The Parallax Brief

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Unrepentant Subjectivity on Economics, Politics, Defence, Foreign Policy, and Russia

Ruble Halts Slide

The precipitous fall of the ruble after the Central Bank of Russia (CBR) ended its managed devaluation program halted this morning.

It had been feared that the CBR would be so alarmed by the nose-bleed drop in ruble value over the last week it might not defend the ruble at the lower limit it set of RUB41 against the bi-currency basket. Financial and Russian media outlets also seemed spooked yesterday when the ruble breached 36 against the dollar, a mark mentioned by the CBR when it drew its ‘line in the snow’ at 41.

However, the Parallax Brief was surprised that outlets like Bloomberg made such a fuss about the 36 mark, which was set as an approximation of the ruble dollar exchange rate (the most important for Russians) if the basket was at 41. The figure did not (and could not) account for a strengthening of the dollar against the euro, which is why yesterday the ruble was able to break the 36 mark while staying within its limit of 41 against the basket.

As the Parallax Brief predicted it would do, the CBR is squeezing ruble liquidity in order to bolster the defense of the ruble. Last week, the Central Bank literally throttled a banking system already gasping for air in order to extrude from the market short positions against the ruble: it provided only RUB389 bn at its repo auctions (against demand of over RUB630 bn), announced that this week only RUB50bn would be offered at its unsecured auction facility, and raised key interest rates by over 100bp. There are even reports that some CBR officials have publicly discussed punishing those banks involved in using money earmarked for bailing out the banking system to short the ruble.

The message was clear: we will defend the ruble, no matter what the effect on you, so get off your short positions and move back to your core business of lending.

The result this morning has been startling, as the CBR has not even had to intervene in the market to sustain the ruble’s position above the 41 mark. Traders have obviously realized, for now, that the CBR is willing to defend its line in the snow.

What next for the ruble?

Of course, a plethora of factors will affect the movement of the ruble in coming months. Russia’s current account, economic growth, budget deficit (or lack thereof), industrial output, capital flows, etc will all impact the ruble. However, for Russia, oil prices have such a pervasive influence the economy that we can mark the ruble’s likely path for given prices of Urals crude oil, Russia’s export blend.

While the CBR has widened the band considerably as part of its switch to a dirty float, the ruble is likely to sit on or near its lower band boundary for the foreseeable future. The current lower mark of RUB41 against the basket correlates to a price of Urals crude of USD40-45 per barrel. Equally, RUB26 against the basket – the top end – correlates to the prices of USD140 we saw in spring last year.

If oil drops into the thirties, and looks like staying there, the Parallax Brief believes the CBR will act quickly and move down the band again. Perhaps the parlous state of key economies for setting oil prices (particularly Chimerica) suggests such a move by Spring, but in the short term, the Parallax Brief is sticking its virtual neck on the line to predict that RUB41 against the basket is here to stay.

Anything else would smash the credibility of the Central Bank. And the ruble.

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Ruble Devaluation Enters Endgame

The Russian ruble finished stronger against the bi-currency basket yesterday (Tuesday 20 January), and has this morning strengthened again, perhaps signaling that ruble devaluation is approaching its end.

The ruble is ‘pegged’ by the Central Bank of Russia (CBR) against a currency ‘basket’ of 55% US dollars and 45% euros. The CBR intervenes in the market — either by selling rubles or buying them to weaken or strengthen the currency, respectively — in order to keep the ruble within a designated trading band against the basket. However, even a pegged currency must bow to economic reality, and with Brent crude at USD41 instead of USD141, the ruble had to be weakened.

But instead of a one-off drop of, say, 25%, the CBR embarked on what many viewed as a costly fudge: a step-by-step devaluation. Economists didn’t like it. Chris Weafer, chief strategist at Moscow based investment bank UralSib argued,

“If the government had actually announced a one-off devaluation of around 30 percent in the autumn the issue would probably be done and dusted by now. Instead, the salami-slice approach that the central bank is using has created considerable uncertainty and the expectation of further weakness”

The managed devaluation was a mechanism born not out of economic orthodoxy, but political expediency. It was designed to avoid spooking a population thrice savaged by devaluation – which might have led to a run on the banks – and as a face-saver for the government. But paradoxically, Russia’s slow devaluation ended up increasing the pressure on the ruble by raising expectations that more would follow, encouraging both speculators to place bets on further slippage and the population to switch savings into ‘harder’ currencies.

Further, the CBR still has to use its dollar reserves to stop the ruble dropping more than a percentage point or so every day, meaning that reserves are eaten up almost as fast as they would have been holding steady.

We are now approaching the point where the ruble must be held at a sustainable level. Russia may have had the third largest reserves in the world, but they are not infinite, and by the end of last week, which saw the fastest rate of devaluation so far, the real amount available for defending the currency had dropped to around USD200 bn.

At the same time, the ruble has lost between 20 and 25% of its value against the basket since the process started, approaching a valuation that makes economic sense, and is sustainable. The CBR now needs to force speculators to close their positions against the ruble in order to relieve pressure. It also needs to signal that the end has arrived, and the ruble will be defended at a position of the central bank’s choosing.

But how would it achieve this?

The CBR has two options: First, it can hold the ruble steady against the basket, sending a strong, if tacit, signal that the process is over and short positions should be unwound. Second, it could squeeze ruble liquidity. The Russian banking system as a whole owes the CBR vast quantities of money, and at the same time the CBR is the main source of liquidity. If the CBR tightens supply, demand for ruble liquidity will increase.

And in the last two days, we have seen something like option two. For the first time in years (perhaps ever) short term indebtedness to the CBR exceeds the liquidity banks have available in CBR deposit accounts. Further, the CBR plans to offer ‘only’ RUB80 bn at its ‘deposit auctions’ this week. Ruble liquidity is being throttled. Yesterday, the ruble actually gained against the basket for 50 minutes, during which time, according to my contact, only a few hundred million dollars were traded – a miniscule volume.

The problem with this method is that banks are already gasping for liquidity. If the CBR squeezes too hard, large swathes of the banking system – even those who haven’t been playing ruble devaluation arbitrage – may go bust.

Readers who have been converting savings or wages into ‘harder’ currencies may want to pause. Those with money saved in smaller banks might want to watch carefully what happens next.

The slow drift of devaluation is coming to a close.

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