The Russia liquidity house | FT Alphaville

The Russia liquidity house

Quick. Someone grab a samovar! Russian liquidity it is on-tap.

In fact, Russia’s recent liquidity operations have been so substantial, they almost make Chinese efforts look puny in comparison.

On Tuesday the Russian central bank offered 1.11tn roubles in seven-day and 200bn roubles in one-day, which amounts to some $42bn.

When you consider that Russia’s GDP is only about $1.85trn, that makes this a liquidity operation equal to more  than 2 per cent of GDP. An equivalent operation in China would be around $150bn.

Moreover, this is NOT a one-off, say EM analysts:

So why the downpour of liquidity?

Well, according to Bartosz Pawlowski at BNP Paribas, Russia’s CBR could be trying to avoid a squeeze on rates. As he wrote earlier in July when operations first started to get sizeable:

Even during the recent depreciation of the RUB, rates moved only marginally higher, in stark contrast to previous episodes of capital flight from Russia.

The conventional wisdom is that rates in Russia tend to spike during a crisis as the central bank withdraws liquidity. The experience of 2008 and 2009 is more than telling in this respect, with 3m implied rates jumping to the high double digits after the Lehman collapse. We now know that this action by the central bank helped to defend the currency, but it deepened the economic slowdown, as liquidity evaporated from the system. Back then, we saw a similar situation in Romania. More recently, we have seen it in Turkey, albeit to a lesser extent.

We have been arguing since Q3 2011 that the CBR’s behaviour has changed. When the RUB started to sell off, the central bank intervened, but simultaneously started pumping liquidity into the system through repo transactions. On top of that, this week, the market borrowed RUB 1trn from the central bank in a weekly transaction at 5.27%. Chart 1 shows the allocations of both daily and weekly repos. Importantly, the CBR has been prepared to pump much more than that into the system when necessary.

In other words, it seems that the RUB market is as close to being free floating as possible, as the central bank is reluctant to intervene and if it does, it wants to avoid doing any damage to the money market. In this vein, note that the CBR has now opened an overnight FX swap facility for USD, indicating that the focus is on money-market stability.

In other words, the Russians could be prioritising the health of the money markets over the outright value of the rouble. In that sense, they may be very close to unleashing a freely-floated rouble, which until now has been kept in a wide band against a basket of currencies.

Now, if this sounds strangely familiar (with things happening in China), it probably is.

For one, Russia’s plans to do way with the currency band are already being presented as ‘progressive’. A show of capital market maturity and strength. As Alfa Bank analysts noted this week:

CBR to abandon currency band in 2015; POSITIVE CBR First Deputy Chairman Alexey Ulyukaev indicated yesterday that the CBR will abandon the currency band in 2015 in line with the beginning of inflation targeting.

We welcome this decision but note that successful inflation targeting would require the CBR to improve its credibility first, as it has yet to improve its communication with the market in terms of providing timely and adequate inflation guidance. We take the CBR’s decision as appropriate because it will substantially increase its room to maneuver in the event of a new round of global instability.

The experience of recent months suggests that Russia is adjusting well to the expansion of the currency band, and the complete abandonment of exchange rate benchmarks by the CBR would be a POSITIVE development. Also, moving to inflation targeting is the proper way to address the lack of savings and the ambitious goal of funding investment growth. However, in the short term the key catalyst indicating a move in the right direction is for the CBR to improve its communication with the market, particularly in terms of providing proper inflation guidance.

The central bank’s new 2012 inflation target of 6.3%, which was announced yesterday, compared with its previous 6.0% guidance is too small of an adjustment and came too late; thus, it was not properly communicated to the market. In this sense, yesterday’s increase of the 2013 target from 5.0% to 5.5% is a way to address the issue, but we still believe that the CBR needs to go a long way to improve its credibility in order to set inflation targeting as a benchmark.

Yet, as Alfa noted earlier last week, the move also follows news that capital outflows from Russia are turning out to be much larger than previously recognised:

CBR First Deputy Chairman Alexey Ulyukaev announced that the regulator had increased its 2012 capital outflow expectations to $65bn and admitted that its 6% inflation target is unrealistic. We believe this reflects the CBR’s reaction to the implicit criticism from the Ministry of Economic Development and welcome the move toward providing more realistic guidance to the market. While Ulyukaev’s announcement represents a deterioration of the CBR’s outlook, we do not take it as negative. First, on capital outflow the CBR’s previous official full-year target was only $25bn despite the fact that the YTD figure is already $52bn, according to our estimates. The new target is very close to our $70bn expectation. Second, the acceleration of inflation seen since early summer has for some time already caused doubts regarding Russia’s ability to stay within the 6% CPI growth target.

The capital flow issue is important and we don’t think it’s a coincidence. After all, while there’s no denying that capital flows in and out of Russia have always been more volatile than those in and out of China, there is something of a parallel emerging.

In terms of central banking intervention policy may be adjusting to what is actually a bit of a dollar shortage reality. It should not be unnoticed, for example, that the CBR opened an overnight FX swap facility for USD earlier this year.

The first casualty of the dollar shortage scenario, in other words, is once again turning out to be the national currency trading band – (presumably, because it simply becomes far too costly to defend).

Indeed, as Pawlowski noted in July:

It may sound controversial, but we think that the cross-currency market in Russia more closely resembles Israel or Hungary, in that it is access to USD liquidity that could become problematic rather than RUB liquidity. After all, the demand for USD in cross-currency transactions among Russian companies has increased in the last year or so. And considering that access to USD for non-US banks has not become any easier, it will be interesting to see whether we will see some further widening of the cross-currency basis.

Definitely one to watch.

Related links:
Putin’s shrinking reserves – FT Alphaville
Rouble sinks to three-year low – FT