Ruble Set to Fall 10% by March on Russia Deficit, Shearing Says

By Alex Nicholson

Sept. 7 (Bloomberg) -- Russia’s ruble will fall 10 percent by March as the government fails to curb its deficit and the central bank comes under political pressure to keep liquidity flowing and raise the money supply, Capital Economics said.

“We’re walking a tightrope,” Neil Shearing, emerging Europe economist at Capital Economics Ltd. in London, said by telephone. “If the Kremlin could have it their own way, what they would have is unsecured loans to the banking sector and a bigger deficit.”

The buildup of rubles in the economy, as the government taps the oil money in its Reserve Fund to finance the country’s first budget gap since the 1998 default, will push the currency below the lower limit of its trading range against a basket of dollars and euros, according to Shearing. He expects the deficit to exceed 9 percent of gross domestic product this year.

Raw material exports helped Russia amass the world’s fourth-biggest reserves over the past decade as the price of Urals crude oil surged, peaking at a record $141.07 a barrel last July. While the reserves helped shield the nation from the worst of the global credit crisis since 2007, its commodity reliance has left the economy, and the ruble, vulnerable to sudden shifts in energy prices.

Political Pressure

The government’s use of reserves to plug the deficit has so far been partly offset by central bank “sterilizations,” as it scaled back emergency lending and issued notes to suck cash from the economy. That balancing act may be undermined as the bank comes under “increasing political pressure to stimulate bank lending,” Shearing said.

Russia expects to run a deficit equivalent to 8.9 percent of gross domestic product this year after the economy slumped a record 10.9 percent last quarter. The government has signaled it won’t cut spending or raise taxes, though it plans to tap international debt markets. Finance Minister Alexei Kudrin said on Sept. 3 the government may seek $17.8 billion abroad in 2010.

Bank Rossii will “gradually replace” its unsecured credit facilities with short term repurchase agreements, First Deputy Chairman Alexei Ulyukayevsaid in a letter to the Association of Russian Banks on Aug. 26.

“The volume of net credit provided to banks continues to fall,” he said in a Sept. 4 interview with Interfax. “In other words, the negative credit issuance will partly extinguish the positive fiscal issuance.”

‘Sterilization’

The government aims to spend an average of 850 billion rubles ($26.8 billion) to 900 billion rubles a month this year before disbursing 1.5 trillion rubles in December, Kudrin said. Bank Rossii can sterilize about 1 trillion rubles by cutting its loan programs, said Aleksandra Evtifyeva, a senior economist at VTB Capital.

“The Finance Ministry plans to issue more rubles and the central bank will have much less capacity to sterilize the extra liquidity,” she said.

Russia’s $85.7 billion Reserve Fund will be drained by the end of next year, the government estimates, as the money goes toward covering the deficit and funding an “anti-crisis” program worth about 2.5 trillion rubles ($79 billion) when tax breaks, central bank lending and other measures are included.

Kudrin, 48, backed by then President Vladimir Putin, championed the accumulation of reserves and the two oil funds over the past decade to ensure the government wouldn’t default on debt as it did a decade ago, the last time commodities prices plunged. The value of the reserves rose $6.6 billion in the week ended Aug. 28 to $404.9 billion.

Biggest Threat

Bank Rossii drained more than a third of the reserves in the second half of 2008 to stem a 35 percent decline in the ruble as oil dropped and investors shunned riskier assets. The ruble now trades inside a 26 to 41 band that the bank has pledged to defend.

The biggest threat to Russia’s economic stability remains another sudden slump in the oil price, Shearing and Evtifyeva say. Energy prices are far from stable, analysts say.

Crude oil is on a “slippery slope,” according to Auerbach Grayson, a brokerage in New York. Crude may see a “significant decline,” with the price set to fall to about $60 a barrel, Richard Ross, a technical analyst at Auerbach, said on Sept. 4.

“If we do get a fall in the oil price, then any liquidity left floating around in the banking system will quickly find its way into foreign currency and that will lead to a big clampdown by the central bank and a big ramp up in sterilization activity,” Shearing said.

If investors repeat last year’s exodus from the ruble after oil plunged by more than two-thirds from its record, the central bank would be forced to reverse a series of rate cuts to discourage bets against the currency as well as tighten the funds it offers at loan auctions, Shearing said. That would stifle lending and nip signs of recovery in the bud, he said.

VTB Capital’s Evtifyeva agrees. “It’s the biggest internal risk,” she said.

To contact the reporter on this story: Alex Nicholson in Moscow at anicholson6@bloomberg.net.