Russian Reserves Drain Away, Threatening Economy

By Maria Levitov

Nov. 19 (Bloomberg) -- Russia's foreign-exchange reserves are draining fast and may take almost a decade of economic stability with them.

Russia's international reserves, the third-biggest after China's and Japan's, have fallen $122.7 billion, or 21 percent, since Aug. 8 as the central bank tried to shore up the ruble. At the same time, President Dmitry Medvedev, 43, has pledged more than $200 billion of tax cuts, loans and other measures to maintain economic growth, threatened by plummeting oil prices and investor flight.

The reserves' decline increases the chance the central bank, which signaled last week it is willing to gradually weaken the ruble, will stop supporting the currency. And rising bailout costs would make it harder for Russia -- which Prime Minister Vladimir Putin, 56, earlier this year called an ``island of stability'' -- to blunt the impact of the financial crisis.

``The draining of reserves is dangerous,'' said Elena Sharipova, an economist at Moscow-based Renaissance Capital. ``They ensure macroeconomic stability.''

Finance Minister Alexei Kudrin, 48, backed by then-president Putin, championed the accumulation of currency reserves over the past decade to ensure the government wouldn't default on debt as it did in 1998, the last time commodities prices plunged. The reserves, including oil funds that exclusively act as a safety cushion for the budget, stood at $475.4 billion on Nov. 7.

Lessons From 1990s

The build-up of reserves reflects Putin's determination to avoid a repeat of 1998, when reserves fell to $12.3 billion as President Boris Yeltsin struggled to defend the currency after a spendthrift seven years following the collapse of communism.

Emergency loans from the International Monetary Fund failed to prevent Russia defaulting on $40 billion in domestic debt that year. Industrial production slumped, banks collapsed leaving depositors penniless and unemployed workers marched in Moscow. The economy shrank for five successive quarters in 1998 and early 1999 and Yeltsin's rule ended with many Russians calling for a return to the more stable days of totalitarianism.

So far, the nation's fiscal policy and its ``substantial financial reserves have protected Russia from deeper consequences'' of the current global turmoil, the World Bank said in a report yesterday. ``Short-term macroeconomic stabilization has to be the immediate priority as the authorities continue to adjust their short-term policy responses to changing economic circumstances.''

Capital flight has gathered pace as revenue from oil and gas, the nation's biggest export earners, declined. The Micex stock index has fallen 64 percent since Aug. 1 and the ruble is down 17 percent against the dollar. Investor anxiety over the global financial crisis has been exacerbated by Russia's August war with Georgia and a 67 percent decline in the Urals blend of crude, Russia's biggest export earner.

Biggest Test

The policy of accumulating reserves and setting aside money is now facing its most crucial test.

Bank Rossii, the central bank, which manages the ruble's exchange rate against a dollar-euro basket, sold as much as $15 billion last week, after the last official figures for reserves were released, according to estimates by Moscow's Trust Investment Bank. Alfa Bank analysts including Natalia Orlova put the figure at $16 billion, predicting the central bank ``will likely continue losing its reserves.''

Kudrin told lawmakers last week that the decrease in oil prices ``will in no way affect the execution of the budget'' next year because even if the budget goes into deficit, the shortfall can be financed by the $134.6 billion Reserve Fund, the nation's oil fund. This year's budget surplus reached $100 billion, or 7.8 percent of gross domestic product, by November.

More Losses Seen

Not everyone is convinced.

``The central bank will continue losing reserves if the situation doesn't change,'' said Anton Struchenevsky, an economist at Moscow-based brokerage Troika Dialog.

Russia's economic growth, which Putin touted as a major achievement before stepping down in May after eight years as president, is set to slow to 3 percent next year after average expansion of 7 percent a year since 1999, the World Bank says.

The central bank estimates net capital outflow will reach $20 billion this year, compared with a record net inflow of $82.3 billion in 2007. Arkady Dvorkovich, Medvedev's top economic aide, said last month that any value of the reserves ``above $100 billion is good for Russia today.''

Buffer Minimum

Sharipova and other economists including Vladimir Osakovsky, senior economist at UniCredit Bank in Moscow, estimate that Russia needs more than $200 billion to maintain a comfortable buffer. Should the reserves drop ``far below'' $500 billion, the estimated level of the nation's total foreign debt as of Oct. 1, Russia runs the risk of being downgraded by ratings companies, Troika's Struchenevsky said.

Standard & Poor's already has lowered Russia's long-term sovereign credit rating outlook to negative, on concern the cost of the government's $200 billion financial rescue package may increase.

The government and the central bank have ``sufficient reserves to protect Russia's currency and the financial system,'' Putin said on Sept. 19. Dvorkovich reiterated on Oct. 31 that the government isn't concerned about the declines.

However, central bank Chairman Sergey Ignatiev, 60, said on Nov. 10 that the ruble may have a ``certain tendency toward weakening,'' after capital outflows totaled a net $50 billion in October.

The central bank allowed the ruble to fall 1 percent against its dollar-euro basket on Nov. 11 and raised interest rates. The ruble was little changed at 27.4722 versus the dollar at 12:46 p.m. in Tokyo today.

`Speculative Attacks'

``The 1 percent devaluation feeds into capital flight,'' said Osakovsky. ``It helps fuel speculative attacks'' on the ruble. ``There will be a few small devaluations and eventually they will be forced to accept a floating currency rate.''

That's not necessarily bad news. The dollar-denominated revenue from energy exports would rise in ruble terms, making it easier to balance the budget even with lower oil prices. At the current level of 27 rubles per dollar, the 2009 budget would, be balanced at an average Urals price of $55 a barrel, according to Struchenevsky's estimates.

``The only solution is to devalue the ruble, to stop supporting it,'' Renaissance Capital's Sharipova said.

To contact the reporter on this story: Maria Levitov in Moscow at mlevitov@bloomberg.net