Next possible steps to stem the RUB slide
After a brief initial rebound
following the significant increase in Russian interest rates this morning, the
sell-off in the RUB has accelerated. So far today, it is down 10%, taking
losses since the end of September to 45%. While RUB depreciation was previously
driven by fundamentals (ie, lower oil prices, weak growth and sanctions), the
recent sell-off suggests overshooting. Recent modest FX sales by the CBR have
not succeeded in arresting the sell-off either. Now that the recent rate hike
has proven insufficient to defend the currency, the CBR has several options, in
our view: 1) it could hike interest rates higher; 2) and/or squeeze RUB
liquidity forcing market rates temporarily higher; 3) it could supplement with
further sizable FX interventions; and 4) it could consider capital controls.
The
CBR increased its key rate (1-week repo) by 650bp to 17% at an emergency MPC
meeting held early this morning in Moscow. So far defending the currency via
interest rates does not appear to have worked, and the RUB has sold off further
following an initial rebound. This seems to be a case of too little too late. A
stronger rate increase previously might have been sufficient to avert the
crisis, but right now it is not enough to stave off panic.
Russia's
financial markets are having a crisis of confidence, in our view. Selling the
RUB has become endemic and the currency has fallen into a self-fulfilling
downward spiral. One cause of the continuing decline in the RUB is the
persistent weakness in oil prices, and with oil breaking below $60/bbl
currently it is adding further pressure. The international sanctions and
weakening growth are also working against the RUB. The combination has made
markets vulnerable. The CBR needs to do something special to stabilise market
sentiment.
Limiting RUB liquidity
Now
that the recent rate hike has proven insufficient to defend the currency, the CBR might
consider an alternative approach, freezing or capping RUB liquidity. In our
opinion, the CBR has been too generous in its liquidity provision to banks.
This was a result of CBR concern that banks need RUB liquidity to offset
sanctions that have restricted access to external funding. Indeed, banks have
considerably increased the share of CBR funding in their balance sheets to
around 15% of total liabilities. Therefore, the CBR is concerned that denying
banks further RUB liquidity may result in tighter lending conditions for the
real sector, hurting growth as well as worsening the asset quality outlook.
In
our view, the generous provision of RUB liquidity has fuelled RUB sales against
the USD. The provision of RUB liquidity gives banks the means to bid
for FX or indirectly companies to bid for FX via bank lending to companies. At
this point, the private sector does not need FX for debt repayments. It has
accumulated enough FX to cover near-term FX liabilities (confirmed by the lack
of demand at CBR FX auctions). In our view, most of the RUB liquidity provided
by the CBR finds its way into the FX market and thereby finances capital outflows
under the current setting. Thus, the CBR can limit demand for FX by limiting
RUB liquidity. Probably a complete freeze on RUB liquidity would be preferable
(so the CBR would only rollover existing RUB credit). Then Russian entities
that need RUB liquidity would have to sell FX and that would turn the market
around. In our view, banks could trade with each other to reallocate the
liquidity. Alternatively, the CBR could place a strict limit on RUB liquidity
and then auction it off to banks. Either way, money market rates will increase
further. It is possible that some form of quantitative tightening help the CBR
gain control of the situation.
FX intervention and capital
controls
The
government and CBR are probably considering further FX intervention to provide
FX liquidity (in fact the CBR sold $2.2bn yesterday). With the CBR freezing or
capping its provision of RUB liquidity, FX sales would help reduce RUB
liquidity further as the sales would take RUB liquidity out of the system and
therefore be doubly effective.
Of
course, the CBR is naturally concerned that it has finite FX reserves
(currently at $415bn compared to external debt payments of $102bn due in the
next 12 months) and it does not want to use them up to finance capital
outflows. Thus, when the CBR provides FX, it would naturally want to ensure
that the FX is being used for the intended purposes, such as paying down FX
debts. We think the CBR may want to limit the selected few who do receive FX to
those who use the funds for verifiable FX payment and, further, these entities
should not have own resources available to make the payments. Thus the CBR does
not want to fund speculative capital outflows. This would be a form of
rationing of FX liquidity. Unfortunately, this looks like, sounds like and is
in fact, a form of capital controls.
Russia
has a current account surplus and the RUB depreciation during 2013-14 has
already fed into current account improvements (we expect a surplus $72bn in
2014). Russia does not need capital inflows but rather needs to slowdown
capital outflows and avoid domestic dollarisation. It is rare for a country in
such circumstances to encounter a currency crisis. That is why selective and
well designed capital controls might make sense. Use of capital controls is not
necessarily bad in and of itself. Selective capital controls could help force
the economy back into RUB transactions, preventing dollarisation.
The
CBR and the Russian government have denied that capital controls are under
consideration. Although a recently proposed Duma bill would force 50% sales of
export proceeds, the government has not supported it. But it is interesting to
contemplate what options are available, such as:
· Forced sales of FX by exporters;
· Limitations of FX withdrawals from banks;
· Limitations on FX purchases;
· Control of bank outflows;
· Other limitations on outflows, such as import licences.
While it is unclear what
actions the CBR will take, the ferocity of the RUB sell-off is such that it
will need another ‘big-bang’ policy to take control of the RUB markets.
