Having devalued the ruble some 20 percent in incremental steps between mid-November and early January, the Central Bank accelerated the process last week when it used a period of higher ruble demand to widen the trading range further.
The new low end of the trading band implies a devaluation of nearly 30 percent from last year’s high. Can the Central Bank successfully defend its new target level? And what are the implications if it can’t?
The key economic objective is to balance Russia’s international trade account by shifting the dynamics of supply and demand. Russia needs a positive trade balance as it struggles to attract the capital necessary to finance a trade deficit. A weaker ruble helps in this battle by making exports and domestic goods cheaper and imports more expensive. Imports have driven Russia's consumer boom in recent years as Western businesses have penetrated deeper into the country. Since this is modern Russia's first consumer-era recession, it is difficult to accurately predict how import parameters will evolve. The signs so far are mixed.
Although growing unemployment should cool consumption, retail data in late 2008 were relatively healthy. To some extent the picture is confused by a return to paying salaries unofficially in cash that is not reported to the authorities. Thus, data on real earnings may no longer fairly reflect the population’s ability to consume. Moreover, since trust in money as a store of value remains low, many Russians prefer to convert capital into possessions as quickly as possible.
Clearly, there is a chance that import demand will be sustained even as the economy weakens. Coupled with low commodity prices, this represents exactly the threat that the Central Bank is trying to overcome. To make matters worse for investors, there is an imbalance in the flow of information: Import data are only reported quarterly, while key export values (oil prices) are observable in real time all day long. Unsurprisingly, it is export expectations that move the ruble the most.
So how are the dynamics of Russia’s exports? It is reassuring that the government has lowered its oil price assumption to $41 per barrel this year. This is in line with conservative market opinion.
But by announcing its line of defense, the Central Bank is de facto placing a huge bet on the near-term price of oil. If oil prices remain at current levels or rise, the new ruble band should be defendable. But if they fall again, preventing further declines will prove to be highly expensive.
Exceptional volatility, brought about by the ongoing global economic turmoil, makes it difficult to assess whether Russia’s oil gamble is going to work. It also exposes the Central Bank’s imprudence as volatility reflects high levels of market uncertainty.
In the case of the oil market, the volatility of recent months has been caused by plunging demand. This left the market oversupplied and caused storage facilities to fill rapidly, particularly in the United States. The result has been plunging prices as traders liquidate positions ahead of monthly contract expiration dates. No one wants to hold oil contracts through expiration since it obligates them to receive delivery at a time when there is little available space for storage.
Will this bearish monthly trend repeat and put further pressure on the ruble next month? Last week there were supportive signs that OPEC is honoring the deep production cuts that were agreed to in late 2008. Nonetheless, January’s economic news has not been reassuring, implying further drops in demand. Oil prices may remain under pressure.
The success of Russia’s new currency policy will depend on OPEC’s continued discipline and the rapid stabilization of oil demand. If oil fails to help, the Central Bank will face the prospect of a rapid expenditure of reserves to support the ruble. This makes sense, as reserves were accumulated precisely to cushion the public from the shock of exactly this kind of macroeconomic stress.
But reserves alone will not prevent a crisis. Slowing the rate of ruble devaluation has already cost some $200 billion, which leaves Russia with about $400 billion to play with. Certainly this is a huge amount, but it will not survive a protracted currency challenge.
It would take a major financial disaster for global economics to wipe out years of economic gain in Russia; the worry is that the world is now facing a real risk of such a catastrophe. The quicker Russia can move to some form of floating its currency, the better.
James Beadle is chief investment strategist at Pilgrim Asset Management.
The new low end of the trading band implies a devaluation of nearly 30 percent from last year’s high. Can the Central Bank successfully defend its new target level? And what are the implications if it can’t?
The key economic objective is to balance Russia’s international trade account by shifting the dynamics of supply and demand. Russia needs a positive trade balance as it struggles to attract the capital necessary to finance a trade deficit. A weaker ruble helps in this battle by making exports and domestic goods cheaper and imports more expensive. Imports have driven Russia's consumer boom in recent years as Western businesses have penetrated deeper into the country. Since this is modern Russia's first consumer-era recession, it is difficult to accurately predict how import parameters will evolve. The signs so far are mixed.
Although growing unemployment should cool consumption, retail data in late 2008 were relatively healthy. To some extent the picture is confused by a return to paying salaries unofficially in cash that is not reported to the authorities. Thus, data on real earnings may no longer fairly reflect the population’s ability to consume. Moreover, since trust in money as a store of value remains low, many Russians prefer to convert capital into possessions as quickly as possible.
Clearly, there is a chance that import demand will be sustained even as the economy weakens. Coupled with low commodity prices, this represents exactly the threat that the Central Bank is trying to overcome. To make matters worse for investors, there is an imbalance in the flow of information: Import data are only reported quarterly, while key export values (oil prices) are observable in real time all day long. Unsurprisingly, it is export expectations that move the ruble the most.
So how are the dynamics of Russia’s exports? It is reassuring that the government has lowered its oil price assumption to $41 per barrel this year. This is in line with conservative market opinion.
But by announcing its line of defense, the Central Bank is de facto placing a huge bet on the near-term price of oil. If oil prices remain at current levels or rise, the new ruble band should be defendable. But if they fall again, preventing further declines will prove to be highly expensive.
Exceptional volatility, brought about by the ongoing global economic turmoil, makes it difficult to assess whether Russia’s oil gamble is going to work. It also exposes the Central Bank’s imprudence as volatility reflects high levels of market uncertainty.
In the case of the oil market, the volatility of recent months has been caused by plunging demand. This left the market oversupplied and caused storage facilities to fill rapidly, particularly in the United States. The result has been plunging prices as traders liquidate positions ahead of monthly contract expiration dates. No one wants to hold oil contracts through expiration since it obligates them to receive delivery at a time when there is little available space for storage.
Will this bearish monthly trend repeat and put further pressure on the ruble next month? Last week there were supportive signs that OPEC is honoring the deep production cuts that were agreed to in late 2008. Nonetheless, January’s economic news has not been reassuring, implying further drops in demand. Oil prices may remain under pressure.
The success of Russia’s new currency policy will depend on OPEC’s continued discipline and the rapid stabilization of oil demand. If oil fails to help, the Central Bank will face the prospect of a rapid expenditure of reserves to support the ruble. This makes sense, as reserves were accumulated precisely to cushion the public from the shock of exactly this kind of macroeconomic stress.
But reserves alone will not prevent a crisis. Slowing the rate of ruble devaluation has already cost some $200 billion, which leaves Russia with about $400 billion to play with. Certainly this is a huge amount, but it will not survive a protracted currency challenge.
It would take a major financial disaster for global economics to wipe out years of economic gain in Russia; the worry is that the world is now facing a real risk of such a catastrophe. The quicker Russia can move to some form of floating its currency, the better.
James Beadle is chief investment strategist at Pilgrim Asset Management.
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