Steely Nabiullina fights Russia’s fires

Sid Verma

Elvira Nabiullina, Euromoney’s central bank governor of the year, is staunchly sticking to her controversial crisis-fighting plan as Russia reels from its biggest financial crisis since 1998. As sanctions and falling commodity prices threaten Putin’s oil-financed state patronage, the central bank – the last bastion of economic orthodoxy – is battling to craft a new growth model. Can Nabiullina turn crisis into opportunity?

Nabiullina-dragonslayer-600At a time when Russia teeters on the brink of pariah status among the political leaders of the west, Elvira Nabiullina is a divisive figure in her own country. In the flesh, she seems an unlikely candidate to stir such emotions.

Euromoney meets the governor of the Central Bank of Russia, her translator, and an aide, in a resplendent meeting room at the stately Tsar-era CBR headquarters in Moscow’s Neglinnaya Street, which runs from the Bolshoi Theatre to Trubnaya Square. Nabiullina is softly-spoken, under-stated, and circumspect. She waxes lyrical about her price-stability agenda with Bundesbank-esque passion.

She also bats away countless questions Euromoney asks surrounding the independence of the CBR, from the political establishment, strategic corporates and Putin himself.

In a rare and wide-ranging interview, Euromoney’s central bank governor of the year defends her shock-and-awe monetary tactics late last year, when she hiked interest rates and committed to the free-float of the rouble.

"There were some voices that said, under the difficult circumstances, we should defer the decision to adopt the flexible-exchange and an inflation-targeting regime," Nabiullina says. "But it became quite obvious that our currency policy did not allow us to meet the challenges. The market did not trust us. Speculative forces were growing. Expectations of devaluation were growing among the population and they started to convert the currency. Essentially, there was no trust left in that exchange rate policy and it did not allow us to meet the challenges from the point of view of building reserves. So we made the decision to accelerate the move to a floating exchange rate because this regime would absorb the external shocks."

Nabiullina’s commitment to a flexible exchange rate is classic economic orthodoxy, which Russia was late to impose in the global financial crisis when it belatedly permitted FX depreciation after wasting billions of reserves in maintaining an implicit band.

From Chile, to Colombia, to Australia, the results are clear: a flexible exchange-rate system allows countries to respond to external economic shocks better than those with fixed exchange rates, since economic agents adjust immediately to relative price changes from nominal depreciation. This adjustment also compares favourably to pegged countries where relative price moves and structural shifts in goods and labour markets are more challenging to achieve.

Capital controls were removed in 2006, further cementing Putin’s contract with oligarchs, who were happy to offer political support in return for capital mobility. Euromoney asks whether capital restrictions were considered in the grip of the crisis, as many Western observers had predicted.

Nabiullina is emphatic: "Capital controls were not even under review by the central bank because I believe that the Russian economy and financial system, despite the difficulties, are part of the global system. After we opened the capital account many years ago, it would be counter-productive and controls, in practice, would not have worked."

Nabiullina’s move, since her appointment in June 2013, to expand FX liquidity facilities – adding new maturities and broadening the definition of eligible collateral in auctions – injected capital and liquidity into the banking system. Despite bearish bets that systemically-important lenders could collapse and Russia would march towards a corporate debt crisis – the outstanding stock of which at its peak represented 40% of GDP – the financial system has weathered the storm.

The CBR’s shock therapy has worked. True to form: imports in the first quarter of 2015 duly declined sharply, reflecting weak domestic demand, in part, thanks to rouble depreciation, which moved the real exchange rate towards levels consistent with medium-term fundamentals. Earlier this year, the external-sector adjustment brought down consumer price inflation, and gave the central bank room to cut rates. What’s more, in May, the CBR suspended the one-year FX repo facility, signalling a return to relative monetary normality.

Moral suasion has helped too. The CBR has installed liaison officers at banks, with a pretext of boosting supervisory oversight in the trenches, but, in reality, bankers say they are seeking to root out anti-rouble speculative bets on trading floors. Still, the governor strikes a free-market note when asked about the role of domestic speculators, among banks and cash-rich state companies, who were blamed by the finance ministry for the hoarding of rouble liquidity last year.

"Speculative operations grow when the existing regime does not match the economic trend, when the central bank keeps the currency policy even when prices are dropping, where there is no access to external financial markets and the currency is going to devalue and everyone knows this," the governor says. "It’s just a matter of ordinary expectations of the currency failing to match reality. Once we introduced a higher interest rate and the free-float the speculative behaviours against the currency declined quite dramatically."

The question of the CBR’s independence vexes the Moscow market. But many concede Putin has given Nabiullina a large degree of freedom to pursue a market-friendly war-plan, by floating the rouble and rejecting capital-controls, which would have further isolated Russia from international finance

Go back to the end of 2014 and such sanguine sentiments would have seemed misplaced. Fear and confusion rocked the Kremlin and the CBR. An oil- and sanctions-driven storm was ravaging the country.