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Has Russia Stopped Worrying and Learned to Love Hot Money?

  • Real rates at two-year peak as central bank chases price goal
  • Ruble a magnet for carry traders after record gains last year

Russia’s central bank has been second-guessed for keeping monetary policy so tight it’s made the ruble a magnet for speculative capital. Now some analysts are starting to wonder if keeping investors coming back for more was the plan all along.

With the cost of money adjusted for inflation at a two-year peak, the Bank of Russia’s focus is increasingly on capital flows as it heads toward resuming interest-rate cuts this year, according to Raiffeisenbank JSC. High rates are drawing in foreign money as the government doubles its domestic borrowing plan this year, while a strengthening ruble helps the central bank rein in inflation. At 5 percent, Russia’s real interest rate is more than double the level in China and Mexico.

“This seems high,” Javier Sanchez, a fixed-income analyst for central and eastern Europe at UniCredit SpA in London, said by e-mail. “The Russian central bank probably has other concerns, such as establishing credibility by achieving the inflation target and attracting flows at a time when the current-account balance has declined significantly.”

The Bank of Russia has held its benchmark above inflation for more than a year, a period that saw only two rate cuts of 50 basis points each even as price growth slowed almost in half to 5 percent. Governor Elvira Nabiullina has said that keeping borrowing costs stable in positive territory is an “important condition for healthy economic growth.” She pledged to keep the key rate up to three percentage points above headline inflation to anchor expectations.

Hot Capital

By contrast, the central bank has previously used rate cuts to beat back speculative inflows. A different stance this time plays into the hand of the government as it looks to push its domestic borrowing in 2017 to 1.05 trillion rubles ($18 billion) from last year’s record without pushing yields higher.

After a meeting this month, policy makers warned they may put off easing until the second half after the Finance Ministry unveiled plans to purchase foreign currency. While the central bank’s goal is to maintain the appeal of savings and bring inflation to its 4 percent target by end-2017, its “moderately tight” stance has stoked the ruble’s appeal as a carry-trade, when investors borrow where rates are low and invest in higher-yielding assets.

Russia’s 10 percent benchmark rate has delivered the highest carry returns this year in emerging markets. Derivatives traders, meanwhile, have scaled back their wagers for a rate cut in the next three months. Forward-rate agreements signal 36 basis points of decreases, down from January’s high of 60.

‘Equilibrium Level’

Real rates will reach their “equilibrium level” of 2.5 to 3 percent when inflation settles at 4 percent, which will take time, according to Oleg Kouzmin, chief economist for Russia at Renaissance Capital in Moscow. Anton Kirukhin, head of debt capital markets at Rosbank PJSC, believes the central bank may wait until 2019 to normalize rates.

That’s powering the ruble’s strongest performance among emerging markets in 2017 after its best-ever year in 2016, when it gained 20 percent against the dollar. It’s up more than 6 percent so far this year. The Russian currency traded 0.5 percent weaker as of 7:05 p.m. in Moscow.

Since a stronger exchange rate makes imports cheaper, the central bank may be content to watch the ruble appreciate as it continues to flag risks for inflation. This year’s goal still isn’t easy to reach and “moderately tight” policy is needed to achieve a sustained slowdown, Nabiullina said on Wednesday. The median value of inflation expectations for a year ahead remains at more than double the target.

Debt Surge

The central bank’s policy could also dovetail with the surge in borrowing by the government. The Finance Ministry expects the domestic market to absorb the bulk of its planned issuance this year. That may be a challenge, with local investors seeing limited potential for growth after a recent rally. 

Ruble bonds known as OFZs, which last year had the second-best performance after Brazil among emerging markets with returns of more than 35 percent, have brought investors gains of 8.2 percent in dollar terms so far this year, ranking them fourth, according to data compiled by Bloomberg.

“The higher the ruble rate, the greater the inflows from foreigners into OFZs and the lower the demand of residents in foreign assets,” Denis Poryvay, an analyst at Raiffeisenbank in Moscow, said by e-mail. “For non-residents, what’s important are both high real rates and high nominal rates when compared with the local sovereign debt of other emerging markets.”

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