28/8/15: CBR and Ruble: Fiscal Balance in Oil's Shadow

As I noted earlier this month, Russia has officially entered the recession. The key drivers for 3.4% contraction in 1H 2015 were the same as the key pressures on growth back in 2H 2014: oil prices, investment collapse on foot of high interest rates, inflationary environment that restricts CBR's room for cutting rates, and sanctions (or rather geopolitical risks and pressures, linked in part to sanctions).

That said, in June and early July there were some hopes for economy starting to stabilise, although fixed investment was down 7.1% y/y in June, marking 18th consecutive month of y/y declines. These are now once again under pressure and the cause is... oil price.

Here is how closely paired has Russian Ruble been to oil prices in trend terms since July 2014, although correlation was weaker in preceding period. Overall, as the chat shows, there are two very distinct periods of Ruble valuations catch up with oil prices: June 2014-February 2015 and mid-July 2015 through present.

Russia's Central Bank is switching between little concern for Ruble to interventions and back to staying out of the markets appears to be more than a simply random walk. Instead, it is a game consistent with rebalancing Ruble valuations to fit budgetary dynamics.

The reason for this is that (as shown in the chart above) Ruble strengthening above oil-linked fundamentals earlier this year was an actual threat to budgetary dynamics, and over the last couple of weeks, correcting valuations of Ruble re-established closer connection to oil prices. Hence, in July, CBR managed to deliver a shallower cut to interest rates (-50bps) compared to June (-100bps).

With CBR continuing to stick to its June 2016 forecast for inflation to fall to 'under 7%' by then and hit 4% in 2017 compared to July 2015 CPI at 15.6%, Russia went on to issue its first CPI-linked bonds / linkers amounting to RUB75 billion (OFZ-IN, 8 year notes) at 91% of nominal, on cover of RUB200 billion (more than 25% of demand coming from foreign investors). Real yield at issuance was 3.84% - relatively high-ish, implying underpricing of the bond in a market with relatively hefty demand and forward expectations for significant easing in inflation. Something is slightly amiss here.

In line with up-down interventions, the CBR continued to trend flat on foreign exchange reserves. End of June, total Russian FX reserves stood at USD361.575 billion, and by end of July these fell to USD357.626 billion. As of last week, the reserves were back up at USD364.6 billion.

Weekly data from CBR does not allow for compositional analysis of reserves, but looking at the monthly data the pattern repeats.

Actual liquid FX reserves and gold stood at USD347.1 billion at the end of July against USD350.957 billion at the end of June. This is barely up on end-April period low of USD345.373 billion, although well within the FX- and gold-valuations range of change.

Meanwhile, data through July 2015 shows net purchases of dollars of USD3.76 billion against USD3.831 billion in June and USD2.531 billion in May by CBR. Overall, from January 2015 through July 2015, CBR bought (net) USD7.8 billion and there were no net purchases/sales of euro.

All of the above suggests that CBR will likely resume rate cuts if Ruble firms up from its recent valuations. Two weeks ago, RUB/USD was at 64.947 (72.197 to Euro), peaking at 70.887 four days ago (82.373 to the Euro) and currently at 66.8875 (74.984 to Euro), not exactly warranting a move by the CBR yet, but back in the relative comfort zone for the Bank to sit on its hands once again.

18/6/15: Russian Central Bank Targets Rebuilding of Foreign Reserves

Recently, speaking at a banking conference in St Petersburg, Elvira Nabiullina, head of the Central Bank of Russia outlined the CBR position on foreign exchange reserves. Nabiullina note that Russian reserves are large - sufficient to cover almost 11 months of imports. However, Nabiullina's 'comfort zone' target for the reserves to cover 2-3 years of "substantial capital outflows", implying she would like to see Russian reserves rising back to USD500 billion mark. Nabiullina is now targeting purchases of forex over the next few years to drive up reserves and to that objective she has been buying on average USD200mln worth of forex per day since mid-May.

In line with forex reserves rebuilding objective, Nabiullina cautioned about markets expectations of further large scale cuts to interest rates as the CBR is trying to balance out inflation targeting (requiring tighter monetary policy), investment supports (requiring looser policy) and accumulation of reserves (implying looser policy).

