|Ksenia Yudaeva, CBR first deputy governor|
The circumstances surrounding the rouble sell-off are different to those around typical emerging-market (EM) currency crises – not least Russia’s strong government and current account, and its net foreign asset and FX reserves – but, to some analysts, there are also uncomfortable similarities.
“The rouble devaluation is running in line with prior major EM currency crises,” warns Chris Turner, head of FX strategy at ING, highlighting the enormity of the rouble’s 30% fall against the dollar this year.
“If history is any guide, the rouble could fall for another three to four months and an average decline could actually see USD/RUB trade to the 55/65 area.”
|EM FX performance vs USD, during exits from managed regimes|
|Source: EcoWin, ING|
The CBR has acted decisively in recent weeks, bringing forward plans to abandon its failing band with the dollar and allowing the rouble to float. This will not arrest the currency’s decline overnight, but it will at least avoid the CBR repeating the $30 billion expenditure of the last month, defending the price band.
“Moving to a floating currency and inflation targeting is a solid, good idea – especially for a commodity exporter,” says Marcus Svedberg, chief economist at East Capital. “It can still intervene when it perceives a threat to its stability, but the market can only guess when that will be and the size of the intervention.
“It means it will be potentially much more costly speculating against the rouble.”
While market participants are almost universally positive about the decision to float the rouble, some have expressed surprise at the timing of the move.
“It is extraordinary it has abandoned the band now,” says Svedberg. “There are so many excuses for delaying this move, including the geopolitical tensions and the tapering. There have been so many disappointments from Russia in the past when it comes to structural reform, but on these monetary … reforms they are pressing ahead.”
He believes this commitment is evidence of the competence of the Russian authorities, proving they understand the importance of these measures.
A month earlier, on the occasion of the IMF annual meeting in Washington DC, Ksenia Yudaeva, CBR first deputy governor, signalled that a long-awaited shift in the monetary regime – inflation-targeting and a free-float – could take root next year. However, the crisis has clearly forced the CBR’s hand.
“Politically, you could say, [a regime] is never appropriate,” she said. “And governments will always complain. But we think we are broadly on track – especially, with internal capacity, monetary instruments, communications and forecasting – though we might not be fully there yet.
“We won’t do FX interventions that depend on some level. We can say we will be ready for an inflation-targeting regime by the beginning of the 2015. We will intervene occasionally to the FX for financial stability.”
The former chief economist at Sberbank was concerned, however, about the ability of the market-makers, broker-dealers and retail-deposit-taking institutions to prepare for the shift and adopt instruments accordingly.
“We need to continue [to educate] banks and the financial system so they understand the changes,” she said. “Inflation-targeting requires education. There is a market with derivatives, but, of course, it needs to be used more developed.”
Yudaeva flatly suggested capital controls would be approved by the CBR – “there is no debate about capital controls” – and added: “This time we have more coordination with fiscal policy. The recent budget was more pragmatic. What is needed is more effort structural reforms are needed to make the economy more-competitive.”
Russia incentive to implement difficult reforms has an inverse correlation to the oil price, and oil-price surges back to $100-per-barrel levels could further delay fiscal efforts.
The second plank of the CBR’s strategy for dealing with the rouble crisis will see it hold an auction on Monday for $10 billion-worth of new one-year repos to provide this liquidity to the market.
The usual market mechanisms for distributing dollar liquidity in the Russian financial market have broken down as banks and corporates have hoarded dollars, forcing the CBR to find new ways to distribute dollars to the Russian market.
Where previously the only repos available had been for one or four weeks, with rates of 2.1% and 2.4%, these longer duration repos are set at the market rate of 2%.
“The FX repo tool was the right strategy,” says Oleg Kouzmin, economist for Russia and the CIS at Renaissance Capital (RenCap). “My only criticism would be it should have offered this liquidity at the same time as abandoning the dollar band. Instead it waited for weeks, which added to the volatility.”
It will be some time before any judgement can be made about whether the move has worked, but one benchmark of its effectiveness will be Russia’s ability to meet the approximately $15 billion of external debt due in Q1 next year.
“If there is no credit crunch and Russian businesses are able to make these payments, it will have been a success,” says Kouzmin. “This will depend on the $10 billion being enough to meet demand.”
However, he notes the strategy will also need to help reduce volatility in the exchange rate and prevent capital flight to be judged a success.
Asked about monetary instruments to offset the liquidity drought ravaging the corporate sector, amid sanctions, CBR first deputy governor Yudaeva said: “We have swaps, seven- to 21-day repos, and we might consider more instruments [but] only governments” can supply long-term hard currency for Russian issuers locked out of international capital markets.
The cost of servicing dollar-denominated debt for companies, whose revenues are in local currency, are sky-rocketing.
A host of factors are contributing to the rouble’s demise, including disappointing growth, the Ukraine crisis and the resulting sanctions, the falling oil price, the rising dollar and the adjustment to the new, less interventionist CBR.
“Our base case is now we will see volatility continue in Q4 with the rouble at around the 45 level as the market gets used to living without the dollar band,” says RenCap’s Kouzmin. “Russia has lived with a more or less managed currency for 20 years, so it will take time to get used to it.
“But we will see things settle in Q1 next year and the rouble should then strengthen again to around the 41 to 42 level.”
East Capital’s Svedberg is optimistic the rouble will come through its current plight. “The market looks like it is overshooting,” he says. “I expect the oil price will rise a little in coming weeks, while the situation in Ukraine will improve eventually, even if there is no real resolution.”
He believes the rouble will eventually settle at a level that is lower than where we are, but higher than where it has traded at the start or even the middle of the year. “At the moment the market is being driven by uncertainty,” he says.
Russia’s problem is that the rouble’s slide is fuelling inflation that was already high. Only a few months ago Russia was forecasting inflation of 7.5% by the end of the year, but the official forecast is now for 8.5%, with some expecting it to be closer to 9%, possibly edging up to around 10% in Q1.
The cocktail of low growth and high inflation is never palatable, yet the mood among Russians is relatively relaxed – for now. Unemployment is low and wages are holding up. Putin’s popularity remains high and for now the public appears to buy the official line, which blames the west for all Russia’s woes.
How long the public will live with such high inflation is another question. The expectation is the spike will prove a short-term phenomenon, with the CBR remaining committed to inflation-targeting once market conditions settle. It has given itself an extra year to meet its 4% inflation target, which is due in 2017.
“If there was a resolution to the Ukraine crisis, we could have inflation falling back to 5.5% by the end of 2015,” says Kouzmin. “But if sanctions remain in place, it is likely to be higher, around 6% to 6.5%. The Russian food embargo itself added around 1% to the inflation figure.”
In the meantime, authorities have to hope rising inflation does not undermine consumption too rapidly, and that the negative impact of the sanctions does not corrode market confidence any further.
“Unless Russian authorities manage to reverse very negative sentiment, the risk is history books look back on the rouble in 2014 as just an average EM crisis,” says ING’s Turner.