Ben Aris in Moscow -
The Russian ruble crashed again on December 15, in the biggest fall since the last big crisis in 1998. The Central Bank of Russia (CBR) belatedly stepped in with a huge interest rate hike overnight, but it has been roundly criticised for being "behind the curve" and unnecessarily threatening the stability of Russia's financial sector.
"You have to kind of ask yourself what a central bank is doing when it lets its own currency fall by 10% in a day, when it has $420bn in FX reserves (like 18 months of import cover). This is extreme central banking, and the question is what are they trying to achieve?" asked the ubiquitous Tim Ash, head of emerging markets research at Standard Bank. "Moves like this create systemic risks – the risk of panic amongst the general population, and surely risks of major deposit flight. And it also comes on the back of already huge moves in the exchange rate."
The ruble has now lost over half its value to the dollar this year – a UK penny was worth more than a ruble on December 16 for the first time ever – while all previous attempts by the CBR to stop the rot have failed. Bankers like Ash are complaining that the central bank's rate hike of earlier in December by 100 basis points and the lack of intervention on the currency market have led to a rout that threatens to spin out of control. Russia watchers had been expecting at least a 150bp hike, and the ruble entirely ignored the increase and continued to slide, before taking another big step-down on December 15.
At a late night panic meeting on December 15, the CBR finally conceded defeat and pushed through a massive 650bp increase in the key policy rate that will almost certainly kill off growth in 2015 and lead to a deep recession on the order of "at least 4.5% in 2015 if oil stays at $60", the CBR said in a statement. The choice has become between a recession next year or a financial crisis now – and the CBR has gone with recession in 2015 as the lesser evil. "This decision is aimed at limiting substantially increased ruble depreciation risks and inflation risks," the central bank said in a statement.
The CBR also said early on December 16 that it would increase the maximum volume of foreign currency it provides to Russian banks, via its forex repurchase agreement auctions for 28 days, to $5bn from $1.5bn.
Unfortunately, the aggressive move looks to have been in vain. Despite coming out of the gate with a 9% gain at the opening of the market on December 16, the ruble has since given up all those gains and by midday Moscow time was down about 3% on the day.
Keeping the power dry
CBR Governor Elvira Nabiullina has made it clear that the last thing she wanted to do was hike rates, as she has been more worried about the effect on Russia's already low growth (Russia will finish 2014 with about 0.5% growth). But in the end, say critics, she now has the worst of all worlds: $100bn has been spent managing the currency lower; total rate hikes this year are still a growth-killing 10%; and the ruble's value has still been cut in half. Some are already calling for her head.
Nabiullina has said that she believes the fall in the ruble is "temporary" as it adjusts to the falling prices in oil, which are also "temporary" and she expects both to rebound next year. The plan was to keep the powder of hard currency reserves dry now, so that Russia could cope with the pain of long-term financial sanctions.
"This is a really high risk strategy from the CBR, and I think few global central bankers would buy into this one. The only thing I can think is what I have been saying for some weeks now, that FX reserves have been deemed mega strategic due to the geopolitical setting and to be conserved at all cost – while the CBR has also been told not to raise policy rates that much," says Ash.
Russia's heavy dependence on oil for budget revenues means that, now the ruble has become a freely floating currency since November, it is only natural for the ruble to recalibrate to the lower oil prices. The Brent oil price was just over $60 at the open of trading on the morning of December 16, but had dropped below this level by mid-morning. If oil loses about half its value, then so should the ruble. What traders and economist are objecting to is the fact that the CBR has not used some of its $416bn in forex reserves (down $4bn on the week last week) to smooth out the fall.
The danger is causing a panic. A crashing currency unsettles depositors, who rush to withdraw cash and destabilise the banking sector. Surprisingly, the crisis-hardened Russians have not panicked so far, as many have anticipated this devaluation, leading to soaring car and apartment purchases this year. But such a large movement could tip them over the edge. In the last two years both the Indian and Turkish central banks have faced similar crises, and massively hiked interest rates by hundreds of basis points to successfully quell fears and stave off potential bank runs.
The collapsing ruble will only hurt corporate Russia more. Underneath the currency crisis Russia has been suffering from a much more debilitating "investment crisis" – the instability means that Russia's business owners have halted investment plans and fixed investment was already falling this year, without which Russia has no chance of growth.
