The Russian Central Bank's Fatalistic Optimism
Investment manager Slava Rabinovich has become something of a celebrity on Facebook as a prophet of doom. Yesterday, as the Russian central bank raised its key rate by 1 percentage point to 10.5 percent, he accused the Russian financial authorities of "completely losing control of the situation" and acting in "powerless and senseless desperation as it has no instruments to fight the geopolitical crisis that is destroying Russia's financial and economic system."
Within the central bank, however, there is no such panic and no sense of impending collapse: The monetary authority has settled on a policy dictated by a kind of optimistic fatalism.
As she announced the rate increase -- which was smaller than expected, prompting the ruble to slide against the dollar -- central bank governor Elvira Nabiullina said a bigger rate hike "would have increased recession risk." Yet a senior official who asked not to be identified told me that wasn't a particularly important consideration. Keeping rates low, the official said, would simply allow companies to borrow more so they could load up on foreign exchange, rather than increase investment.
The Russian monetary authorities do not want the Russian economy to use credit for growth. Russia has a different resource that other economies lack: the hundreds of billions of dollars in capital that has fled Russia in recent years, especially since the annexation of Crimea last March. As the weak currency makes imports pricey, it will eventually make sense for businesses to bring that money home to invest in import substitution, as they did after Russia's 1998 default and devaluation. To make that happen, reduce current capital flight and get foreign portfolio investors interested in Russian assets, the central bank is looking for an interest rate level that will make ruble assets attractive again. And it may be having some initial success. In the past three days, the yield on the 10-year, ruble-denominated Russian government bond has fallen, and since the rate hike the trend has held:
This seems somewhat counterintuitive: Shouldn't yields go up when the central bank makes borrowing more expensive? Yet, in the Russian context, the bond's performance means that more investors are interested in buying at this rate level. When I asked the official whether there is any concrete data to prove that investors are more interested in ruble assets, the answer was, "No, but I have information that they are." If that turns out to be wishful thinking, the central bank is likely to keep raising the rate in small increments.
That policy, of course, can be successful only if the ruble halts its rapid decline. The conventional wisdom is that it follows the trajectory of the oil price, but in fact, in the past 30 days, it has dropped faster, losing about 18 percent compared with 16 percent for the price of Brent crude:
The correlation between the oil price and the ruble has almost always been weaker than during the recent rout:
To the policy maker I talked to, that means the current relationship between oil and the ruble is something of a self-fulfilling prophecy built into trading algorithms. If that's true, when oil settles at a certain level, the ruble should halt its decline. Then, the logic goes, the high rates should attract serious investment in ruble assets.
As Rabinovich pointed out, the central bank is swimming against strong political countercurrents. Trust in the Russian government in general and the country's investment climate in particular is at a post-Soviet nadir. President Vladimir Putin's next moves are unpredictable because he appears to be motivated not by economic considerations but by a sulky, aggressive nationalism. The monetary authorities are under pressure to unleash financing for the defense industry, and to keep the ruble from falling so low that high inflation gives rise to social unrest.
To the technocrats running Russia's economic policy, however, the country is merely going through a painful but inevitable process of adjustment to a lower oil price. Once an equilibrium is reached, there will be new business conditions, and economic agents will regroup, the thinking goes. During the adjustment, it makes no sense to deplete the country's international reserves. Nabiullina said yesterday that the central bank would be prepared to spend $85 billion to smooth the ruble's fluctuations if the oil price settles at about $60 per barrel. From Jan. 1 to Dec. 1, 2014, the reserves shrunk by $90.7 billion to $418.9 billion, so she is not suggesting anything unrealistic, though the reserves have been going down at a faster rate in recent months.
The financial authorities' expectations may sound overoptimistic to investors who are being routed in the falling Russian market. Diamond Age Russia Fund, a hedge fund run by Rabinovich's management company, Diamond Age Capital Advisors, is down 57.13 percent for the year. That much pain tends to make people pessimistic, especially since Putin's anti-Western paranoia seems to be getting worse. It's true he might overturn the chessboard at any moment, introducing capital controls, sicking police on currency speculators or forcing the central bank to provide direct funding to industries. The team of highly competent economists running the Russian central bank and finance ministry could soon be out, replaced by adherents of Soviet-style economic management.
The Russian economic policy makers' calculus, however, appears to ignore the possibility of such shocks. That's probably the only way they can stay sane and do what they can to implement their vision. And it's no less understandable from a psychological point of view than Rabinovich's prophesies of economic meltdown.
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