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 The Russian central bank this week scrapped so-called targeted
interventions, bringing an end to hard currency sales of up to $60
million a day and indicating that a planned shift to a fully
floating ruble on January 1, 2015, is on track.
Having spent a third of its hard currency reserves to defend the
ruble in 2008, Russia is clearly signaling it will take a different
tack during the current market turbulence by letting the currency
take the strain.
The intention to target inflation rather than the exchange rate is
widely seen as positive for Russia, with a weaker ruble providing
stimulus and helping to halt the steady balance of payments
deterioration.
But in today's world, which looks distinctly unfriendly towards
emerging markets, the move was interpreted as an invitation to sell
the ruble, which fell to four-year lows against a euro-dollar
basket.
The weakness may continue — risk-reversals, a measure of the
relative demand for options on a currency rising and falling against
the dollar, show a clear near-term skew for sharp ruble weakness.
"They are doing the right thing, but it's going to be difficult to
make the change in such a turbulent market for emerging currencies.
It will make people wary of ruble-denominated assets," said Luis
Costa, head of CEEMEA strategy at Citi.
He noted that Russian debt was relatively resilient during the
emerging markets sell-off caused by the U.S. Federal Reserve's
decision to start cutting back on its bond-buying.
That's down to Russia's relatively strong financial position but
also authorities' implicit support for the ruble.
Foreign bond investors who piled into Russia following the 2013
liberalization of the OFZ ruble bond market have largely stayed
put, their portion of the market at 26 percent at the end of
November 2013, from less than 5 percent in early 2012.
They are also mostly in the mid- to longer-dated bonds, which Costa
says is most correlated with the ruble rate.
"From a foreign investor's point of view, the ruble component of
holding the OFZ is now definitely negative. The odds are you will
have losses on the currency irrespective of how the bonds do," he
added.
POSITIVE
The flip side? Policy focus on inflation and transparency will
benefit financial markets if it brings down volatility and
encourages saving. The economy, which Russia acknowledges will grow
at just 2.5 percent a year in the next two decades, may also get a
boost.
And crucially during these turbulent times, a flexible currency may
insulate the economy from 2009-style shocks.
Russia's exchange rate has long been a political totem for President
Vladimir Putin, who took power a year after a default crashed the
ruble and wrecked the banking system in the 1998 economic crisis.
The post-Soviet history of hyperinflation, devaluation and default
in the 1990s has engendered deep-seated aversions among Russians to
long-term saving and investment.
But with the country's $2 trillion economy now stalling, the
targeted exchange rate had exacerbated economic volatility, said
Morgan Stanley economist Jacob Nell.
"Fixed exchange rates generally make it more difficult for
policymakers to adjust to changing commodity prices, especially oil
prices," Nell said. "The move to a flexible regime opens up the
prospect of a much smoother adjustment to a changing oil price."
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And the ruble is by no means undervalued: against its main trade
partners and adjusted for inflation, it is just off decade-highs hit
last year.
The $200 billion defense of the currency in 2008 averted a run of
defaults by indebted Russian companies, but deprived the economy of
a lift that could have been provided by a cheaper currency. The
economy shrank 9 percent the next year.
"The ruble may weaken, but you can't be too short-termist, they are
doing it for right reason. It's positive if they seriously target
inflation," said Grant Webster, a bond fund manager at Investec
Asset Management.
Webster said short-dated Russian yields were high enough at over 6
percent to compensate for currency volatility, providing a roughly 2
percent pick up over inflation.
But most Russian bond positions are unprotected from ruble
fluctuations, because of a flat bond yield curve. That means hedging
currency exposure is costlier than, say, in South Africa, where
yields on short-dated bonds are much lower than on the 10- or
30-year segment.
An investor hedging exposure on his 10-year South African bond would
get a net return of around 2 percent a year after hedging costs, a
similar level to what is available in Russia, says UBS analyst Manik
Narain.
But in Russia, returns may diminish as the curve extends while in
South Africa the reverse is true, he said, adding that bond coupons
net of hedging costs are also more attractive in other markets such
as Mexico and Hungary at around 3.5 percent
EQUITY GOOD NEWS
Equity investors are less fazed. Ed Conroy, portfolio manager at
HSBC Global Asset Management says a weaker ruble would provide an
earnings margin boost for the energy and metals exporters that
dominate the Moscow stock market <.MCX>.
That upside will take the edge off the weak ruble's immediate
impact on foreigners' equity portfolios.
"Then we get to the issue of at what point does it become a problem
to be exposed to ruble weakness and to companies that may be highly
geared to debt in dollars," Conroy said,
He noted that Russian companies' gearing level — the ratio of
borrowed funds — has risen to 2.1 times from 1.3 in 2008, but
attributed this to increased borrowing by solid big-name state firms
such as Gazprom and Sberbank.
"(Since 2008) most companies have de-geared and others have
refinanced wisely," Conroy said. "Now is not a bad time to go for
exchange rate flexibility.
(Additional reporting by Douglas Busvine
in Moscow; Graphic by Natsuko Waki; editing by Peter Graff)
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