Ruble devaluation looms

Just 10 years ago, Russia let the ruble fall as much as 71 percent as the government defaulted on $40 billion of debt and world stock and bond markets collapsed. Now, the combination of a 61 percent drop in oil prices from their peak in July, slowing economic growth and increasing investor concern about emerging markets are draining Russia's foreign reserves, which fell 19 percent to $484.6 billion in the 12 weeks through Oct. 31.

Russia, which uses reserves to curb swings in the ruble that hurt the competitiveness of exports, may find the resistance futile after the currency fell 13 percent against the dollar since Aug. 1. The central bank sold a record $40 billion in October, according to Moscow-based Trust Investment Bank.

Troika Dialog, the country's oldest investment bank, said the currency may slump as much as 30 percent in the event of a devaluation.
"When oil falls, capital runs out of Russia and the ruble weakens, it's not justified to hold your positions," said Anas El Maizi, who oversees $342 billion in fixed-income assets in Paris at Axa Investment Managers, a unit of Europe's second-largest insurer. "If oil stabilizes at this level, Russia will have some trouble." Axa cut its Russian bond holdings in August.

Widening the trading band
Bank Rossii, the central bank, may "gradually" widen its ruble trading band if the current account falls into a deficit next year, Arkady Dvorkovich, an economic adviser to President Dmitry Medvedev, said Nov. 7. Goldman Sachs said the comment marked a "departure from the previous party line."

When Russia defaulted in August 1998, it caused an investor stampede to the safest assets. Yields on 10-year U.S. Treasury notes dropped more than half a percentage point to 4.98 percent that month and the Standard & Poor's 500 Index slumped 15 percent. Hedge fund Long-Term Capital Management collapsed after losing about $4 billion, prompting a Federal Reserve-backed bailout by Wall Street. Gross domestic product in Russia shrank 6.5 percent and inflation accelerated to 84 percent.

Since then, rising prices of oil, gas and metals such as nickel and aluminum provided Russia with 10 years of economic growth. Foreign reserves grew to $598.1 billion in August, the world's biggest behind Japan's and China's, from $18.4 billion just before the 1998 default.

Commodity billionaires
With average economic growth of about 7 percent a year since 1999, rising commodity and stock prices created more than 100 Russian billionaires, including aluminum magnate Oleg Deripaska and soccer club owner Roman Abramovich.

Russia's current account, the widest measure of flows in goods and services, is now headed toward a deficit. Investors pulled at least $140 billion out of the country in the past three months, according to BNP Paribas, sending the dollar-denominated RTS Index of stocks down 61 percent.

The benchmark 30-year government bond slumped in 2008, pushing the yield to an almost seven-year high of 12.55 percent on Oct. 27. So far this year, the RTS Index lost 67 percent, headed for the worst performance since 1998.

"With the oil price falling we were concerned that the trajectory of Russia's reserves had changed from building them up to selling them," said Kieran Curtis, a fund manager in London at Aviva Investors, which cut Russian holdings in August from the $787 million of emerging-market assets it has under management.

Russia is poised to grow 7.7 percent this year, the Economy Ministry said Oct. 29, down from 8.1 percent in 2007.
The combined wealth of Forbes magazine's 25 richest Russians fell more than 50 percent in four months, based on the equity value of stocks and analysts' estimates.

Bank Rossii, headed by Chairman Sergey Ignatiev, began managing the ruble's exchange rate in February 2005 against a currency basket comprised of about 55 percent dollars and 45 percent euros. Policy makers let it trade within a fixed range in mid-May. Since then, it has dropped 2 percent against the basket to 30.34. Though the central bank doesn't reveal the limits of the band, BNP Paribas considers 30.40 to be its weaker end.

Change in attitude
"You can't stimulate a slowing economy by keeping the currency fixed," said Lars Christensen, head of emerging-markets currency strategy in Copenhagen at Danske Bank. "They will have to change their attitude to using reserves for the sake of the economy."

Dvorkovich increased speculation that Russia will reduce its interference in foreign exchange last week when he told reporters in Moscow a "prolonged" period of deficit in the current account may prompt policy makers to "gradually" widen the trading band.

The current account, now at a surplus of $91.2 billion, may swing into a deficit as early as next year, though there will be no "sharp devaluation" in the ruble in 2008 or in 2009, Dvorkovich said.

"These remarks mark a departure from the previous party line among top officials that there was no reason for the ruble to depreciate," Rory MacFarquhar, a senior economist at Goldman Sachs in New York, wrote in a note Nov. 7. "They confirm our view that there is a strong political preference for gradual depreciation over a steep devaluation, even though the central bank would prefer the latter approach."