Is the rouble overhyped?

October 4, 2012

For many months now the Russian rouble has been everyone’s favourite currency. Thanks to all the interest it rose 4 percent against the dollar during the July-September quarter. How long can the love affair last?

It is easy to see why the rouble is in favour. The central bank last month raised interest rates to tame inflation and might do so again on Friday. The  implied yield on 12-month rouble/dollar forwards  is at 6 percent — among the highest in emerging markets.  It has also been boosted by cash flowing into Russian local bond market, which is due to be liberalised in coming months. Above all, there is the oil price which usually gets a strong boost from Fed QE.  So despite worries about world growth, Brent crude prices are above $110 a barrel. Analysts at Barclays are among those who like the rouble, predicting it to hit 30.5 per dollar by end-2012, up from current levels of 31.12.

All that sounds pretty bullish. But there are reasons why the rouble’s days of strength may be numbered. First the QE effect is unlikely to last. As we argued here, QE’s impact will be less strong than after the previous two rounds. Analysts at ING Bank point out that in 3-6 months after the launch of QE2 oil prices gained 40 percent, pushing the rouble up nearly 10%. This time oil won’t repeat the trend this time, and neither will the rouble, they say:

A chance for higher policy rates may support the rouble in the short-term, but we doubt it will steadily gain from these speculative carry-trade

Second, flows to the rouble-denominated OFZ bond market may be overhyped, ING says,  noting that the finance ministry has cut 2013 borrowing forecasts by 30 percent. Capital flight, Russia’s old headache, continues unabated and is expected around $70 billion this year.

The longer-picture is most troubling. A major source of support for the rouble has been Russia’s current account surplus. But ING calculates this will more than halve in 2013 from this year’s expected levels around $80 billion — a consequence of lower oil prices and Russia’s WTO accession which will encourage imports.  The central bank has gone a step further to concede Russia will actually swing into deficit by 2015. Unless Russia puts in big reform by then, it could be in trouble, says Capital Economics:

The big risk going forward is that oil prices fall, thus requiring either domestic demand or the rouble (or both) to weaken in order to limit the deterioration in the external position.

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