Unless Alexander Lebed is highly unpredictable, the second round of Russia's presidential election should have financiers licking their lips. The widely expected victory for Yeltsin is set to bring hefty stock market gains. Yet with the election season at its climax, the financial circuit chitchat is less about candidates' programs and more about the minutiae of monetary economics. At least until the first-round votes are counted, the broad themes of Russian high politics have been replaced by hair-splitting analysis of the Central Bank's balance sheet.
During the week preceding the elections, market talk focused on the 5 trillion rubles ($991 million) Yeltsin pinched from the Central Bank of Russia (CBR) for last-minute pre-election sweeteners. The CBR does not widely circulate detailed financial statements. And because official currency-market intervention often takes place under "fronts" -- particularly Sberbank but other commercial banks as well -- getting a handle on Russia's financial fundamentals is generally more of an art than a science.
But in the last two weeks, Sergei Dubinin has displayed remarkable candor. He revealed that since the beginning of April, the CBR has channeled a staggering 25 trillion rubles to the cash-strapped federal budget, in part by buying up GKOs -- short-term government debt. At the same time, the CBR has reduced net international reserves from $16 billion to $12.5 billion, selling dollars to defend the ruble. So the widely discussed 5 trillion ruble transfer is part of a broader CBR trend: Monetary discipline has withered in the name of election-spending imperatives.
These monetary misdemeanors have not escaped the notice of the IMF: Monthly tranches of the $10.1-billion loan are linked to monetary targets which have probably now been overshot. IMF targets are defined, rather obscurely, in terms of "net domestic assets" (NDA) -- the monetary base (roughly, notes and coins in circulation) minus the CBR's net international reserves (NIR). IMF conditions on the Russian government limit the monthly growth of NDA. This is a good idea when the exchange rate is fixed, as NDA growth is kept low both by minimizing the expansion of the monetary base and by bolstering the CBR's hard-currency reserves. Low monetary growth reduces inflation, while high CBR reserves in turn make the exchange rate fix more credible. Meaningful NDA limits are therefore a doubly useful device to ensure good macroeconomic housekeeping.
So, in plainspeak, if the CBR prints money, then uses that money to buy dollars which it places in its vaults, NDA stays the same -- the IMF's targets can then be met despite the fact that the government has printed money and used it for a quick political fix. This is precisely what happened last spring. The CBR increased the money supply by almost 28 percent in two months. The market groaned audibly; this was a serious policy U-turn after almost six months of tight money. Yet, the IMF target was not broken because at the same time CBR reserves almost doubled to reach $6 billion.
The difference between last spring and now is that the money supply then was expanded on the back of a rising ruble, so the CBR simply printed rubles, threw them to the market and reaped dollars by return of post.
In the current situation, the money supply has increased 6 percent in both March and April, pushing up NDA. But unlike last spring, because the ruble is fixed, there has been no way for the government to bolster its reserves on the foreign exchange market. And because the monetary side of the NDA expansion has not been offset by a reserve increase, the IMF target has probably been popped. In fact, given Dubinin's admission that reserves have been falling during this period, NDA has been driven up from both sides.
Election madness means IMF targets are not currently at the top of the government's agenda. In fact, given the importance of a Yeltsin victory to the West, the IMF itself is probably not in a position to crack the whip -- at least not until the second round is over. But even if the government could not care less about the IMF, it could soon be reminded that capitalist economies are disciplined, in the final analysis, not by groups of white-shirted men from Washington but by markets.
The ruble has been fixed in nominal terms since July 1995. Base money, meanwhile, has been expanding by more than 5 percent per month. Monthly inflation, much reduced of late, has still averaged almost 4 percent. Now is not the time to be messing with the ruble.
None of this is news to Dubinin. Slapped around lately by the government, he has just raised reserves asset requirements -- the proportion of total deposits that commercial banks must hold at the CBR -- "in response." He said the idea was to offset the inflationary impact of the money transferred from the bank's reserves to the budget by Yeltsin. Yet Dubinin knows that high reserve assets do nothing to hold down inflation and inhibit long-term lending -- this is why he lowered them at the beginning of May.
The reserves increase serves two other purposes. Firstly, Dubinin needs to salvage some lost credibility. More importantly, the CBR needs to provide some explanation of why interbank rates exceeded 200 percent last week. The official line is that banks are scrambling for rubles to meet Dubinin's new reserve conditions. Yet the conditions do not bite until July 1, and they are rarely strictly adhered to anyway. The May decrease was partly an attempt to make rules reflect reality.
Unfortunately, Russia's high interbank rates are driven by more serious factors than an obedient response to Dubinin's institutional edict. Russia's commercial banks, even the strongest, are in a liquidity squeeze as depositors have withdrawn their money to hold election-proof dollars. The interbank market is shrinking and increasingly being challenged by an over-the-counter market conducted by a small group of top men at Russia's big-20 commercial banks, who are keen to insulate themselves from less stable banks.
