Russian Central Bank, Putin at Odds as UBS Says Ruble Is 25% Undervalued

Russia’s central bank may let the ruble strengthen more than the government wants as it balances a free float target with legislative demands for a managed currency, UBS AG and Commerzbank AG said.

The ruble, which has gained about 6 percent against a basket of dollars and euros this year, is still 25 percent undervalued, given the current oil price, according to UBS. The bank may allow a ruble appreciation to keep a lid on import prices and help contain inflation, even after the government called for stronger currency controls, Commerzbank said.

“At the moment, the central bank is essentially letting the ruble float,” Clemens Grafe, chief economist at UBS in Moscow, said in an interview. “But they don’t feel safe that they will not come under pressure from the government because they don’t feel they are backed up politically.”

The ruble’s strength may exacerbate a split between the bank and Prime Minister Vladimir Putin’s government, which has warned a strong ruble is hurting exporters including the country’s biggest oil producer, OAO Rosneft. Deputy Economy Minister Andrei Klepach said on March 16 the bank needs to step up interventions, while Bank Rossi Chairman Sergei Ignatiev said on April 9 his ruble policy remains subject to a “political decision.” He targets a free float in 12 to 18 months.

The ruble gained 0.4 percent against the dollar, rising for the first day in four, to 29.1000 at the close of official trading in Moscow. It appreciated 0.1 percent to 39.2250 per euro.

‘Policy Conflict’

“While the Kremlin wants to avoid a sharp appreciation of the ruble, the central bank is gradually running into a policy conflict,” Barbara Nestor, an emerging-markets strategist at Commerzbank in London, said in an April 12 report. “We expect that the central bank will lower interest rates further and allow some gradual ruble appreciation to keep inflation risks at bay at the same time.”

Bank Rossii has cut the benchmark by 4.75 percentage points since last April, bringing the rate to a record-low 8.25 percent as consumer price growth eased to 6.5 percent in March, the slowest pace since July 1998.

The bank plans to meet to discuss interest rates on April 30 and may decide to keep its benchmark unchanged, the regulator’s First Deputy Chairman Gennady Melikyan said today.

Relative Returns

Even after rate cuts to date, Russia’s benchmark remains higher than India’s 3.75 percent reverse repo rate, China’s 5.31 percent lending rate and compares with 1 percent in the euro region and 0.25 percent in the U.S., attracting investors in search of higher relative returns.

The bank hasn’t stopped responding to government demands to avoid extreme fluctuations. The regulator bought a net $14.5 billion in March, the biggest dollar purchase in five months, compared with $6.7 billion in February and $1.6 billion in January, in an effort to stem ruble gains.

“There won’t be a free float in the near future,” said Julia Tsepliaeva, head of research at BNP Paribas in Moscow. “What we’ll have instead is a dirty float. The central bank will intervene in a difficult moment and exceed the usual volume.”

Even so, Bank Rossii would need to double its currency interventions from the first quarter to keep the ruble market “in balance,” Commerzbank estimates. Some economists deem interventions on this scale unlikely.

‘Sharply Reduced’

A transition to a free float is “what the Russian central bank clearly wants, that’s what they say, and that’s what they’ve been doing basically for the last 12 months, seeing how far they can get away with it before they get told by politicians not to do it,” UBS’s Grafe said.

The central bank has “sharply reduced” the extent to which it steers the ruble, Ignatiev said on April 9. Those remarks followed a March 16 warning from Klepach that the ruble may appreciate as much as 20 percent over the next three years if controls aren’t stepped up.

Russia, which is still haunted by a 71 percent ruble depreciation following its 1998 default, “isn’t ready to move to a floating currency,” Klepach said. Putin said in December the oil-dependent economy remains “insufficiently diversified” and is “unprepared for a full-fledged floating exchange rate.”

Oil and natural gas make up about 25 percent of Russia’s gross domestic product, a reliance President Dmitry Medvedev has called “humiliating” and “primitive.” Urals crude has surged 94 percent since the end of 2008.

Reserve Volatility

Ruble controls also force Russia to rely heavily on its foreign reserves, complicating the regulator’s efforts to stem inflation, according to some economists.

Reserves were at $448.6 billion in the week through April 9, compared with $383.9 billion a year earlier and $515.4 billion in the second week of April in 2008, central bank data show. The narrow money supply has increased more than 20 percent in the past year, according to central bank data.

The ruble controls are creating “background noise for the monetary authorities and their ability to control inflation,” said Sergei Voloboev, a Credit Suisse economist in London. “It’s much better to have exchange rate volatility than volatility of reserves and other monetary aggregates.”

To contact the reporter on this story: Paul Abelsky in Moscow at pabelsky@bloomberg.net.

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