Russia halts the rouble's depreciation | Done with depreciation? | The Economist

Done with depreciation?
Jan 28th 2009From the Economist Intelligence Unit ViewsWire
Russia arrests the decline of the rouble
Russia’s authorities have signalled an end to the policy of gradual rouble depreciation, although the new wide trading band allows the currency room toweaken further against the dollar/euro basket. Assessing an equilibrium rate for the currency is difficult, yet there are no clear signs that it is nowovervalued. There is an expectation that the new floor will be tested within weeks or months; however, it is a confrontation that the authorities may eitherstill be able to avoid or else choose to shy away from.
The Russian Central Bank (RCB) announced a change in its policy towards the rouble on January 22nd, widening the trading band for the rouble against thecurrency basket (55% US dollars and 45% euros) to 26-41 and insisting that this would hold for several months. On that day, the rouble closed at 37.03versus the basket and Rb32.73:US$1. Since then it has weakened, reaching 37.85 versus the basket by the afternoon of January 27th. At that point, againstthe basket’s two currencies, the rouble stood at Rb43.73:€1 and Rb33.01:US$1.
In August the rouble had traded at Rb36.2:€1 and Rb24.4:US$1. Since then investor sentiment towards Russia has reversed dramatically, reflecting a combinationof concerns over the business environment, declining oil prices, weaker economic performance, increased tensions with the West and, above all, the globalfinancial crisis. This has prompted the RCB to inject considerable liquidity into the economy. This has, however, exacerbated pressure on the rouble inrecent months, prompted above all by the dramatic decline in international oil prices and the imminent shift of Russia's current account and budget balancesinto deficit. Russia is not alone in this regard. Most of the states in eastern Europe have seen their currencies fall against the dollar and euro sinceAugust 2008 and have suffered marked falls this year.
Gently does it
The authorities have sought to prevent a large, one-off devaluation, as it is feared that this would trigger large-scale capital flight, and spark publicpanic and a banking crisis. Thus the RCB adopted a gradual, managed approach to the exchange-rate changes. Between early November and mid-January it undertook18 step devaluations of the rouble against its basket, leading to a weakening of the rouble by more than 20%. Thereafter the central bank stepped up thepace of the mini devaluations amid concerns about a further decline in oil prices and about the scale of foreign-exchange reserve losses; the latter totaledUS$30bn in the week ending on January 16th. Foreign-exchange reserves have declined by around US$200bn since the second week of August, to stand at US$396bnon the most recent data. However, this decline is not solely the result of RCB interventions: part of the decline is explained by the strengthening ofthe US dollar against the euro, which has reduced the dollar value of the portion of Russian reserves held in euros.
The RCB’s January 22nd announcement was taken by some as drawing a line in the sand: the central bank has now indicated the minimum value of the roubleversus the basket and the dollar, and stands ready to defend this if need be.
Defendable position?
If this interpretation of the central bank’s stance is correct, it raises a question: does 41 versus the basket represent an equilibrium level for the rouble?If so, the RCB’s chances of fending off a speculative attack—which is widely expected among market watchers—would rise.
Assessing the equilibrium exchange rate for the rouble is not straightforward. However, based on exchange-rate movements and relative consumer price indicesin Russia and its top 20 trade partners, the real effective exchange rate of the rouble at present is roughly the same as in 2006. In that year the EconomistIntelligence Unit estimates that the rouble was still slightly undervalued relative to its estimated equilibrium level (based on the level of Russia'swages relative to its productivity and other drivers).
The equilibrium rate would change significantly according to other factors. If, for instance, the oil price were to collapse from the current level of aroundUS$44/barrel for Urals Blend, or if the authorities engaged in a massive injection of liquidity, the equilibrium level would be weaker.
Ignatiyev’s last stand?
Those anticipating a grand struggle between currency speculators and the RCB may be disappointed. As the central bank made clear, the decision to maintain41 roubles to the basket as the lower end of the trading range is only applicable for a matter of months. Moreover, as RCB head Sergei Ignatiyev has said,it would have to be revised in the event that the oil price fell to around US$30/b and stayed there.
Furthermore, the RCB has indicated that it will intervene in and around the trading bands, thus injecting more uncertainty into the market. It is equallyplausible that it might on occasion allow the rouble to weaken beyond 41 to the basket. Consequently, the central bank may prove to be a less elusive targetthan currency speculators would prefer.
When the RCB does choose to intervene, it can draw on what is still a huge pile of foreign reserves. In addition, the central bank is the major determinantof the level of liquidity in the system and it has in recent days put limits on the volume of currency swaps made available. Thus it has a range of toolsto defend the rouble when it chooses to do so.