No Putin Yes-Man on Policy as Nabiullina Stalks Inflation

A year into the job, Russia’s central bank chairman is proving to be anything but a yes-man for President Vladimir Putin.

Bank of Russia head Elvira Nabiullina’s determination to tackle inflation and bolster the ruble has led to two interest-rate increases since February, to 7.5 percent, and a warning that more may be on the way. The hawkish policy helped weaken Russia’s $2 trillion economy amid U.S. and European sanctions following Putin’s annexation of Ukraine’s Crimean peninsula.

At the same time, rising borrowing costs are boosting the ruble carry trade, which has generated the world’s third-best returns in the second quarter, according to data compiled by Bloomberg. Russia’s so-called OFZ government bonds returned 6.9 percent in the period in dollar terms, the best performance among European emerging markets after Turkey, the data show.

“Nabiullina proved to be an independent central banker, so that in a positive way surprised the market,” Piotr Matys, an emerging-market economist at 4Cast Ltd. in London, said by phone June 27. “Russia offers one of the highest interest rates among emerging markets in an environment dominated by demand for carry trade. The country’s bond yields are also looking attractive.”

Short Dollar

The carry-trade, or return generated by shorting the dollar to buy the Russian currency, gave a 5.9 percent profit this quarter, the third most after the Brazilian real/dollar and Argentine peso/dolalr trades, among 23 emerging-markets tracked by Bloomberg. Bondholders are lured to Russian debt by expectations that Nabiullina, 50, will squash inflation to 5.5 percent next year from an annual average of 8.9 percent since 2007, according to the median estimate in a Bloomberg survey of economists.

The first female central bank governor in the Group of Eight, appointed eight months before U.S. Federal Reserve Chairman Jan Yellen, raised the key rate 150 basis points in an emergency meeting March 3, two days after Putin received parliamentary approval to use troops in Ukraine. She surprised investors again with a 50 basis-point increase to 7.5 percent on April 25 and told reporters on June 16 that more tightening may be in store should “inflation risks materialize.”.

Higher rates are helping attract investors after $49.3 billion in capital left Russia in the first quarter, the largest outflow since the last three months of 2008, according central bank data. Outflows slowed to $16.2 billion in April and May, Nabiullina said June 16.

‘Perfect Situation’

“The central bank created the perfect situation for international FX speculators to play the carry trade,” Alexander Losev, chief executive officer at Moscow-based Sputnik Asset Management, said by e-mail June 27. “While the main global central banks cut rates and launch monetary stimulus to boost the economy, our central bank squeezes liquidity, reduces the money supply and holds high rates.”

Bank of Russia targets inflation of 5 percent this year and 4.5 percent in 2015, according to a three-year plan published in November. Consumer prices rose 7.6 percent in May from a year earlier, the most since August 2011, and will start “seriously decelerating” from July, Maxim Oreshkin, head of strategic planning at the Ministry of Finance, said June 25.

The economy may expand 0.4 percent in 2014, after a 1.3 percent advance last year, the central bank forecasts.

Long-term Credibility

“The slowdown in economic growth will bring a disinflation trend,” Vladimir Kolychev, chief economist at VTB Capital in Moscow, said by phone June 26. “Even if we see a rather strong deceleration, the central bank will be in no hurry to lower rates.”

Given the risks to growth and forecasts that price growth could slow, lower interest rates may be appropriate, Russian Economy Minister Alexei Ulyukayev said on May 13.

In her second year, Nabiullina plans to steer the ruble to a free float and switch monetary policy to direct inflation targeting. For this she will benefit from keeping the goodwill of investors such as Esther Law, who helps oversee about $8 billion of emerging market debt for Pioneer Investments.

“The market has been surprised by the hawkishness of the central bank but this in a way should improve the long-term credibility,” London-based Law said by e-mail on June 27. “A very modest rate cut will have little impact on the Russian credit market, which is likely to benefit more from structural reforms and risk sentiment rather than monetary policy.”

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