Per Nabiullina: "Attempts to reduce the interest rates too fast or even acquire certain assets may simply lead to stronger inflation, to an outflow of capital or to dollarisation of the economy, and that would slow down the economic growth, other than promote it."

In its latest outlook, CBR forecast unemployment reaching 6.5% this year from the current rate of 5.6%, before falling to 5.6-5.8% by 2018. GDP is expected to shrink 3.2% in 2015, returning to trend growth of 1.7-2.4% around 2017-2018. Inflation is expected to hit 11% at the end of 2015 with rather optimistic outlook for a decline to "less than 7%" by June 2016, and "close to the target level" of 4% in 2017.

Net capital outflows are expected to decline from USD90 billion in 2015 to USD55-65 billion in 2018. "We are expecting the financial sanctions against Russia to remain in place. Payments on foreign debts during this period will constitute the bulk of the capital outflow. It will gradually reduce from $90 billion to about $55-65 billion during 2015-2018, depending on the scenario," according to Nabiullina.

Russian International Reserves reached USD360.6 billion at the end of last week, up on USD356 billion low registered in April 2015. Still, the reserves are down USD117.7 billion y/y (-24.6%) and down USD132.73 billion (-26.9%) on pre-sanctions period.

10/4/15:Ruble's Mysterious Rise: Some Thoughts

There is an interesting debate starting up around the Ruble: in recent weeks, Ruble appreciation against the USD has pushed it out of its traditional long term alignment with oil prices, as noted in the chart below:

Source: @Schuldensuehner 

There are several possible factor that can account for this.

1. Oil price expectations - if the markets expect oil prices to rise further, Ruble buyers can bid the currency up ahead of the oil price changes. This is unlikely in my view, as we are not seeing oil price firming significantly in both spot and futures markets.
2. Oil price revelation - if the markets priced in severe forecasts uncertainty linked to oil price dynamics to the Russian economy back in October-December 2014, then the new information about Russian economy's performance in Q1 2015 should lead to re-pricing of risks. In my opinion, Ruble was heavily oversold in December (not in october-November) and there is some upside potential, given that the Q1 2015 data coming out of the Russian economy is not as apocalyptic as some currency markets analysts expected. Notably, there has been a significant cut in USD long positions vis-a-vis Ruble in recent days, which signals speculative re-alignment toward long-Ruble.
3. Demand Factor 1 - March is the end of Q1, so it is the month of rising demand for Ruble to cover corporate tax liabilities (Russian corporates pay taxes in Rubles). VAT receipts are also coming due. And estimated forward taxes and charges. In my opinion, this helps to temporarily boost Ruble valuations.
4. Demand Factor 2 - March is the last month before major companies in Russia are due to reverse their forex holdings to October 2014 levels (per December agreement hammered out by President Putin). This means increased supply of USD and other currencies, and increased demand for Rubles. Again, a temporary factor, in my opinion.
5. Supply Factor - March and April are also large months for corporates to book in energy-related exports earnings. Note that Russian Central Bank is recording a small rise in reserves in late March, followed by a decline in April.
6. Demand Factor 3 - March also was the month of largest (for 2015) external debt redemptions by Russian banks and corporates. Repayment of these debts involves buying dollars and selling Rubles, but timing-wise, companies have been pre-building their forex reserves for some time, so it is most likely that in recent 3 weeks there has been less demand for dollars (and other forex) than in previous 2 months. Note, I covered this here: http://trueeconomics.blogspot.ie/2015/04/8415-rubles-gains-are-convincing-but.html
7. Demand factor 4 - since the start of 2014, Russia actively pursued reduction of the degree of dollarisation in its economy. The first stage of this process involved increasing trade settlements in other currencies (most recent one - announced this week - with Indonesia). This, alongside with imports collapse, reduced external trade-linked demand for dollars. The second phase of de-dollarisation started in February, when Russian retail deposits started exiting dollars and shifting back into Ruble on improved confidence in the banks and high deposit rates. Again - a temporary support for the Ruble.
8. Demand factor 5 - as Russian CDS show, probability of default declines for Russia sustained in recent weeks implies improved demand for Russian Government (and local) bonds, issued in Ruble markets. The result is improved demand for OFZs and, thus, for Ruble. 
9. Real vs Nominal exchange Rates - inflation dynamics in Russia are most likely drawing a gap between real and nominal exchange rates, so nominal rate firming up is not imposing equivalent increase in the real rates. 

