Aggressive Reduction of the Key Interest Rate Entails Risks

2 may 2017 | Rossiyskaya Gazeta

The gradual reduction of the nominal interest rates and the easing of the other non-interest related loan terms are going to continue, and reliable borrowers are the ones that are going to feel it first. That was the forecast the Bank of Russia made in a comment on the reduction of the key interest rate by 0.5 percent. "At the same time the expectations of a lowering of the key interest rates brought about a rally in the market of Russian state bonds: the yield on ten-year Russian federal treasury bills has fallen by 0.4 percentage points in the past two weeks, below the historic lows seen in late 2013," Analytical Center expert Daniil Nametkin commented on the situation for the Rossiyskaya Gazeta.

Daniil Nametkin
Daniil Nametkin
Department for Expert Analytics

According to him, the narrowing of the spread between the actual risk-free instruments in Russia and the US is encouraging foreign investors to expand their long positions in ruble assets to keep their yield at the current level.

In the meantime, the relatively aggressive lowering of the key interest rate entails certain risks in a situation where a large number of non-residents accumulate speculative positions in Russian assets in an attempt to make extra cash off the difference between the interest rates in Russia and in the west (the so-called carry trade). "If the US Federal Reserve increases its base rate again (and it is estimated that the chance of that happening at the June meeting of the Federal Reserve is 67 percent), the profitability of this strategy may be cast into doubt," Mr. Nametkin warns. "This will prompt portfolio investors to move their money out of ruble assets, brining about another wave of devaluation of the national currency and pushing up inflationary expectations."

However, if the ruble partially depreciates, its exchange rate will approach the level justified by the economic fundamentals and that would have a positive effect on the trade balance, reducing the pressure on the federal budget, the expert notes.

Source: The Rossiyskaya Gazeta