Inflation Targeting the Ruble

Whenever we have a discussion about the Russian Central Bank’s defense of the ruble, it’s hard not to talk about the political backlash that could come along with the inflation, something we have already begun to see with the public discontent over the handling of the economy (which frankly could be happening in any country, but in one with so few pressure release valves, the government looks more threatened).  Given that on Jan. 22 we saw the currency nearly breakthrough the floor of the targeted value, we are seeing an increasingly precarious situation for the monetary authorities – one that cannot easily be solved by truncheon-wielding OMON sent to dispatch the rowdy crowds.  From the Financial Times:

The bank indicated it would defend this level unless oil prices fell to $30 a barrel. With Urals blend still around $43, the rouble’s value currently looks in the right ballpark. The trouble is that currencies tend to overshoot as they decline. Forward markets are pricing the rouble 18 per cent lower against the dollar in 12 months. And the bank’s ammunition is running short.

Remainingforeign exchange reserves are $386bn. But JPMorgan estimates Russia canafford to use only $60bn of those on rouble defence, after covering thebalance of payment deficit of $81.5bn and restrictions including legalrequirements to keep $200bn in two sovereign wealth funds in hardcurrency. At the rate Russia has consumed reserves since August, $60bnwould last six weeks. Raising interest rates might work, but only ahefty 250-500 basis point hike. The relatively underdeveloped bankingsystem would only partly mitigate the blow to the weakened economy.

Thatleaves capital controls – or letting the rouble float. But thepolitical costs of a further devaluation, given Russians’ obsessionwith the rouble/dollar rate, would be enormous. Russia has also burnedthrough $200bn in reserves to get to this point. That makes Wednesday’sone-off 20 per cent devaluation of neighbouring Kazakhstan’s tenge lookpreferable to Russia’s protracted depreciation.