27.01.09

Russia's Central Bank on Thursday first reported a huge one-week drop of $30 billion in its international reserves, and then announced an adjustment of its exchange rate policy that is supposed to make it possible to avoid such drops in the near future.

Wide corridor

The Central Bank will set the upper threshold of the euro/dollar basket's technical trading corridor to the 41-ruble level effective January 23, the Central Bank said in a statement.

At the current exchange rate of $1.3/1 euro, that upper limit would correspond to roughly 36 rubles/$1. That level takes into account the persisting risk of a deterioration in Russia's external trade position, a risk the Central Bank assesses as moderate. It does not plan to change the boundary again in the coming months.

The change on January 23 completes the gradual adjustment of the technical corridor begun on November 11, 2008. The technical corridor is the band the Central Bank uses as a guide in conducting currency policy.

Central Bank Chairman Sergei Ignatyev said the 41-ruble level is the upper bound of the corridor. The actual value of the basket may be substantially lower. It may be lower than the level of January 22 - 37.2 rubles, meaning that the dollar exchange rate (32.8 rubles/$1 on January 22) might also move lower.

The dual currency basket is calculated as the ruble value of $0.55 and 0.45 euro.

The adjustments to the corridor's boundaries were prompted by the fundamental changes to the state of the global economy. For Russia, that was reflected first and foremost in Russian banks and companies losing access to new loans and refinancing for existing loans, massive capital outflows and steep declines in Russian export commodities.

The rolling nature of the adjustments enabled Russian banks and companies to react to currency risks and, therefore, made is possible to avoid the negative consequences of an abrupt drop in the ruble exchange rate, for the overall economy and for individual economic sectors, the statement says.

According to Central Bank calculations, which largely coincide with those by the Economic Development Ministry, the current ruble exchange rate, given the current prices of oil and other major export commodities, will equalize the current balance of payments.

The actual value of the currency basket within the corridor will be based on market factors and on Central Bank interventions. It could be substantially below the corridor's upper bound.

In order to ensure ruble stability, the Central Bank will continue using other fiscal instruments such as interest rates, quantitative limits on refinancing volumes.

It has not been determined exactly how long the upper threshold for the corridor will remain in place, but it could be months.

Ignatyev said a factor such as world oil prices could force the Central Bank to change the upper threshold. If the oil price will be $37-$38 per barrel, the Central Bank is unlikely to change the threshold, but if the price falls to $30 and remains at this level for an extend period of time, the Bank may have to change the threshold.

Ignatyev said the Central Bank set the upper threshold for the basket at 41 rubles "with a certain reserve," considering risks related to falling world prices for certain Russian export commodities.

The lower threshold of the corridor for the dual currency basket is 26 rubles, but it is currently irrelevant and may therefore be adjusted.

"The lower threshold - 26 rubles, is currently irrelevant, but could become relevant when oil prices go up. Perhaps we will adjust it considering its irrelevancy, but this is not an issue for the time being," Ignatyev said.

A good time to stop the "nonsense"

The new upper threshold for the currency corridor is economically sound, MDM Bank (RTS: MBWB) chairman and former Central Bank first deputy chairman Oleg Vyugin said.

"With such a ruble exchange rate against the dual currency basket, the current account balance will be positive even at an oil price of $30 per barrel. That is, there will actually be an inflow of foreign currency into the country through trade operations," he said.

"Clearly, the Central Bank can still sometimes sell foreign currency before the exchange rate approaches the set up threshold, based on the schedule of payments on foreign debt," Vyugin said.

Theoretically, the ruble's exchange rate could fall to the new threshold - "you can go far on panic" - but then there will still be a rebound as the economic course is sound and there will be an inflow of foreign currency, Vyugin said.

On the other hand, the resources of market players are limited and they cannot accumulate so much liquidity," he said.

In the near future, one can expect the exchange rate to fluctuate while gradually weakening within the bounds of the corridor, Vyugin said.

MDM Bank analyst Nikolai Kashcheyev said the current situation was a middle ground "between a dirty float and a clampdown on liquidity, with a big bow toward a dirty float due to the very wide corridor."

