Foreign speculators that have been propping up the value of the ruble since last summer may get out of the game as soon as the second half of this year, Analytical Center experts are warning. They are talking about speculative carry-trades, in which money is borrowed in foreign markets at a low interest rate and then invested in ruble financial instruments that offer high fixed rates.
Any negative factor may weaken the ruble
Carry-trades became especially profitable in July 2016, when the spread between the risk-free Russian and American T bills began to increase; at least peak in late February 2017 it reached 4% thanks to a record drop in inflation. Foreigners started buying up Russian T-bills like hot pancakes and their share in the Russian sovereign debt market exceeded 30%. The ruble began appreciating even as the price of oil was falling.
"Any negative factor such as a drastic decline in commodity prices, an increase in the rate that the Federal reserve is increasing its interest rate while the Bank of Russia reduces its key rate at the same time, can bring about a wave of closures in the long positions in Russian assets (primarily in the debt market) to lock in future revenue and that's going to bring the ruble down," Daniil Nametkin commented on the situation in an interview for a Rossiyskaya Gazeta correspondent. Everything else being equal, the Russian currency is going to fall to at least RUB 60-62 per dollar, the expert believes. And if things should tense up in the foreign affairs arena or the price of oil goes into a long-term decline while both the public and business start getting out of the ruble on a large scale, the ruble's exchange rate to the dollar is going to fall a lot more, Mr. Nametkin noted.
The Analytical Center has published a special review on the carry trade problem and its effect on the policy of the Russian financial regulator from now on.
As inflation was slowing faster than the Bank of Russia was relaxing its monetary policy, Russian assets (especially federal treasury bills) became extremely attractive to foreign investors as they suddenly were generating very high real yield, the analysts write. One corollary of the high volume of carry-trade transactions was that the ruble appreciated far more than it should have been and that created a feedback loop that slowed down inflation even more than had been expected. At the same time, this very factor also creates a serious risk that the current rate of change in the consumer prices may not hold. First of all, this has to do with the counter-cyclical trends in the monetary policies of the US Federal Reserve and the Bank of Russia, the result of which is that the difference between the real risk-free yield on treasury bonds in Russia and the US began to decrease in March 2017, making carry trade transactions less attractive. Second, the current high ruble exchange trade with its constantly hitting short term highs is creating a risk of increased volatility and riving expectations that the FOREX market may soon make a U-turn on the ruble.
Unless the oil prices pick up in the short term, these and the other factors described in the review may bring about another round of devaluation of the ruble and drive up inflation expectations, which will make the task of keeping inflation within the target 4% per year almost impossible, while the faster more aggressive lowering of the key rate will be completely out of the question, the review says. In the medium term this may put a significant constraint on economic growth in Russia because high interest rate on investment loans coupled with low business profitability are bound to put significant downward pressure on investment demand.