladimir Putin on Friday told Central Bank Chairman Sergei Ignatyev to keep the ruble from strengthening too much, and Ignatyev later said that real effective ruble appreciation against a dollar-euro basket of currencies would be limited to just 7 percent this year.

To do that, however, the bank has to print more rubles and buy up dollars on the market, which has created even more liquidity, Vyugin said.

Deputy Prime Minister Alexander Zhukov warned Wednesday that a surging money supply is threatening the economy. The broad estimate of money supply, or M2, rose 51 percent last year, he told a banking conference.

Ignatyev has suggested that since inflation is within the government's target band, the Central Bank will pay more attention to reining in the ruble's appreciation. A stronger ruble hurts manufacturers because it raises their costs, making their goods less competitive.

Ignatyev is also mooting the idea of imposing capital controls to limit short-term liquidity, known as "hot money." A new law that comes into force in June will allow the Central Bank, if it wishes, to freeze up to 20 percent of incoming foreign exchange -- even corporate loans -- and park it in a non-interest-bearing account for up to a year.

Many economists say that although this is the only tool the Central Bank has to slow inflows, it only intends to use it as a threat. "Vyugin has argued in the past against letting the ruble float because the currency would then find itself tied to volatile oil prices," said Alexei Vorobyov, an economist at Aton. "And the Central Bank's main goal is to not let the currency fluctuate wildly."

Vyugin was not available for clarification Thursday. The Central Bank would not immediately comment.

Vyugin was not alone in criticizing his former employer. Macroeconomic instability "is inevitable" when central banks insist on keeping exchange rates at the levels they want, Renaissance Capital wrote in a note to clients.

"In the medium term ... we believe that Putin will find that the laws of economics prove substantially more difficult to bend than the laws of Russia," it said.

(The Moscow Times 16.iv.04)