In other words, we have many, many moving parts to one equation. One can't tell the dominant one, or which are likely to last longer, but my sense is that majority of these forces are temporary and the long-run link between Ruble and oil price will be regained.

Now, assuming oil price dynamics remain where they are today (weak upside), Ruble is likely to devalue again, back to USD/RUB 55-57 range. If inflation does not fall toward 10% in Q2 2015 (and I do not think it will), we are likely to see Ruble move into USD/RUB 60-65 range over this quarter. On the other hand, improved outlook for the economy (signalling, say annual contraction closer to 3.5-4 percent) can see Ruble staying within the USD/RUB 50-53 range.

One thing is for sure: so far, the Central Bank of Russia has managed damn well its dance in a very tight monetary policy corner between runaway inflation, prohibitively high interest rates and a massive squeeze on forex valuations. How long this 'smart game' in multidimensional and highly dynamic chess can go on is everyone's guess.

20/3/15: Central Bank Interventions in Ruble Markets down to Zero in February

Don't hear much of "Panic at the Central Bank of Russia" reports as of late in the Western media - the ones that whipped into frenzy Russia 'analysts' back in November-December? Why, no surprise:

Per latest data, CBR interventions in forex markets defending the Ruble have shrunk in February 2015 to zero for USD and zero for EUR. Yep, zero.

Oh, and the table above shows, the panic of November-December 2014 Ruble crisis - real as it was - was not as bad as CBR supporting Ruble prior to the free float and during the peak of Crimean crisis.

So was the decision to let Ruble float wise? You decide. On the trend, it saved CBR some USD8.5 billion and EUR1.2 billion, even counting in December 2014 crisis.

1/1/2015: Russian Reserves Down USD10.4bn in the Week of December 26th

CBR published data on Russia's foreign exchange reserves for last week (through December 26th), showing another drop in reserves to the tune of USD10.4 billion. So far, since the onset of the accelerated Ruble crisis, Russian FX reserves are down 26.1 billion. December total (excluding December 29-31) decline in reserves is now USD32 billion, which makes it the  worst month for FX losses since the January 2009 when Russia lost USD39.4 billion in reserves. December 2014 so far ranks as the third largest decline month for the entire period for which data is available (since January 1998).

Couple of charts to illustrate:

As of the end of last week, Russian External (Forex) Reserves stood at USD388.5 billion, down from USD420.5 billion in the last week of November. Since the beginning of the sanctions period (from the week of the Crimean Referendum) through the end of last week, Russian reserves are down substantial USD 98.1 billion, while from January 2014 through end of December 2014, the reserves are down approximately USD107 billion. At this rate, and accounting for varying degree of liquidity underlying the total reserves cited here, but omitting the reserves held by larger state-owned enterprises, by my estimates, Russia currently has roughly 18-20 months worth of liquid reserves available for cover of debt redemptions and unrelated forex demand.

14/9/2012: Russian CB raises rates

Bank of Russia hiked key refinancing rate to 8.25 by 25bps on the foot of rising inflation pressures, with current rate back at the levels seen last in November 2011. The bank also hiked overnight repo rate to 5.5% and deposit rate to 4.25%.

Inflation in agricultural commodities is the core driver as Russia raised some food tariffs and as weaker crops bit into domestic supply. Imports demand for agricultural goods and relative pressure on the ruble vis USD are additional factors.

The signal from the BR is relatively clear: although Russian economic growth has been under some pressure in H1 2012, inflation is back on the rise, hitting 5.9% in August up on record low of 3.6% back in Q2 2012. BR target is for inflation at 5-6% so the move is reactionary, rather than precautious. The balance in BR decision is between containing inflation and political fallout from rising food prices, associated pressure on the ruble, against the corporate sector demand for capital. In other words, the BR is comfortable with the overall levels of investment in the economy in the short run. This highlights the dilema faced by the Russian policymakers, who are aware that Russia needs to push up domestic investment in core areas where capital modernization is desperately required: manufacturing and industrial base, as well as basic infrastructure. This longer term objective is likely to be supported by a combination of public investment and incentives for longer term private investment. With this in mind, recent restructuring of the Russian SWF and easing of the new SWF mandate to invest in a range of financial instruments, including listed equities.

Chart for Russian CPI forecasts: