Rouble to remain steady despite recession risk and Ukraine crisis

Simon Watkins
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Although current account deterioration, persistent capital outflows and the Ukraine crisis would seem to weaken rouble, the central bank’s flexible FX regime should keep the currency out of turmoil, say analysts.

There has been much speculation that the crisis in Ukraine will lead to a spike in capital outflows and a collapse of the rouble, just as happened in the aftermath of the August 2008 war with Georgia.

But markets retain their faith that the trinity of high oil prices, large FX reserves and the central bank’s credible backstop will shore up the currency.

“Even the collapse of Russian asset markets around the time of the Georgia war had little to do with that conflict and everything to do with the price of oil collapsing from $150 per barrel [p/bbl] in early summer to less than $40 p/bbl barely six months later,” says Christopher Weafer, CEO of CJW Macro-Advisory, in Moscow.

“The price of Brent crude is holding close to $110 p/bbl and looks safe due to supply disruptions in Africa and the Mid-East, plus steady demand growth. [What’s more], unlike in 2008/09, Russia has a sound balance sheet and favourable budget execution,” he adds.

Barring a worsening of the Ukraine crisis, Russia’s economy and, by extension, its currency, should be able to weather the storm, say bullish Russia observers.

As tensions in the Crimea ratcheted up on Monday, the Central Bank of Russia (CBR) implemented a temporary emergency 150 basis points hike its main policy rate to 7%, the Micex equities index dropped through its key 1300 support level, and the rouble traded through the top of the day’s trading corridor.

However, as Russia ended its military exercises on the border of Ukraine a day later, the rouble returned inside its daily corridor, the Micex jumped the most in four years, while analysts maintain that they were expecting at least a 50bp hike in interest rates in any case.

Moscow remains upbeat. According to a statement on Monday by the CBR’s first deputy governor Ksenia Yudaeva, the interest rate hike should not just bring the rouble's depreciation to a halt but may also lead to a currency appreciation in the medium term.

Broadly, the direct impact from the crisis in Ukraine on Russia’s economy appears limited, as Ukraine accounts for under 5% of Russia’s total trade, says Jacob Nell, senior Russia economist for Morgan Stanley in Moscow, although there could be a ‘security shock’ that would hit growth via slower consumption growth (as a result of increased savings) and a fall in investment (delayed in the face of uncertainty).

While analysts are bullish on the CBR’s role as a backstop to the currency, oil prices are exerting a weaker influence on the currency compared to recent years. In other words, the idea that high oil and gas prices will offset economic contraction, triggered by the Ukraine conflict, overlooks the changing correlation between the Russian economy and hydrocarbons prices.

“Stronger trading in oil prices should have been good for Russia, but this hasn’t been the case for the past two years as, even before the tapering began, the number of same-sign weekly moves between the rouble and oil prices, which can be seen as a simple measure of commonality, has reached historical lows,” says Olgay Buyukkayali, head of emerging markets research for Nomura International in London.



One of the probable reasons for this breakdown, he adds, is the trend deterioration in the current account.

“For a country that had a current account surplus above 5% of GDP in 2011, the current account reaching its lowest level since 2008 is remarkable given that oil prices have been in a 15% range for the past two years; and preliminary Q4 figures signal that the 2013 current account has narrowed to $33 billion or 1.5% of GDP, despite high oil prices,” he adds.


Under the assumption that the average oil price stays around $101 p/bbl, the CBR expects the current account surplus to deteriorate to $19 billion, which is around 0.9% of projected GDP. However, citing a fall in investment income and trade, Buyukkayali concludes that, even if oil prices stay around current levels, the current account balance would contract to $15 billion or 0.6% of GDP, with Q2 and Q3 recording current account deficits.

As a contributing factor, says Morgan Stanley’s Nell, although nowhere near the scale of the 2008 Georgia crisis period, there is still persistent private sector capital outflows from the country.

“In 2013, despite a fall in political uncertainty and a broadly pro-business policy agenda and government, capital outflows amounted to $62.7 billion, 3% of GDP, higher than the $54.6 billion outflows in 2012, and we see this as evidence that capital outflows are persistent and are likely to fall only gradually in response to sustained structural reforms,” he adds.