Russia to Rebuild Reserves Eroded Amid Ukraine Conflict

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Central Bank Governor Elvira Nabiullina
Central Bank Governor Elvira Nabiullina pauses during the 26th Congress of the Association of Russian Banks (ARB) in Moscow, on Tuesday, April 7. Photographer: Andrey Rudakov/Bloomberg

Russia is seeking to boost central bank reserves by about $143 billion in the next few years to the level before it annexed Ukraine’s Crimea, provoking international sanctions and leading to a currency crisis.

Reserves should reach a “comfortable” level of about $500 billion within the next few years from about $357 billion now, Bank of Russia Governor Elvira Nabiullina told the International Banking Congress in St. Petersburg on Thursday.

“In optimal conditions, reserves should be enough to cover considerable capital outflows for two to three years,” she said. “The increase in reserves should be gradual and solely in a way that doesn’t contradict monetary policy goals, particularly reducing inflation to 4 percent in the medium term.”

The reserves fell by about a quarter in 2014 as Russia propped up the ruble, which lost almost half its value against the dollar in the face of declining oil prices and U.S. and European Union sanctions after Crimea was annexed in March last year. Sanctions were expanded last July as the U.S. and the EU accused Russia of aiding separatists in eastern Ukraine with troops and weapons, a charge President Vladimir Putin rejects.

The regulator may reach the desired level of reserves in the next three to five years, the RIA Novosti news service reported Thursday, citing First Deputy Governor Dmitry Tulin.

The central bank’s holdings shrank for a second week, dropping by $4 billion to $356.5 billion in the seven days through May 29, according to a statement on Thursday.

‘Ultra-Comfortable’

The current level of reserves is “sufficient” and reaching what the central bank considers to be the “ultra-comfortable” buffer of $500 billion “will be done quite smoothly, stretched over time during at least several years,” Nabiullina told reporters during a later briefing. “We’ll carry out operations depending on the situation on the currency market, and the parameters of the operations can vary.”

Following the world’s best currency rally this year, the central bank last month started a program of buying as much as $200 million a day. In determining the size of the interventions, the central bank sought to limit their impact on the currency market and the ruble, according to Nabiullina.

The ruble has rebounded 8.6 percent this year as oil prices stabilized and tensions eased in Ukraine. It weakened 3 percent to 55.95 against the dollar at 7:49 p.m. in Moscow.

Policy Easing

The Bank of Russia began easing monetary policy this year as the economy enters its first recession in six years. The regulator lowered its key interest rate three times, cutting borrowing costs by 4.5 percentage points to 12.5 percent. That followed an emergency increase to 17 percent in December aimed at halting the ruble’s slide.

Russia’s effort to build up reserves doesn’t amount to support for the ruble, Nabiullina said. Russia isn’t abandoning the currency’s free float, though “more frequent interventions on the currency market” are possible during the “initial phase” of the regime the bank adopted in November.

It’s an “ambitious” goal for the central bank with a free-floating exchange rate, Natalia Orlova, chief economist at Alfa Bank in Moscow, said by phone. “Either they have very optimistic expectations or they are ready for a weakening of the ruble rate.”

Nabiullina’s announcement is meant to show “that things are fine in the economy, but also that they have a mechanism to keep the ruble weakening if required,” Vladimir Miklashevsky, a strategist at Danske Bank A/S in Helsinki, said in e-mailed comments.

Financial Stability

While the threat of financial instability has been largely neutralized, faster rate reductions involve risks and curbing inflation expectations remains the bank’s priority, Nabiullina said.

Inflation expectations remain elevated, though the rate of price growth will continue to ease, she said. Inflation in Russia was at 16.4 percent in April from a year ago after accelerating to 16.9 percent in March, the fastest in 13 years.

Rate cuts were motivated by risks to economic growth, Nabiullina said. She cautioned against relying on exports to spur the economy, saying Russia will miss out on $150 billion to $170 billion of earnings per year.

There are “difficult” years ahead for Russian banks and the economy, which is adapting to new conditions and performing better than forecast, though it’s too early to say that it’s overcome the worst of the crisis, Nabiullina said.

Russia spent 509 billion rubles ($9.3 billion) in total to rescue banks and the regulator withdrew 145 licenses in the past two and a half years, Nabiullina said. The economic slump is no reason to ease bank oversight, while Russia’s banking industry is showing stability and its profit may be 100 billion rubles in 2015. There may be “moderate” growth in banking indicators this year and a turnaround in the credit market in the second half, she said.

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