Russian policy makers' latest bid to shore up the nation's currency sounds complex but is actually simple: They will take rubles out of the hands of banks.
Fewer rubles means bankers will have less cash to buy dollars. That in turn will stem the selloff in the ruble. Or so goes the argument. On day one, the plan—or at least the unveiling of the plan—worked. The ruble surged 1.7 percent yesterday, to 45.8525 per dollar, rebounding from a record low even as policy makers simultaneously took other steps to allow it to trade freely.
The risk is that the strategy could deepen the economy's slump. Just as bankers will have fewer rubles to buy dollars, they will also have fewer rubles to lend to companies and consumers, choking off credit in an economy already on the verge of recession amid the strain of international sanctions tied to the Ukraine conflict. The Bank of Russia is offering the least seven-day loans known as repos in a month at an auction today.
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"This is the right thing to do," Paulo Vieira da Cunha, a former Brazilian central bank board member who is now the chief economist at hedge fund Ice Canyon LLC, said in a phone interview from New York yesterday. "They could squeeze domestic liquidity, but if it's too hard, some of the firms and banks will go under. I am not sure they are willing to pay the price."
In announcing the policy change yesterday, central bank Governor Elvira Nabiullina revealed few details, saying only that she will limit ruble funding to squeeze speculators betting against the currency. The comments come 10 days after Nabiullina raised the benchmark lending rate 1.5 percentage points to 9.5 percent, showing that she is relying more on monetary tools to defend the ruble.
Previously, the policy had been based more on selling dollars and euros to meet Russians' demand for foreign currencies, a strategy that has triggered an US$83 billion drop in the country's international reserves this year. The ruble's 29 percent decline since the end of December has added to inflation pressures, spurred capital outflows, and made it more difficult for Russian firms to pay back foreign-currency debt.
The central bank said yesterday that it will stop selling $350 million daily to support the ruble when it falls beyond its trading band, moving toward a free-floating currency. Policy makers reiterated that they still could intervene in the foreign-exchange market if they deem it necessary to preserve "financial stability."
'Painful Measure'
While Nabiullina didn't elaborate on her plan, Danske Bank A/S and Renaissance Capital Ltd. said the central bank will probably curtail the amount of rubles offered to lenders through repurchase auctions and currency swaps.
At the last offering of week-long repurchase agreements, or repos, on Oct. 31, lenders borrowed 2.85 trillion rubles (US$62 billion), up from a nine-month low of 1.83 trillion on Sept. 30. At today's auction, the central bank is making 2.7 trillion rubles available.
In a repo operation, the central bank buys securities such as government bonds from lenders for a set period, temporarily raising the amount of money available in the banking system. Forcing the banks to return the money at maturity, rather than rolling it over into a new repo, would leave them with less cash in their coffers.
"We consider this as a potentially painful measure," Oleg Kouzmin, an economist at Renaissance, said by email. In the worst case, it may result in a shortage of rubles in the domestic money market, Kouzmin said.
Russia's central bank has struggled to stem the ruble's decline as fighting flares anew in Ukraine and crude oil, a major export, trades at a four-year low.
The ruble, which traded 0.7 percent lower at 11:43 a.m. in Moscow, fell 8 percent against the dollar last week and is the world's second-worst performing currency this year after Ukraine's hryvnia, according to data compiled by Bloomberg. Russia's currency is heading for the worst year since 1998, when the country defaulted on $40 billion of local debt.
The selloff has no fundamental basis, and volatility will ease as the central bank steps up the fight against speculation, President Vladimir Putin said yesterday at the Asia-Pacific Economic Cooperation summit in Beijing.
While the ruble's slump helped boost inflation to a three-year high of 8.3 percent last month, the depreciation has benefited state-run energy exporters, who get their revenue in dollars and have mainly ruble-based costs. That has helped the government boost its budget surplus by 70 percent in the first nine months of 2014.
Preserving Reserves
"Putin wants the ruble to be weaker, though not to an absurdly low level," Jean-David Haddad, a strategist at OTCex Group in Paris, said by email. "Only a weaker ruble can partially offset weaker oil prices."
Policy makers last week brought forward plans for a free-floating currency after a larger-than-estimated interest rate increase on Oct. 31 failed to halt the ruble rout.
The previous policy required the central bank to buy rubles every time it weakened beyond a prescribed trading band, a predictable system that drained reserves and spurred traders to bet on further weakness.
The central bank last week restricted those interventions to once a day, before abolishing them entirely yesterday. It will now intervene in the market with undisclosed quantities to defend against "threats" to financial stability.
"This is a central bank looking to preserve its foreign-exchange reserves as a priority," Tom Levinson, the chief currency and interest rates strategist at Sberbank CIB in Moscow, said in emailed comments. By keeping the ability to sell foreign currency unannounced, "it is accepting elevated volatility, but not persistent extreme volatility," he said.
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