Moscow News
www.mnweekly.ru
July 20, 2009
Conflicting interests
By Ed Bentley
With the economy expected to shrink 6.8 per cent this year according to the Organisation for Economic Cooperation and Development, the interest rate cuts it prescribes to boost growth could be at odds with the government's policy of protecting the rouble.
"Monetary policy in the short term should make financial conditions as easy as possible, which means ... not resisting fundamental pressures for depreciation of the rouble," the group wrote in its Economic Survey of Russia released last week.
The Central Bank cut the interest rate half a point to 11 per cent on July 13, but analysts attributed the rouble's volatility to the falling oil price.
"The last rate cut was largely ignored by the market and the rouble was linked to oil prices," said Alexandra Yevtifyeva, senior economist at VTB capital. "It started to depreciate before the rate cut."
Crude prices bounced back last week, carrying the rouble with them, but some analysts are warning that the currency could test the euro-dollar trading band as the government will be forced to fund ailing banks.
"The government is trying to keep the rouble stable and delay resolving the bad loan crisis," said Natalia Orlova, chief economist at AlfaBank. "They should inject money into the banks' equity capital which will cause the rouble to weaken."
Orlova predicted that the rouble could reach between 35 and 38 against the dollar by the end of the year. UBS agreed, saying in a report, "we cannot see any trend appreciation of the rouble". However, Deutsche Bank doesn't believe the rouble will challenge the currency band in the short term.
"It is more appropriate to talk about rouble appreciation because there is a sizeable current account surplus and starting from May there have been net capital inflows," said Yaroslav Lissovolik, chief economist at Deutsche Bank.
Russia spent more than $200 billion defending the rouble last year, while pursuing a managed depreciation as the oil price dropped rapidly from its high of $147 a barrel in July.
Central Bank head Sergei Ignatyev has stated that it would like to see a free float in two years to avoid continued heavy spending of foreign currency reserves.
The OECD has given its backing for a float, saying the "real exchange rate eventually has to move in line with large swings in fundamentals", although some feel that a free float would be unworkable.
"I don't think that a free float is an option for Russia given the dependency on oil prices," said Lissovolik. "I think there will continue to be further interventions by the Central Bank."
The OECD report also saw positive signs that Russia is moving to inflation targeting rather than protecting the exchange rate. While for many countries this would seem at odds with the loose monetary policy needed to stimulate the economy, the crisis is helping bring inflation down.
"Inflation is coming down due to capital outflow and weak demand from developed countries," said Yevtifyeva. "Money supply growth has turned negative, minus 10 per cent, and this is a major shock for the Russian economy."
The managed depreciation last year failed to cause the price rises many predicted, providing more evidence that inflationary pressure is decreasing, she added.
As inflation falls, further cuts in the Central Bank interest rate will help stimulate the economy while keeping inflation under control.
"They can lower interest rates as long as inflation is coming down," said Lissovolik. "It is important that you don't have a lowering of the real interest rate."