"It was done at a very good time, as ruble liquidity on the market is bad due to tax payments and other factors. And the Central Bank has slightly squeezed liquidity, recently lowering limits for unsecured auctions and swaps. Against this backdrop, they simply announced that there is an upper limit to devaluation, as they see it, thus eliminating the question of when will it end. Now is a time when the market has virtually no strength left to speculate in favor of the dollar. It's a good attempt to finally stop this nonsense," Kashcheyev said.

"In the short-term - I won't assert this 100% because there may be hidden speculators sitting in ambush - this could lead to a certain correction. Indeed, there are very many (long positions) on the dollar on the market. The liquidity of the currency market is not very good right now, meaning they overbought," Kashcheyev said.

Speaking about a possible reduction of unsecured lending to banks, he said that the Central Bank would likely "monitor the situation and try to hold the corridor with the help of such methods as well."

"Essentially, the Central Bank is preparing to move to a free exchange rate. The Central Bank is setting the stage so as to completely leave the currency market," UniCredit Aton analyst Vladimir Osakovsky said.

The Central Bank has chosen a very appropriate time for such a step, as now is the period of tax payments and speculative pressure on the ruble will be minimal, he said, adding that this was absolutely the right decision and it should have been made back in November.

Osakovsky said the ruble is now fairly close to its balanced exchange rate, which he reckons is 34.5-35 rubles per dollar or 40-41 rubles against the dual currency basket. In light of this, he expects the situation on the money market to improve, as currency speculation dies down.

"The Central Bank has done its work. It has announced the new reality, which will come tomorrow. Thus it has proven that it can control the exchange rate," Trust Bank analyst Yevgeny Nadorshin said.

The designation of the upper threshold does not mean that the rate for the dual currency basket will hover there, however it will take some time for the currency market to calm down, he said.

"Many wanted the dollar to cost 45 and even 55 rubles or more, there was very active foreign currency buying. Several weeks will be needed for the market to calm down," Nadorshin said.

He compared the adjustment of the rate and establishment of the technical corridor to the Central Bank's actions in October to restore stability in the banking sector. "Then, in October, the Central Bank handled the problem admirably, and it has done the same now," Nadorshin said.

UBS analyst Dmitry Vinogradov said the Central Bank's decision is a step in the right direction, as the instability of the ruble is one of the key problems in the Russian economy, a factor in nonpayments, nonworking banking system and problems in the real sector.

"Why work when you can earn a profit on the weakening ruble?" Vinogradov said.

He said that the Central Bank first accelerated the weakening of the ruble, bringing it in line with current prices for commodities, particularly oil. Now it wants to show the market where the ruble exchange rate will be, so that businesses and banks can work normally.

The expansion of the corridor gives the Central Bank a fairly free hand in managing the exchange rate, as it is still clearly the biggest player on the currency market, Vinogradov said.

The situation with ruble liquidity in the banking system will improve, but one should not expect immediate changes. In order to ease pressure on the ruble, the market still needs to make sure that everything will be like the Central Bank says, Vinogradov said.

Word and deed

Alfa Bank (RTS: ALFB) analyst Nataliya Orlova, unlike most of her colleagues, downplayed the Central Bank's actions.

"On one hand, many reproached the Central Bank for not being very transparent. Now it has come out with commentary. On the other hand, this is a commentary on what is evident. The main question was whether the Central Bank would continue to increase support for the banking sector and increase ruble liquidity - this was the main factor that was putting pressure on the currency market. Simply a verbal intervention, that the Central Bank will set the basket at a certain level, does not actually help the market and confidence in the stability of the ruble has been seriously undermined," Orlova said.

"I don't really understand what the point of this (Central Bank) press conference was. To calm, that's clear, but I would like to hear about some real mechanisms with which the stability of the ruble will be supported," Orlova said.

For example, if one were to say that the Central Bank will reduce the amount of unsecured lending to banks by 30% in the coming month, then tomorrow there would be sales on the currency market, she said.

Whether or not the value of the dual currency basket rises to the upper threshold will depend on whether the Central Bank will provide liquidity. "If it will provide it, then it will go up quickly, if not then it will not go up at all and the ruble will strengthen. This depends exclusively on the supply of money," Orlova said.

Read More about Services from Alinga Consulting Group

Source: Interfax