Banks are in a stronger position having already built up some $40bn in hard currency reserves in 2014 and so are better able to weather the storm. However, the high interest rates will kill their lending business, cutting them off from one of their main sources of income. It will also accelerate the accumulation of non-performing loans, which have been at modest levels in 2014 and are not an immediate threat to the system. But banks were already struggling to make profits in 2014, which were down by a quarter from the peak profits of over RUB1 trillion in 2012, and 2015 will be an even more difficult year for the sector.
The generally accepted theory on the CBR's inaction is that the US/EU financial sanctions have been far more successful than Russia at first anticipated; with more than 1.8 years of hard currency reserves in the bank, Russian President Vladimir Putin calculated Russia could tough it out. However, now the CBR is called on to burn through about $10bn a week ,that cash pile doesn’t look quite as big.
The focus changed about two weeks ago at the CBR when it stopped intervening and allowed the ruble to sink unhindered as the hard currency reserves have become a "strategic resource". The CBR preferred to let the ruble slide so that it could keep its cash to support the banking sector and help cover an estimated $150bn of debt repayments that come due next year – mostly money owned by big state-owned corporations that have been cut off from refinancing their debt on the international capital markets by financial sanctions.
Oil prices fell to below $40 in 2009 and caused none of the panic that Russia is currently feeling. What scares everyone this time around is that oil prices could fall to $40 and stay there for at least a year. In 2009, low oil prices were seem as temporary and Russia's low debt levels reassured investors that it could borrow its way out of trouble if it really had to. Today, financial sanctions mean that Russia will have to rely entirely on its hard currency reserves and now no-one is expecting oil to return to $100 a barrel next year.
A debate has started on where the "red line" is for a fall in Russia's forex reserves; how far do they have to fall before Russia's financial system goes into meltdown? On paper, Russia should be fine, all other things being equal, until $60bn, or three months’ worth of import cover (and Ukraine's economy is currently defying gravity with half this amount of import cover).
The economist Anders Aslund suggested in a recent blog that Russia's reserves are actually $200bn of "useable money" and so a collapse could come even earlier, but as bne argued in a blog, this is an extreme view.
On December 16, the Association of Institution International Finance said the red line for Russia's hard currency reserves was at $330bn, whereas Charlie Robinson, chief economist at Renaissance Capital, said in a tweet, "We strongly disagree," pointing out that Russia still has $270bn of cash reserves and another $170bn in the two reserve funds, which should be more than adequate to support the ruble. The CBR's new policy of letting the ruble sink means that the money will last much longer.
Nabiullina has been betting that the oil price will stop falling soon and the price rebound to something like $70, bringing the ruble up with it. But that looks a lot less likely now and last night's rate hike suggests the CBR has caved into a new, much darker economic outlook.
Everything now depends on whether the oil price stabilises and at what level. There has been a lot of speculation that Opec members, and Saudi Arabia in particular, are happy to let oil prices fall in the short term to drive marginal US shale oil producers out of business. But the selloff is causing its own problems.
"Financial investors into oil have stop-loss positions which cause them to sell off their positions whenever the prices falls to certain levels," says one senior Russian fund manager, who has just been negotiating with Arab sovereign wealth funds. “What we are seeing now is several of these mandatory sell-offs being triggered, each one which drives oil down to the next trigger level.”
Most worryingly, Russia's problems are starting to spread. Ukraine has been in deep trouble all year and it is now teetering on the edge of collapse; its hard currency reserves dipped below $10bn earlier this month, or about 1.3 months’ of import cover. The hryvna is down by some 40% since the start of the year and the only thing holding it up now is the promise of more international bailout money in the new year.
Kazakhstan devalued the tenge in February by 18%, but all the wiggle room it created has now been used up. Fears of another devaluation are mounting fast, as Kazakhstan's economy remains closely tied to Russia's as well as being a major oil exporter.
The falling currencies are no longer just hitting countries that are tied to Russia and the contagion is spreading out, leading some to start talking about a repeat of 1998 when oil prices fell to $10. Last week the Turkish lira sank to its lowest levels against the dollar for a year, despite the fact it is one of the big winners from falling oil prices, as it is heavily dependent on oil and gas imports. Likewise, China, another major energy importer. has watched its currency fall by 26% since May, and 7% since the end of October alone.
Collapsing currencies around the world, coupled with the "death spiral" of selling in the oil markets, is sparking worries that we are coming to the point where things could spin out of control – and not just for Russia.
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