Nov. 28 (Bloomberg) -- Russia’s ruble had its biggest weekly decline against the euro in at least five years as the central bank let the currency depreciate and raised interest rates to halt an exodus of foreign capital.

Bank Rossii widened the ruble’s trading band for the second time this week by about 30 kopeks (1 U.S. cent), or 1 percent, on each side, according to Mikhail Galkin, head of fixed-income and credit research at MDM Bank in Moscow. The central bank raised its key rates, including the refinancing rate and repo rates, by one percentage point to help stem capital outflow and damp inflation.

Russia is among a handful of countries raising borrowing costs after it drained $148 billion from the world’s third largest foreign-currency reserves to arrest a 16 percent currency slide against the dollar since August. Investors pulled $190 billion out of the country, BNP Paribas SA estimates, as oil fell below the $70-a-barrel average required to balance the budget in 2009.

“The government’s priority is budget stability, but for business the ruble policy is more important,” said Viktor Vekselberg, a billionaire partner in oil company TNK-BP. “I hope in the near future the government will weaken the ruble.”

Bank Rossii, which keeps the ruble within a trading band against the dollar-euro basket to limit swings that hurt exports, spent $57.5 billion to shore up the currency in September and October. The basket is made up of about 55 percent dollars and the rest euros.

Ways to Fight

The ruble weakened 1.6 percent to 27.86 per dollar and depreciated 0.4 percent to 35.5270 per euro. The ruble dropped 1 percent to 31.3073 against the central bank’s basket of dollars and euros today and 2 percent this week, the biggest weekly decline since the basket was introduced in February 2005. The weaker end of the band is now 31.30, MDM’s Galkin said.

“This is happening because there are market expectations -- from the population, companies -- of a weakening ruble,” central bank Chairman Sergey Ignatiev said on Nov. 19, referring to net private capital outflow of $50 billion last month. There are “several ways to fight this,” including high interest rates on the domestic market, he said.

The central bank has a policy of not commenting on its operations in the currency market and spokesman Vladimir Lavrov declined to comment today.

“The currency is overvalued in nominal and real terms,” Nouriel Roubini, the New York University professor who predicted the current financial crisis two years ago, said in a Bloomberg Television interview in Moscow. “How to move to a more flexible exchange-rate regime is going to be one of the most important policy challenges to avoid a hard landing.”

Weakest Perimeter

Oil may drop as much as 20 percent next year should the financial crisis worsen, Roubini said. Urals, Russia’s main export oil blend, has closed for the past four days below $50 a barrel and was 1.3 percent lower at $48.61 a barrel today.

The benchmark Micex index of 30 stocks dropped 0.8 percent to 611.48 today, paring this week’s 19 percent advance.

The central bank sold as much as $2.3 billion this week to prevent the ruble from falling beyond the weakest perimeter of its trading band, compared with about $7 billion last week, according to MDM Bank estimates. Today’s interest rates increase is a bid to dissuade banks from converting rubles into foreign currency as the central bank scales back its defense of the ruble.

Finance Minister Alexei Kudrin, 48, backed by then-president Vladimir Putin, who’s now premier, championed the accumulation of currency reserves over the past decade to ensure the government wouldn’t default on debt as it did in 1998, the last time commodities prices plunged. The reserves, including oil funds that exclusively act as a safety cushion for the budget, stood at $449.9 billion on Nov. 7.

Not ‘Lethal’

While most of the world’s central banks are cutting interest rates to ease the worst financial crisis since the Great Depression, Russia along with Iceland, Pakistan and Serbia are having to increase borrowing rates in an attempt to prevent a flight from their currencies. The move is also aimed at curbing the annual inflation rate, which reached 14.2 percent last month. The government’s official year-end forecast is 11.8 percent.

Russia’s refinancing rate, seen as a ceiling for borrowing money and a benchmark for calculating tax payments, will rise to 13 percent on Dec. 1, from 12 percent. The interest rate for one- day and seven-day loans from the bank in repurchase auctions will be 10 percent, from 9 percent.

The rates increase “isn’t lethal” for business, TNK-BP’s Vekselberg said. “The move is understandable. It’s part of an attempt to stop rubles from being exchanged for dollars. Let’s see how it works out.”

Bank Rossii set a limit of 10 billion rubles today on so- called currency swaps. The agreements allow traders to bet on the exchange rate without having to sell currency upfront. The bank has restricted them since Oct. 20. The limit was 5 billion rubles yesterday and 10 billion rubles on the previous four days.

Avoid Panic

To reduce pressure on the ruble, the central bank also told financial firms yesterday not to increase bets on foreign currencies during December above their average for the past month, in a letter on its Web site.

The central bank is unlikely to allow a “one-step devaluation” because it wants to avoid “panic among the public an abrupt move might trigger,” Jussi Hahtela, an analyst in Stockholm at Nordea Bank AB, wrote in an e-mail to clients today.

Troika Dialog, Russia’s oldest investment bank, forecasts a 30 percent depreciation as declining oil prices erode the country’s $91.2 billion current-account surplus.

To contact the reporter on this story: Emma O’Brien in Moscow at eobrien6@bloomberg.net

Last Updated: November 28, 2008 10:54 EST