The ruble – how high can it go?

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This post is a guest contribution by Jacob Nell of Morgan Stanley.

In 2010 the ruble did not live up to expectations: In particular, the weak 3Q10 saw a sharp slowdown in growth (from 5.2%Y in 2Q to 2.7%Y in 3Q), with unexpectedly heavy capital outflows on the balance of payments in 4Q (US$22.7 billion), which, together with a poor harvest in 2010 (37%Y fall in the grain harvest), weighed on the ruble.

Since November 2010, however, the ruble has been increasing steadily, fuelled by a rising oil price, and the consequent strong position on the current account: As of February 16, the ruble has risen against the basket to 33.95, a rise of 7% in nominal terms and 11% in real terms since the start of November.  How much further could this run continue?

We still expect the ruble at 34 to the basket by end-2011: We looked at this question recently (see Will the CBR Tighten in January? January 24, 2011) when we called for a rise in the ruble to 34 to the basket by end-2011, on the basis of a forecast US$70 billion surplus on the current account, and forecast that any rise above that rate at a US$96/bbl oil price would run into increasing headwinds.  This call translates into the following numbers:

At the moment, based on balance of payments fundamentals and central bank statements, we do not see a strong reason to change this call:

•·   Balance of payments: Although the oil price has been slightly stronger than expected, total reserve accumulation in the year to February 4 was only US$7.6 billion, or about half of what we would have expected from the forecast US$40 billion 1Q current account surplus.  This implies ongoing capital outflows offsetting the current account.  There are some signs that there may be a change of investor sentiment towards Russia and a resumption of capital inflows, including the successful US$3.3 billion VTB share sale and the CBR tightening at end-January by raising reserve requirements rather than rates because of a concern about short-term capital inflows. But, the picture on investor sentiment is mixed, with three recent planned IPOs cancelled – Chelpipe, Koks and NordGold – and Barclays announcing a loss of £244 million on its Russian acquisition and exit from retail banking in Russia.  The next data release on the balance of payments – 4Q10 data due on March 31 – may provide information to revise this view.

•·   Central bank attitude: The CBR does not like excessive short-term volatility in the exchange rate, and is, we think, currently buying US$300-350 million per day, and will lean further against appreciation as the rate approaches the edge of the intervention bands, which Deputy Governor Ulyukaev said was 33 to 37 on February 1.  Governor Ignatiev’s comment, reported by Interfax on February 10, that the CBR intends to further widen the intervention bands around the central rate, as part of the ongoing move to a more flexible exchange rate, later in the year has two implications.  First, it implies that the CBR will not widen the bands in the short term, and will therefore not allow appreciation beyond 33 to the basket.  Second, if the widening later in the year is by a further ruble around the central rate from 4 to 5, similar to the widening by a ruble around the central rate from 3 to 4 in October 2010, it implies that the CBR would allow appreciation up to a maximum of 32.5 to the basket by year-end.

We Forecast a Rate Rise in February

We expect a 25bp hike in the deposit rate with high conviction, a 50-100bp hike in reserve requirements and a 25bp hike in all other active policy rates (repo, refinancing) in February: Our call is that the CBR will tighten further at the policy meeting at the end of February, given rising inflation (currently 9.6% annual rate versus 6-7% target) and hawkish language (the CBR will “most likely” raise rates in February, said Governor Ignatiev on February 4).  Given Ignatiev’s frequent recent references to reserve requirements as an instrument of monetary policy, the high rates of reserve requirements in Russia previously (up to 8.5%) and the current high rates in other key emerging market central banks (for instance, Turkey 6%) trying to tighten in the face of rising inflation without raising rates and provoking capital inflows, we think that the CBR will raise reserve requirements again by 1pp to 4.5% for liabilities to corporate non-residents and by a further 0.5pp to 3.5% for liabilities to residents. However, we think that the CBR will also raise rates, given inflation well above target and robust recent indicators of growth (industrial production in January up 6.7%Y, slightly above our expectations of 6.6%Y and above consensus of 6.0%Y).  In addition, we believe that it is uncertain that raising reserve requirements, which might require banks to increase their reserves at the CBR by RUB 50-100 billion from the current level of around RUB 200 billion, will have an impact on monetary growth when the banks already have huge ruble liquidity of RUB 1.4 trillion at CBR correspondent accounts or on deposit at the CBR.  Given the CBR’s incrementalist recent approach, we call for a 25bp hike in the deposit rate with high conviction, a 50-100bp hike in reserve requirements and a 25bp hike in all other active policy rates (repo, refinancing) in February.  In our view, the Ministry of Finance is also behaving as if it expects a rate hike from the CBR in February, since despite running a budget surplus in the year to date, it has been taking advantage of high ruble liquidity and consequent low rates to increase the volume of borrowing in the domestic market.

Source: Jacob Nell, Morgan Stanley, February 18, 2011.

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