The Central Bank’s new policy to peg the exchange rate to a euro/dollar basket will be unable to keep the ruble from growing stronger. This will resume as early as in the second quarter of this year

Yana Galukhina and Ekaterina Shokhina

On April 9, Vladimir Putin held a meeting with Sergei Ignatiev, head of the Bank of Russia, during which he voiced his concern about excessive ruble appreciation that “adversely affects the export of Russian commodities.” In response, the central bank chairman promised the president to limit real ruble appreciation versus a basket of currencies to 7 percent in 2004. This marginal forecast was set in the document, “The Main Areas of Government and Central Bank’s United Monetary Policy for 2004.” Meanwhile, according to Central Bank data, the ruble grew by as much as 4.7 percent versus the basket of currencies in the first quarter of this year. Central Bank officials will have to work hard to keep the ruble from an additional 2.3 percent in the remaining eight months of the year.

Enough fun and games
 
A number of factors have caused a steady decline in the ruble-dollar exchange rate beginning February last year and continuing through February this year with short breaks. The first is a massive currency inflow in Russia due to high world prices for exported Russian raw materials. The second is the investment-level rating Moody’s gave Russia last autumn, which made many anticipate an influx of investment into Russia. Under the influence of these factors, Russian financial market participants preferred to borrow short-term hard-currency loans abroad and immediately convert them into ruble assets, so as to make some quick speculative profits. “Most foreign loans banks raised late last year were placed in diverse liquid ruble instruments, like Central Bank deposits, liabilities of stock exchange modified repo, or corporate ruble-denominated bonds,” says Oleg Solntsev, a leading expert with the Center for Macroeconomic Analysis and Short-Term Forecasting. “These funds were used for currency and interest rates arbitrage: foreign loans, which were getting less expensive, were placed in appreciating ruble instruments, thus causing even greater strengthening of the ruble versus the dollar.”
The increased demand for rubles resulted in an unprecedented rise in gold and currency reserves of the Bank of Russia – by mid-February, they had reached an all-time high of $88 billion.
However, the situation soon changed. Results for March showed that for the first time in the last six months, gold and foreign currency reserves sank by $2.9 billion. A significant part of the reduction was due to foreign debt payment, which amounted to $2.5 billion in March. The lower euro rate versus the dollar played a considerable role, as well. “The single European currency accounts for 25-30 percent of the gold and foreign currency reserves. Given that in March, the euro/dollar exchange rate fell by 1.8 cents, the reserves could have been reduced by another $300-360 million due to the decline of the `European part’ in dollar terms,” says Valeri Petrov, Deputy General Director of MICEX.
Virtually at the same time it announced the reduction in its gold and foreign currency reserves, the Central Bank reported increased capital outflow from Russia. According to the balance of payments, the net capital taken abroad by banks amounted to $1.8 billion in the first quarter of this year – $0.2 billion more than the counter-flow of funds in Russia. In the fourth quarter of the last year, inflow exceeded the outflow by $3.2 billion. “In February and March of this year, the dollar exchange rate remained relatively stable, and the Bank of Russia almost stopped buying foreign currency. As a result, commercial banks had to increase investment in foreign assets to balance the foreign currency component in their assets and liabilities,” explains Elena Matrosova, Director of the Center for Macroeconomic Research at the BDO-Yunikon company. Other analysts share her opinion. “Since speculative short-term loans ceased to be attractive as the ruble exchange rate stabilized, companies to all appearances began to gradually pay off the loans they had picked up in the fourth quarter of last year and this January for arbitrage,” says Anton Struchevsky, an economist at Troika Dialog Investment Company. “As a result, the net inflow of foreign capital was reduced.”
The reduced yield on domestic financial market instruments also contributed to capital outflow. “GKO-OFZ yield, for example, is low now,” says Andrei Klepach, Executive Director of the Development Center. “Thus, for example, the yield of long-term US bonds is around 6 percent now; in Russia, it is around 7.5 percent. It will be the same in dollar terms. As a result, risks exist, while the opportunities to make a profit are significantly reduced.” Therefore, the speculative demand for rubles has become noticeably slacker.
One can say that the Central Bank has been granted a respite. However, it will unlikely be long – as soon as the second quarter, capital outflow will most likely change to inflow. There are a number of reasons for this. “While in the first quarter companies’ investments lag, in the second quarter they usually tend to grow,” says Oleg Solntsev. “Since the main bulk of profits fall in the second half of the year, enterprises start to need external financing.” In the second quarter, many Russian corporations plan to float eurobonds to the tune of around $3 billion. Among them are Gazprom issues totaling 1.2 billion euros, Alfa-bank – $400 million, Rosbank and Alrosa – $300 million each, Vneshtorgbank and Vympelkom – $250 million each, and Promsvyabank – $100 million. A substantial part of these funds will inevitably be converted into Russian rubles, which will become a serious factor in ruble appreciation.
At the same time, last year the rise in the euro/ruble exchange rate largely compensated for ruble appreciation versus the dollar. However, powerful euro appreciation on the global currency exchanges, which helped restrain the real ruble exchange rate, is not expected to continue in future.  The ratio of two world currencies began to change in March. By Matrosova’s estimates, even if the dollar/euro rate remains unchanged until the end of the year, the dollar should be worth at least 30.3 rubles and the euro at least 36.2 rubles by New Years to fit the guide of ruble appreciation set by Sergei Ignatyev.

Wasted effort

The monetary authorities are very concerned, and specialists at the Bank of Russia are feverishly devising ways to keep the ruble back. Last week, Konstantin Korishchenko, Deputy Chairman of the Central Bank, announced plans to introduce a bi-currency index as a guide for on-line control over the foreign currency exchange rate. The new index, which will be introduced in the next few weeks, will at first be pegged to a basket of the two currencies, where the euro will initially account for about 10-20 percent and increase up 50 percent in the long term.
Nowadays, the Central Bank actively participates in dollar auctions, putting up its lots for purchase or sale of the US currency. Thanks to this, the bank has the opportunity to influence the exchange rate. Quotations for other currencies are determined as cross-rates, taking into account their price versus the dollar on the world currency market and the dollar/ruble exchange rate on the domestic market. With the bi-currency pegging, the Central Bank should supposedly intervene in both the dollar and the euro segment of the domestic foreign currency market. However, Korishchenko swears that the Bank of Russia won’t participate in euro auctions. In this case, it is absolutely unclear what in practice will make the new ruble rate regulation method different from the current one. “This is the devil’s work,” stated Alexander Khandruev, a former Deputy Chairman of the Bank of Russia and now head of the BFI Group, assessing the new idea proposed by the Central Bank.
However, if Central Bank officials manage to make their plans a reality, the only consequence will perhaps be a reduction of the volatility of the euro rate versus the ruble. Yet dollar fluctuations will increase. At the same time, the ruble rate set on the domestic foreign currency market versus the basket of the currencies will be more stable than exchange rates of individual currencies that would make up the basket.  The benefits of this measure are vague, while the negative aftereffects are clear. The extension of the spread between purchase price and selling price of a currency at currency exchange offices will become the most perceptible effect for citizens. In Alexander Khandruev’s opinion, at the macroeconomic level, pegging of the ruble to the bi-currency basket will lead to an increase in the Central Bank’s transactional costs and increased incomes for foreign currency speculators, who gain profits from speculating on the difference in exchange rates. 

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