Jan. 23 (Bloomberg) -- Russia’s ruble weakened after the central bank said it would let the currency fall as much as 10 percent to help preserve foreign-currency reserves.

The ruble dropped 1.4 percent to 33.1089 per dollar, extending the sixth weekly decline to 1.5 percent, and lost 0.7 percent to 37.2924 versus the dollar-euro basket, by 5 p.m. in Moscow. Bank Rossii expanded the ruble’s trading range to allow the currency to fall to 41 against the basket and said it will allow “market factors” to help determine the rate yesterday in a move toward a free float.

“This is an open invitation for speculators to test how quickly the ruble can get to 41,” said Ulrich Leuchtmann, head of currency research in Frankfurt at Commerzbank AG, which ranks itself among the biggest 10 traders of the ruble worldwide. “They wanted to decrease speculative pressure, but now they’ve given the market a good reason to increase it.”

Bank Rossii is switching policy after reserves slid $30.3 billion last week, the second-biggest drop on record, as it mitigated a 29 percent slump against the dollar since August triggered by falling oil prices and the worst financial crisis since Russia’s $40 billion default in 1998. Policy makers accelerated the pace of devaluations with almost daily depreciations this year, after widening the band in November and December about twice a week.

The ruble is headed for the longest run of weekly declines against the dollar since May 2005. The currency was little changed at 42.4087 per euro, gaining 1.6 percent in the week.

Reserves Drained

Prime Minister Vladimir Putin pledged last month to use Russia’s reserves, the third-largest worldwide, to avoid “sharp” currency declines that were the hallmark of the 1998 financial crisis, when the ruble tumbled 71 percent. Investors and Russian citizens withdrew at least $278 billion from Russia since August, according to BNP Paribas SA data.

Fitch Ratings said yesterday further reserve declines of last week’s magnitude would lead to a downgrade of the country’s credit rating of BBB+, which is three levels above junk.

The wider trading band means the currency is moving toward a so-called “dirty float,” where the central bank only intermittently intervenes if it fears an economic shock, said Nikolai Kascheev, head of economic research at Moscow’s MDM Bank. Moving the target to 41 expanded the trading band by about 4 percent, he added.

Bank Rossii, which has managed the ruble against the basket of about 55 percent dollars and 45 percent euros since 2005 to protect exporters and manufacturers, said it expected to maintain the band “for months” unless the slump in oil prices deepens.

Oil Dependent

Should Urals crude trade at $30 “for a long time,” policy makers may be forced to widen the band again, further depreciating the currency, Chairman Sergey Ignatiev told reporters in Moscow yesterday. The bank will continue interventions, he said. Central banks intervene in currency markets by arranging purchases or sales of foreign exchange.

Urals crude, Russia’s chief export blend, slumped 65 percent to $42.62 a barrel since August, below the $70 average required to balance Russia’s budget this year. It fell 1.4 percent this week.

Declining oil prices and a deteriorating economy will push the ruble to 41 against the basket, according to State Street Corp. and Barclays Plc. Koon Chow, London-based emerging-markets strategist at Barclays, predicted the ruble will reach 41 in about four months.

“Continued weak fundamentals may further embolden speculators to test the mettle of the authorities,” State Street’s currency strategist Dwyfor Evans, wrote in an e-mail to clients today.

Bank Runs

The change in policy may spur Russians to convert ruble savings to dollars, triggering “further currency devaluation,” RBC Capital Markets analysts led by Nick Chamie in Toronto, wrote in a note to clients today. Russian bank deposits may shrink this quarter, after growth slowed to 14 percent last year from 35 percent in 2007, Alexei Simanovsky, head of the central bank’s regulatory division, said yesterday.

Industrial production in the energy-led economy fell the most since at least 2003 in December as the global slowdown crimped demand for other Russian commodities such as steel, cars and coal. Danske Bank A/S forecasts the economy will contract 3 percent this year.

Forward contracts on the ruble show traders are betting the ruble will break the widened band range of 36 per dollar within three months.

Non-deliverable forwards put the ruble 8.8 percent lower at 36.29 per dollar in three months time, and at 39.58 in a year, representing a 16 percent drop. The contracts are a way of gauging expectations of a currency’s movement, as they protect companies against foreign-exchange fluctuations by fixing a rate at a particular level.

Reducing Pressure

Bank Rossii reintroduced a limit on the amount of currency swaps it offers to the market today, after a three-day break when the need for banks to make tax payments reduced the amount of rubles available.

Currency swaps allow traders to bet on the exchange rate without having to sell the currency up front. The Moscow-based central bank has limited their use since October to reduce speculative pressure on the ruble.

“The central bank will try to keep liquidity conditions tight in coming weeks” to reduce the scope for speculation within the new corridor and minimize further threats to reserves, Anatoliy Shal, JPMorgan Chase & Co.’s chief Moscow economist, and Robert Beange, its London-based currency strategist, wrote in a note to clients today.

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

Last Updated: January 23, 2009 10:17 EST