Added to the liquidity crunch, the interbank market is feeling currency concerns in the wake of Dubinin's balance-sheet candor.
During the week preceding the elections, market talk focused on the 5 trillion rubles ($991 million) Yeltsin pinched from the Central Bank of Russia (CBR) for last-minute pre-election sweeteners. The CBR does not widely circulate detailed financial statements. And because official currency-market intervention often takes place under "fronts" -- particularly Sberbank but other commercial banks as well -- getting a handle on Russia's financial fundamentals is generally more of an art than a science.
But in the last two weeks, Sergei Dubinin has displayed remarkable candor. He revealed that since the beginning of April, the CBR has channeled a staggering 25 trillion rubles to the cash-strapped federal budget, in part by buying up GKOs -- short-term government debt. At the same time, the CBR has reduced net international reserves from $16 billion to $12.5 billion, selling dollars to defend the ruble. So the widely discussed 5 trillion ruble transfer is part of a broader CBR trend: Monetary discipline has withered in the name of election-spending imperatives.
These monetary misdemeanors have not escaped the notice of the IMF: Monthly tranches of the $10.1-billion loan are linked to monetary targets which have probably now been overshot. IMF targets are defined, rather obscurely, in terms of "net domestic assets" (NDA) -- the monetary base (roughly, notes and coins in circulation) minus the CBR's net international reserves (NIR). IMF conditions on the Russian government limit the monthly growth of NDA. This is a good idea when the exchange rate is fixed, as NDA growth is kept low both by minimizing the expansion of the monetary base and by bolstering the CBR's hard-currency reserves. Low monetary growth reduces inflation, while high CBR reserves in turn make the exchange rate fix more credible. Meaningful NDA limits are therefore a doubly useful device to ensure good macroeconomic housekeeping.
So, in plainspeak, if the CBR prints money, then uses that money to buy dollars which it places in its vaults, NDA stays the same -- the IMF's targets can then be met despite the fact that the government has printed money and used it for a quick political fix. This is precisely what happened last spring. The CBR increased the money supply by almost 28 percent in two months. The market groaned audibly; this was a serious policy U-turn after almost six months of tight money. Yet, the IMF target was not broken because at the same time CBR reserves almost doubled to reach $6 billion.
The difference between last spring and now is that the money supply then was expanded on the back of a rising ruble, so the CBR simply printed rubles, threw them to the market and reaped dollars by return of post.
In the current situation, the money supply has increased 6 percent in both March and April, pushing up NDA. But unlike last spring, because the ruble is fixed, there has been no way for the government to bolster its reserves on the foreign exchange market. And because the monetary side of the NDA expansion has not been offset by a reserve increase, the IMF target has probably been popped. In fact, given Dubinin's admission that reserves have been falling during this period, NDA has been driven up from both sides.
Election madness means IMF targets are not currently at the top of the government's agenda. In fact, given the importance of a Yeltsin victory to the West, the IMF itself is probably not in a position to crack the whip -- at least not until the second round is over. But even if the government could not care less about the IMF, it could soon be reminded that capitalist economies are disciplined, in the final analysis, not by groups of white-shirted men from Washington but by markets.
The ruble has been fixed in nominal terms since July 1995. Base money, meanwhile, has been expanding by more than 5 percent per month. Monthly inflation, much reduced of late, has still averaged almost 4 percent. Now is not the time to be messing with the ruble.
None of this is news to Dubinin. Slapped around lately by the government, he has just raised reserves asset requirements -- the proportion of total deposits that commercial banks must hold at the CBR -- "in response." He said the idea was to offset the inflationary impact of the money transferred from the bank's reserves to the budget by Yeltsin. Yet Dubinin knows that high reserve assets do nothing to hold down inflation and inhibit long-term lending -- this is why he lowered them at the beginning of May.
The reserves increase serves two other purposes. Firstly, Dubinin needs to salvage some lost credibility. More importantly, the CBR needs to provide some explanation of why interbank rates exceeded 200 percent last week. The official line is that banks are scrambling for rubles to meet Dubinin's new reserve conditions. Yet the conditions do not bite until July 1, and they are rarely strictly adhered to anyway. The May decrease was partly an attempt to make rules reflect reality.
Unfortunately, Russia's high interbank rates are driven by more serious factors than an obedient response to Dubinin's institutional edict. Russia's commercial banks, even the strongest, are in a liquidity squeeze as depositors have withdrawn their money to hold election-proof dollars. The interbank market is shrinking and increasingly being challenged by an over-the-counter market conducted by a small group of top men at Russia's big-20 commercial banks, who are keen to insulate themselves from less stable banks.
Added to the liquidity crunch, the interbank market is feeling currency concerns in the wake of Dubinin's balance-sheet candor.
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