Talking Points:
Russia Has Scrapped its Managed FX Regime, Allowing Ruble to Float Freely
Policy Change Aimed at Scaring Away RUB Sellers with Threat of Intervention
Capital Controls Loom Ahead, Warning of Aggressive Volatility on the Horizon
The Central Bank of Russia (CBR) abandoned the exchange-rate “corridor” containing the Ruble’s value against the Euro and the US Dollar, allowing the unit to float freely. The move marks the latest in policymakers’ attempts to deal with a precipitous drop in the currency that has thus far produced losses of as much as 47.8 percent this year against the greenback.
The Ruble started what would evolve into a near-parabolic plunge in mid-July following the downing of Malaysia Airlines flight MH17 over the Ukraine. The incident marked an escalation of tensions between Moscow and Western powers that began as the toppling of Ukraine’s government amid mass protests early in the year led to the secession of Crimea and its subsequent Russian annexation. The US and the EU unveiled a new round of anti-Russian sanctions by the end of the month.
Investors spooked by swelling geopolitical risk began pulling money out of Russia, sending the capital account to lows unseen since 2009 and helping to push the Ruble to record lows against the Euro as well as the US Dollar. Selling pressure was compounded by a sharp reversal in crude oil prices. Energy sales account for close to two-thirds of Russian exports and a deteriorating outlook on that front helped encourage liquidation across the spectrum of assets sensitive to the country’s economic fortunes.
The dual headwinds of sanctions and a dimming exports outlook coupled with the sinking currency made for a toxic mix. A survey of analysts polled by Bloomberg reveals increasingly acute “stagflation” expectations as median forecasts for 2015 economic growth and inflation race in opposite directions. This has put the central bank squarely between the proverbial “rock and a hard place”. On one hand, soaring price growth demands tightening; on the other, fading output expansion begs for easing.
Faced with this dilemma, policy officials set about attempting to stem the currency’s slide in an apparent bid to calm the waters before tackling larger issues. Trying to discourage sellers with aggressive interest rate hikes as well as directly fighting the drop by selling FX reserves in exchange for the local unit have proven futile. This has left the central bank with a hard choice: allow the Ruble selloff to run its course or introduce a far more draconian regime of restrictions to squash capital flight.
In this context, the choice to move to a freely floating exchange rate represents an attempt at the former. Scrapping the corridor allows markets free reign to sell the Ruble but likewise unchains the central bank to launch large one-off interventions. Indeed, CBR officials have hinted at exactly that, swapping predictable daily purchases of $350 million-worth of Rubles for the threat of unpredictable incursions of far greater scale. In this way, the central bank presumably intends to scare away shorts with the risk of suffering sudden outsized losses.
The markets dutifully took notice, with USD/RUB stalling after hitting yet another record high and turning downward. This early victory is hardly encouraging however. As history amply demonstrates, the threat of big-splash intervention and even its repeated realization has failed to sustainably deflect investors’ assault on a given currency. One need only look at Japan and New Zealand’s recent attempts at bullying the markets to see how quickly their impact evaporates as traders shake off losses and return to the offensive.
On balance, this means that a turn to capital controls looms on the horizon. These may take the form of trapping Ruble-based dividend and royalty payments in local bank accounts as well as subjecting foreigners selling RUB-denominated assets to lock-up periods. Policymakers may likewise limit the amount of FX allowed for purchase by locals, effectively cutting off Russians’ cross-border investment outlets.
The potential implications of a new capital controls regime for global financial markets are too broad to identify precisely. The threat of aggressive volatility seems overwhelming however. In fact, the markets already reveal worries about such a scenario, with USD/RUB 3-month implied options volatilities and ATR readings soaring. Russia is far from an economic backwater, with deep financial links around the world. A sudden rupture of these connections may trigger violent gyrations across the asset spectrum as investors scramble to adjust portfolios.
— Written by Ilya Spivak, Currency Strategist for DailyFX.com
To receive Ilya’s analysis directly via email, please SIGN UP HERE
Contact and follow Ilya on Twitter: @IlyaSpivak
DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.Learn forex trading with a free practice account and trading charts from FXCM.
Source: Daily fx
