Last month, the Bank of Russia announced a floor under the rouble. So much for that. The floor was already tested this week and the central bank is burning through reserves faster than Putin does ABBA cover bands. On the surface, we would expect Russia to have little difficulty in defending the rouble, given the substantial accumulation of foreign exchange reserves in recent years (high commodity prices + booming exports + the long shadow of the 1998 rouble crisis = big time reserves). But look a little deeper, and that cushion isn't quite a comfortable as it appears.
In fact, Russia is in big, big trouble.
The Russian government didn't anticipate the sudden, rapid decline in commodity prices (to be fair, few did), and it is now struggling to balance its obligations amidst declining revenues and FX earnings. Its 2009 budget relies on $95/barrel oil, and billions of dollars have been committed in support of the banking sector (not to mention the money provided major companies crippled with debt). Defending the rouble and supporting the banking sector/companies alone consumed approximately 40% of Russia's FX reserves since summer 2008, and were a major factor in the Fitch downgrade on Wednesday. If the government's recent actions are any indication, Russia's foreign exchange reserves will come under increasing pressure in 2009. It delayed discussions on amending the budget, and publicly stated that it won't make any cuts to this year’s spending. With social instability spreading, it is unlikely the government will make any significant cut to the budget over 2009-2010. Furthermore, its new crisis strategy directly targets the banking sector, which should be applauded, but will require a significant amount of capital.
Which brings us back to the rouble. The central bank's ability to defend the rouble will be seriously constrained by the budget and banking sector support. Its decision to gradually devalue the rouble, as opposed to allowing it to freely fall to its market equilibrium, has proven ill advised and sacrificed a greater share of foreign exchange reserves than was otherwise necessary. Little official debt, falling imports, and the complacency of the Russian elite would have made a single devaluation possible. But now the central bank is in a bind; let the rouble fall and you risk a loss of confidence in the central bank, keep defending it in the hope that the oil price recovers and you play a dangerous game of Russian roulette (no pun intended).
Russia's spending and banking sector support are necessary under the current economic and financial conditions. The market already expects a further devaluation of the rouble; artificially supporting it is a losing battle that only increases the risk of a serious run on the currency and drains its foreign exchange reserves. Russia should set the rouble free.
In fact, Russia is in big, big trouble.
The Russian government didn't anticipate the sudden, rapid decline in commodity prices (to be fair, few did), and it is now struggling to balance its obligations amidst declining revenues and FX earnings. Its 2009 budget relies on $95/barrel oil, and billions of dollars have been committed in support of the banking sector (not to mention the money provided major companies crippled with debt). Defending the rouble and supporting the banking sector/companies alone consumed approximately 40% of Russia's FX reserves since summer 2008, and were a major factor in the Fitch downgrade on Wednesday. If the government's recent actions are any indication, Russia's foreign exchange reserves will come under increasing pressure in 2009. It delayed discussions on amending the budget, and publicly stated that it won't make any cuts to this year’s spending. With social instability spreading, it is unlikely the government will make any significant cut to the budget over 2009-2010. Furthermore, its new crisis strategy directly targets the banking sector, which should be applauded, but will require a significant amount of capital.
Which brings us back to the rouble. The central bank's ability to defend the rouble will be seriously constrained by the budget and banking sector support. Its decision to gradually devalue the rouble, as opposed to allowing it to freely fall to its market equilibrium, has proven ill advised and sacrificed a greater share of foreign exchange reserves than was otherwise necessary. Little official debt, falling imports, and the complacency of the Russian elite would have made a single devaluation possible. But now the central bank is in a bind; let the rouble fall and you risk a loss of confidence in the central bank, keep defending it in the hope that the oil price recovers and you play a dangerous game of Russian roulette (no pun intended).
Russia's spending and banking sector support are necessary under the current economic and financial conditions. The market already expects a further devaluation of the rouble; artificially supporting it is a losing battle that only increases the risk of a serious run on the currency and drains its foreign exchange reserves. Russia should set the rouble free.
(photo from melted snowball's photostream)
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