There has been much speculation that the crisis in Ukraine will lead to a spike in capital outflows and a collapse of the rouble, just as happened in the aftermath of the August 2008 war with Georgia.
But markets retain their faith that the trinity of high oil prices, large FX reserves and the central bank’s credible backstop will shore up the currency.
“Even the collapse of Russian asset markets around the time of the Georgia war had little to do with that conflict and everything to do with the price of oil collapsing from $150 per barrel [p/bbl] in early summer to less than $40 p/bbl barely six months later,” says Christopher Weafer, CEO of CJW Macro-Advisory, in Moscow.
“The price of Brent crude is holding close to $110 p/bbl and looks safe due to supply disruptions in Africa and the Mid-East, plus steady demand growth. [What’s more], unlike in 2008/09, Russia has a sound balance sheet and favourable budget execution,” he adds.
Barring a worsening of the Ukraine crisis, Russia’s economy and, by extension, its currency, should be able to weather the storm, say bullish Russia observers.
As tensions in the Crimea ratcheted up on Monday, the Central Bank of Russia (CBR) implemented a temporary emergency 150 basis points hike its main policy rate to 7%, the Micex equities index dropped through its key 1300 support level, and the rouble traded through the top of the day’s trading corridor.
However, as Russia ended its military exercises on the border of Ukraine a day later, the rouble returned inside its daily corridor, the Micex jumped the most in four years, while analysts maintain that they were expecting at least a 50bp hike in interest rates in any case.
Moscow remains upbeat. According to a statement on Monday by the CBR’s first deputy governor Ksenia Yudaeva, the interest rate hike should not just bring the rouble's depreciation to a halt but may also lead to a currency appreciation in the medium term.
Broadly, the direct impact from the crisis in Ukraine on Russia’s economy appears limited, as Ukraine accounts for under 5% of Russia’s total trade, says Jacob Nell, senior Russia economist for Morgan Stanley in Moscow, although there could be a ‘security shock’ that would hit growth via slower consumption growth (as a result of increased savings) and a fall in investment (delayed in the face of uncertainty).
While analysts are bullish on the CBR’s role as a backstop to the currency, oil prices are exerting a weaker influence on the currency compared to recent years. In other words, the idea that high oil and gas prices will offset economic contraction, triggered by the Ukraine conflict, overlooks the changing correlation between the Russian economy and hydrocarbons prices.
“Stronger trading in oil prices should have been good for Russia, but this hasn’t been the case for the past two years as, even before the tapering began, the number of same-sign weekly moves between the rouble and oil prices, which can be seen as a simple measure of commonality, has reached historical lows,” says Olgay Buyukkayali, head of emerging markets research for Nomura International in London.
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One of the probable reasons for this breakdown, he adds, is the trend deterioration in the current account.
“For a country that had a current account surplus above 5% of GDP in 2011, the current account reaching its lowest level since 2008 is remarkable given that oil prices have been in a 15% range for the past two years; and preliminary Q4 figures signal that the 2013 current account has narrowed to $33 billion or 1.5% of GDP, despite high oil prices,” he adds.
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Under the assumption that the average oil price stays around $101 p/bbl, the CBR expects the current account surplus to deteriorate to $19 billion, which is around 0.9% of projected GDP. However, citing a fall in investment income and trade, Buyukkayali concludes that, even if oil prices stay around current levels, the current account balance would contract to $15 billion or 0.6% of GDP, with Q2 and Q3 recording current account deficits.
As a contributing factor, says Morgan Stanley’s Nell, although nowhere near the scale of the 2008 Georgia crisis period, there is still persistent private sector capital outflows from the country.
“In 2013, despite a fall in political uncertainty and a broadly pro-business policy agenda and government, capital outflows amounted to $62.7 billion, 3% of GDP, higher than the $54.6 billion outflows in 2012, and we see this as evidence that capital outflows are persistent and are likely to fall only gradually in response to sustained structural reforms,” he adds.
Although the combination of a shrinking current-account surplus and persistent outflows implies sustained pressure on reserves and the rouble, neither of these mean that the currency will fall out of bed any time soon, even if the Ukraine crisis rolls on in its current contained form.
Additionally, says Oleg Kouzmin, FX strategist for Renaissance Capital in Moscow, the central bank policy allows the currency a great degree of flexibility to float within a corridor against its target dollar-euro basket. This policy has beefed up the central bank’s credibility to ward off speculative FX attacks.
He adds: “The central bank has stated that it will set the amount of market interventions it takes to shift the trading band on a daily basis, giving officials more flexibility in determining how many dollars it sells at a given price level before weakening the rouble’s trading band, and this is a major advantage for the rouble.”
In this context, on Monday, the central bank confirmed that it boosted the threshold of accumulated interventions required for a R0.05 shift in the boundaries of the FX intervention band from $350 million most recently to as much as $1.5 billion.
“The statement explicitly linked the decision to suspend the previous rules-based mechanism (in favour of fine-tuning parameters of the intervention band on a daily basis, depending on the CBR's assessment of the current situation) to a spike in volatility in the domestic FX market,” says Sergei Voloboev, emerging markets economist at Credit Suisse in London.
Since the inception of the current mechanism, the CBR has been progressively reducing the intervention threshold for a band shift, from $750 million in 2009 to $350 million in December 2013.
“The associated increase in the flexibility of the intervention mechanism has been a key policy objective of the CBR, alongside the narrowing of the interest rates corridor, and Monday’s shift in the threshold was clearly caused by a sharp change in operational environment, specifically the risk of a military conflict with Ukraine that triggered a dramatic surge in demand for FX, particularly from households,” concludes Voloboev.
This well-flagged policy means the greater flexibility in the FX regime and growing sophistication of monetary policy – as the CBR rejects capital controls and argues for an inflation-targeting regime – are two reasons why analysts are broadly bullish the rouble trading band can be maintained, buoyed by the CBR’s $500 billion war chest and barring an escalation of the conflict. Nevertheless, the structural challenges on the current account raise questions about whether or not medium-term rouble appreciation will meet Moscow’s expectations.