Financial Regulatory Forum

SCENARIOS-What capital controls might Russia adopt?

By Reuters Staff
December 31, 2009

MOSCOW, Dec 31 (Reuters) – Russia will step up its efforts to curb the influx of speculative capital, which can flee the country with the “first rain,” Prime Minister Vladimir Putin said this week, adding the measures will be moderate.

“There will be no revolutions,” Putin said.

Nonetheless, his remarks pushed the rouble considerably down, as investors were easily spooked by hint the government might take steps soon.

The comments have intensified the talk on capital controls, which began earlier this autumn when a new wave of short-term capital entered the Russian forex market, driving the rouble rapidly up.

Here are some possible scenarios:

FULL-SCALE CAPITAL CONTROLS – UNLIKELY

The government has been vague about what measures it is considering, with the Kremlin’s top economic adviser Arkady Dvorkovich saying only that there is no need for a Brazilian-style tax on capital inflows. [ID:nLDE5BD1J4]

Finance Minister Alexei Kudrin and central bank chairman Sergei Ignatyev have reiterated their opposition to “hard” capital controls, which were scrapped in 2006 as Russia moved towards a more open economy and free-floating currency.

Analysts agree such a move is unlikely, given Russia’s search for long-term foreign investment, its goal to move to a currency free-float by 2012 and its drive for a greater international role for the rouble.

“Russia is keen on elevating the status of the rouble internationally. Any hard kind of capital controls will simply kill this off, said Ivan Tchakarov, analyst at Nomura.

Russia resisted calls to reinstate capital controls at the height of the latest crisis and rouble depreciation, making it even less likely it will resort to them now.

Before the capital controls were scrapped in 2006, non-residents had to deposit money at the central bank when buying rouble-denominated securities while Russian exporters had to change 10 percent of foreign currency earnings into roubles.

No “hard” capital controls means there are no plans to controls flows out of Russia, nor to slap restrictions on exporters. Any foreign currency held as savings or bought for holidays abroad by ordinary Russians would also be unaffected.

SOFT MEASURES – LIKELY

Soft measures — potentially a range of them — are seen as quite likely, on the other hand, even if not all analysts are convinced they would be effective.

There are two main directions soft measures could take: discouraging external borrowing and discouraging speculators.

MEASURES TO LIMIT FOREIGN CURRENCY BORROWING

Russia is keen to reign in borrowing abroad by companies and banks, who are starting to return to financial markets after months of crisis-enforced absence.

Their heavy external borrowing — totalling some $400 billion — was one of the reasons Russia was so hard hit by the global financial crisis, as companies found themselves unable to restructure debt and struggling to make repayments as the value of the rouble plummeted.

Analysts say limiting external borrowing would be an important act for Russia, but some doubt how successful such attempts will be, especially as they are likely to meet with stiff opposition from companies.

Measures to discourage external borrowing could include:

a. Reserve Requirements — Russia could increase reserve requirements for banks’ foreign currency liabilities, making them higher than those for rouble debt. This will make it more expensive for banks to borrow in foreign currency.

b. Limits on State Companies’ Borrowing — As a key shareholder in many of Russia’s biggest companies, from banks to energy firms, the government could place restrictions on how much they can borrow abroad. This is likely to prove unpopular with the companies however, who argue that external capital markets offer better terms than domestic ones.

c. Reducing Tax Shield on Foreign Borrowing — Russia could reduce the amount of interest on foreign currency loans that is tax deductable. Under a plan proposed by central bank board member Sergei Shvetsov this “tax shield” could be reduced to 3 percent instead of the current 22 percent.

For an analysis click on [ID:nGEE5AN2BK]

MEASURES TO DISCOURAGE SPECULATORS

Russia could make it less profitable or more risky for investors to place speculative bets on the rouble and Russian assets — a trend flagged as problematic by officials.

Possible steps include:

a. Tax on Short-Term Investment Profits — Kudrin has said profits on some transactions could be taxed, but not transactions themselves [ID:nGEE5AO0KZ]. Analysts say such a measure could be applied to short-term investments.

b. Caps on Banks’ Open Foreign Currency Positions — The central bank could put limits on commercial banks’ foreign currency denominated assets and open positions in foreign currencies. Such measures were temporarily introduced in 2008 at the height of the crisis, but have since been scrapped.

c. More Interventions — The central bank has already said it is stepping up interventions within the rouble’s floating corridor versus a euro-dollar basket <RUS=MCX> rather than just on its boundaries. Such interventions are harder to spot and to predict, increasing the risk for would-be speculators.

d. Rate cuts — Russia is expected to continue cutting interest rates, thereby reducing the rouble’s yield appeal. Some analysts say this is ultimately the only way to put an end to the rouble rally, but the central bank may not be willing to cut far enough given the potential inflationary risks. (Writing by Lidia Kelly and Toni Vorobyova)

((lidia.kelly@reuters.com; Tel: +7495 7751242))

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