Rouble fixing eats Russia's reserves
November 16, 2008
By Emma O’Brien and Ye Xie
Russia's currency reserves, the world's third-largest, are no match for tumbling oil prices and an exodus of capital that may force the country's central bank to accept a devalued rouble.
Just 10 years ago, Russia let the rouble fall as much as 71 percent as the government defaulted on $40 billion (R415 billion) of debt and world stock and bond markets collapsed.
Now, the combination of a 60 percent drop in oil prices from their peak in July, slowing economic growth and increasing investor concern about emerging markets are draining Russia's foreign reserves, which fell 19 percent to $484.6 billion in the 12 weeks to October 31.
Russia, which uses its foreign reserves to curb swings in the rouble that hurt the competitiveness of exports, may find the resistance futile now that the currency has fallen more than 13 percent against the dollar since August 1.
The central bank sold a record $40 billion of reserves last month, according to Moscow-based Trust Investment Bank.
Troika Dialog, the country's oldest investment bank, said the currency might slump as much as 30 percent in the event of a devaluation.
"When oil falls, capital runs out of Russia and the rouble weakens; it's not justified to hold your positions," said Anas El Maizi, who oversees $342 billion in fixed-income assets at Axa Investment Managers in Paris. "If oil stabilises at this level, Russia will have some trouble." Axa cut its Russian bond holdings in August.
The Bank of Russia might have to increase the "flexibility" of the rouble exchange rate, involving a "certain tendency toward weakening", Sergey Ignatiev, the chairman of the central bank, said on Monday.
Forced hand
Last week Arkady Dvorkovich, an economic adviser to President Dmitri Medvedev, said that Russia might "gradually" widen the rouble's trading band if the current account fell into a deficit next year. Goldman Sachs said the comment marked a "departure from the previous party line".
The Russian currency traded at 27.55 roubles to the dollar on Friday, compared with 24.64 roubles to the dollar at the beginning of the year. It was trading at 34.42 to the euro.
When Russia defaulted on its debt in August 1998, it caused an investor stampede to the safest assets. Yields on 10-year US treasury notes dropped more than half a percentage point to 4.98 percent that month and the Standard & Poor's 500 index slumped 15 percent. Hedge fund Long-Term Capital Management collapsed after losing about $4 billion, prompting a Federal Reserve- backed bailout by Wall Street. Gross domestic product (GDP) in Russia shrank 6.5 percent and inflation accelerated to 84 percent.
Since then, rising prices of oil, natural gas and metals have provided Russia with a decade of economic growth under former president Vladimir Putin and his successor, Medvedev. Foreign reserves grew to $598.1 billion in August, the world's third largest, from $18.4 billion just before the 1998 default.
With average economic growth of about 7 percent a year since 1999, rising commodity and stock prices have created more than 100 Russian billionaires, including aluminium magnate Oleg Deripaska and soccer club owner Roman Abramovich. Last December Time magazine named Putin "Person of the Year" for bringing his country "roaring back to the table of world power".
Russia's current account, the widest measure of flows in goods and services, is now headed toward a deficit. Investors pulled $147 billion out of the country in the past three months, according to BNP Paribas, sending Moscow's dollar-denominated RTS stock index down 52 percent. So far this year, the RTS index has lost 64 percent, headed for the worst performance since 1998.
The trade surplus narrowed to $16.4 billion in September from $18.5 billion in August, the Bank of Russia said this week.
The benchmark 30-year government bond has slumped this year, pushing the yield to an almost seven-year high of 12.55 percent on October 27.
"With the oil price falling we were concerned that the trajectory of Russia's reserves had changed from building them up to selling them," said Kieran Curtis, a fund manager in London at Aviva Investors, which cut Russian holdings in August.
Russia's gross domestic product (GDP) was poised to grow 7.3 percent this year, the economy ministry said last month, down from 8.1 percent last year. GDP will expand 5.4 percent next year, according to a Bloomberg survey of 14 economists.
The combined wealth of Forbes magazine's 25 richest Russians has fallen more than 50 percent in four months, based on the equity value of stocks and analysts' estimates.
The Bank of Russia began managing the rouble's exchange rate in February 2005 against a currency basket comprising about 55 percent dollars and 45 percent euros. Policy makers let it trade within a fixed range in mid-May. Since then, it has dropped 2.1 percent against the basket to 30.4020. Although the central bank does not reveal the limits of the band, BNP Paribas considers 30.40 to be its weaker end.
Attitude change
"You can't stimulate a slowing economy by keeping the currency fixed," said Lars Christensen, the head of emerging markets currency strategy at Danske Bank in Copenhagen. "They will have to change their attitude to using reserves for the sake of the economy."
Dvorkovich increased speculation Russia would reduce its interference in currency markets when he said last week that a "prolonged" period of deficit in the current account might prompt policy makers to "gradually" widen the trading band.
The current account, now at a surplus of $91.2 billion, might swing into a deficit as early as next year, though there would be no "sharp devaluation" in the rouble this year or next, Dvorkovich said.
Rory MacFarquhar, a senior economist at Goldman Sachs, said on Monday: "These remarks mark a departure from the previous party line among top officials that there was no reason for the rouble to depreciate.
"They confirm our view that there is a strong political preference for gradual depreciation over a steep devaluation, even though the central bank would prefer the latter approach."
Urals crude, Russia's export oil blend, rose to an all-time high of $142.94 a barrel in July. For the past three weeks, it has averaged $61.15, below the $70 mean price that finance minister Alexei Kudrin said in September the government would need to balance its budget next year.
"Without an increase in oil prices or an improvement in the capital account of the balance of payments, the central bank will eventually have to devalue," Evgeny Gavrilenkov, Troika Dialog's chief economist, wrote last week. An average price for Urals crude of $60 a barrel "would imply a devaluation of the rouble against the bi-currency basket by 25 percent to 30 percent", he said.
Russia's reserves are 25 times bigger now than on the eve of the default, central bank data show. The world's biggest energy exporter, Russia still earns $700 million a day from oil, compared with $100 million 10 years ago, according to Chris Weafer, the chief strategist in Moscow at UralSib Financial, Russia's biggest privately owned bank.
Overly bearish
"The market is getting overly bearish," said Michael Ganske, the head of emerging markets research in London at Commerzbank. "This is a temporary phenomenon and the rouble will stay stable until investors realise the value."
Brazil, Russia, India and China were planning co-ordinated measures to increase trade and capital flows between their economies, Kudrin said last week.
The world's second-biggest oil producer would also pursue an "independent" strategy on production, ignoring Opec's moves to cut output, the finance minister added.
While Russia's plight 10 years ago reflected an economy emerging from communist control, the turmoil today is part of a crisis hurting nations worldwide as a shortage of credit prompts investors to sell higher-yielding assets in favour of the safest securities.
Gazprom, Russia's exporter of natural gas, said last month it might have trouble getting new loans and refinancing debts even after posting record earnings. Norilsk Nickel, the world's largest producer of the metal, posted a 33 percent decline in first-half earnings early last month as demand slumped.
Russians are taking note. Svetlana Malyarevich, a Moscow-based accountant, says she considered changing some of her savings into foreign currency after people in her office said the rouble might slide to 40 to the dollar.
"People who have rouble accounts understand that their savings decline if the dollar rises," she says. "The security of my money is directly dependent on the economic situation in Russia."
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