Dr Vladimir Tikhomirov, Chief Economist at BCS Financial Group comments on the rouble’s recent fall to a new low…
Hopes that the Minsk summit and the first direct talks between the Russian and Ukrainian presidents would open the way for a peaceful resolution of the conflict were short-lived.
On 28 August, less than two days after the summit ended, Ukrainian authorities publicly stated that Russia intensified its support for the rebels and moved regular troops in to Ukraine numbering in the thousands. These statements provoked an escalation in Russia-West relations, which were accompanied by renewed discussions of sanctions against Russia. As a result, the Russian market and the currency came under pressure.
During the first day of sell-off (28 August), the rouble quickly weakened to its previous historic lows – first seen in February 2009 and then again recently, in March 2014 – at around RUB36.8/USD. However, the currency then stabilised at this level, which was an expected trend: the market believed the Central bank was not prepared to let the currency slide below its previous historic lows,as such a move could provoke panic FX buying and would put more pressure on Russian banks. On the following day, FX trading started with the rouble falling through its previous levels of support to around the RUB37/USD level. This move immediately brought up the question of further CBR action: did the Central bank decide to give up on the currency instead of spending its FX reserves to support it?
Last week, the Central Bank announced some important changes to its FX policy. These changes included the broadening of the bi-currency basket corridor and removal of the mechanism of ‘technical’ FX interventions within the basket. In effect, the CBR said that it will now intervene in FX trade only when the basket crosses its upper or lower limits. This was seen as a major step by the bank towards the free-floating of the rouble,which is planned to take place in full from 1 January 2015. The events of the past week (and probably this week as well) come as the first real test of this new CBR policy. When the CBR made its announcement, we said the changes would result in much higher volatility of the rouble, something that we are seeing today.
Technically, the value of the official bi-currency basket set on Friday was RUB42.2/basket, much higher than the new low limit of the CBR basket corridor (RUB44.4/basket). If we assume that the current USD/EUR exchange rate remains stable,in order to hit the low limit of the CBR basket corridor, the rouble would have to fall to RUB38.8/USD. At the same time, factors to support the rouble from a free fall are rouble liquidity (which remains expensive and tight) and the possibility that the CBR will eventually intervene – either directly via FX sales or indirectly through hiking its interest rates again.
There are two other important factors, besides rising geopolitical risks, that added to the rouble’s weakness.On Thursday, domestic demand for the currency started to fall following the end of the monthly tax payment season. The next rise in demand is expected in two weeks, which leaves the RUB without the support of FX sales by exporters and purchases by the banks. Another factor is the current level of crude oil prices: for the past two weeks, Urals crude was trading at levels of around USD99-100/bbl, which increased concerns that if these (or even lower)price levels are here to stay, this could lead to more budget problems in Russia and push the country’s economy into recession.
The developments ofl ast week show that the CBR is not yet prepared to support the RUB through interventions. In doing so, the CBR follows its announced policy goal, which centres on inflation targeting and allows for a much higher volatility in rouble trade. This means that in the event of geopolitical risk remaining elevated or rising even further, the rouble can fall further without CBR intervention. At the same time,if risks abate, the currency can bounce back strongly: we see levels of RUB35.5-36.5/USD as adequate in this case. However, there is one important fundamental contradiction in this new policy response by the Central bank: we have no doubt that a weaker rouble will become a significant factor for a future rise in inflation due to the share of imports in the consumer basket.
Today, the inflationary effects of a weaker RUB and restrictions imposed by Russian authorities on food imports are largely balanced by seasonal deflation in locally-produced foods. This seasonal deflation will end in one month’s time, however, which could lead to acceleration in consumer price growth – exactly the same way as we saw during this year’s spring, when RUB weakening in March affected a spike in the CPI rate in April-June.
The CBR’s withdrawal from active participation in FX trade through interventions leaves the bank with one tool to ensure the stability of the financial and currency system – monetary policy. Earlier this year, the CBR showed that it is prepared to use this lever resolutely when needed,and we do not rule out a similar response again, if pressures on the currency continue to rise. This means that chances for a new official rate hike are on the rise. The bank could also consider other ways to support the RUB, like cuts to the volumes of rouble liquidity it is prepared to offer to banks via various mechanisms. No doubt, these steps will be painful for banks and are likely to result in further deceleration in the growth of the economy,as credit becomes more expensive, but it might well be that the CBR will have no other option to maintain financial stability. The CBR is scheduled to discuss its rate policy at its next meeting on 12 September, but it could tweak its monetary policy earlier – even this week – if the situation demands it.
