Although the decision to remove restrictions on the currency market earlier this month is unlikely to force a change in central bank exchange rate policy, analysts believe that it will have positive implications. “By relinquishing control over Russia’s capital flows, the Kremlin is effectively taking more responsibility for its actions, since to attract funds into the country and keep them there, economic policy will have to be favourable and more stable,” says Troika Dialog chief economist Evgeny Gavrilenkov.
Balance of flows
Especially in the short term, Russian capital might leave the country as domestic investors look to diversify their holdings, although this should be balanced by greater inflows.
Between the 1998 crisis and 2004, foreigners were not allowed to invest in government securities known as OFZs at all; since then, they have only been able to invest using new “S-type” accounts that were introduced for non-residents to invest in government paper. These required part of the funds invested to be frozen at the central bank for 12 months.
Although in recent months the government has gradually been removing restrictions on the flow of capital entering and leaving Russia, full convertibility is expected to bring even more movement. Gavrilenkov says that OFZs will be the biggest beneficiaries of the liberalization, with the share of foreign capital on the OFZ market growing from 5% to 15%. In Hungary, by contrast, overseas investors make up as much as 27% of the local state bond market, while the figure in Poland is 24% and in Turkey 20%.
However, the extent of overseas investment in OFZs will depend partly on international investors’ predictions for the rouble exchange rate. “Most foreign players believe that the rouble will continue to appreciate, which suggests that interest in domestic securities is set to increase,” Gavrilenkov says.
Heightened interest in the OFZ market resulting from full rouble convertibility should have the effect of re-establishing OFZs as the main Russian market benchmark, a role the market lost after the 1998 financial crisis. This would have a knock-on effect of removing the spread differential between Moscow City bonds – the current benchmark – and other blue-chip issues, such as those of Gazprom, Russian Railways and Vneshtorgbank. Yields on OFZs could fall by as much as 50 basis points if foreign demand proves to be as strong as has been expected.
Although some analysts are concerned that the state might not be able to satisfy foreign investors’ demand for OFZs, given the budget surplus and restrictions on borrowing, Gavrilenkov argues that the central bank could simply sell its own portfolio, worth around R300 billion ($11 billion), on the open market. Before rouble liberalization, the central bank held as much as 37% of the OFZ market, followed by Sberbank, with about 22% of the market, and the Russian Pension Fund, with 14%.
Rouble convertibility should have little, if any, impact on Russia’s equity market, though, as the reserve rate for foreign investment in Russian stocks has long been zero. Any limited impact is expected to be positive. Gavrilenkov says: “the change is likely to have only a psychological effect: the removal of even the possibility to limit foreign access to local securities might serve as a sign that the Russian authorities are committed to establishing a proper market.”
