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WorldDecember 1 2011

Russia's central bank governor happy with hands-off approach

Russian central bank governor Sergei Ignatiev's decision not to intervene when the country's currency came under pressure earlier this year has been welcomed by economists as a sign that the country's commitment to a more open economy is genuine. The governor explains to The Banker that such a policy is part of his long-term plan for the country.
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Russia's central bank governor happy with hands-off approach

Russia appears to be steadfast in moving towards a more open economy and a free-floating exchange rate, despite the pressures of fluctuating oil prices and a generally volatile global situation. The ruble came under pressure in August and September 2011, as investors engaged in a flight to safety and sold ruble assets. But the Russian central bank preferred to let the exchange rate take the hit rather than intervene massively in the markets.

The view among analysts appears to be that this approach is ultimately more effective because it dampens expectations of further interventions to come. Economist Evgeny Gavrilenkov of brokerage Troika Dialog says in an October report: “The [Russian] central bank’s activity on the foreign exchange market was very moderate: it only tried to smooth daily volatility and did not play against market trends. Thus, the ruble is currently in a ‘dirty’ floating regime. Given the current oil price and low inflation, we believe the Russian currency has depreciated too much and it could well bounce back in the fourth quarter.”

Pressing on with policy

In an interview held in Washington, DC, during the IMF/World Bank annual meetings in September 2011, Russian central bank governor Sergei Ignatiev outlined the transition in policy that is under way with the ultimate goal of a free float and inflation targeting. Mr Ignatiev won The Banker’s award for best central bank governor of the year for Europe in January 2011 in part due to these policy actions.

“Five to seven years ago we had a dual [policy] goal – one aim was to bring down inflation to a certain level and the other was not to let the ruble effective exchange rate rise above a certain level. So, for example, we might announce that we would try to contain inflation at the level of 10% to 12% and at the same time try not to let the ruble real effective exchange rate rise by more than say 6%.

“At the time that was not the worst policy we could opt for. Our econometric research found that there was a high level of interdependence between the industrial production level and the real effective exchange rate of the ruble. In other words, when the ruble was appreciating, industrial production was going down. However, over time that interdependency started to weaken.”

“The reasons for this are quite understandable – the Russian economy was becoming more market orientated, the economic resources and production factors were becoming more flexible, and there was a flow of those resources from one sector to another. If we imagine a model in which factors of production flow freely from one sector to the other, in that model the real effective exchange rate does not affect production volumes at all. 

“The economy has now matured and three or four years back we gave up that goal of not letting the real effective exchange rate appreciate. At the same time we announced that over several years we intended to move to inflation targeting and to a free float – not overnight but over a period of several years. In the meantime we would have a floating band and the width of that band was first two rubles, now it is five rubles.

“The [aim] of the central bank is to mitigate vast fluctuations in the exchange rate. The Russian economy is extremely vulnerable to changes in oil prices and to changes in the international financial markets – the reason being that since 2006 we have had no restrictions on capital flows. All of them have been lifted which is unlike the situation in other BRIC [Brazil, Russia, India and China] countries.

These days, the central bank is more reluctant to refinance banks, which helps limit depreciation expectations to a much lower level than three years ago

Evgeny Gavrilenkov

“This has a major impact on the exchange rate. Sentiments change and the money flows in or out. To mitigate those fluctuations [we do intervene in the markets].”

Net effect

As Mr Gavrilenkov at Troika Dialog notes, however, these interventions are becoming less substantial and ironically more effective as a result. According to Troika, in 2008, when there were similar conditions, Russia's central bank “initially defended the ruble by spending international reserves amid increased lending to commercial banks [to provide liquidity]. As a result the more rubles the regulator pumped into the system, the more reserves it had to spend.

“These days, the central bank is more reluctant to refinance banks, which helps limit depreciation expectations to a much lower level than three years ago.”

In fact, Russia's Ministry of Finance has taken on the role of lender of last resort by using its fiscal surplus to make deposits into the banking system. As this money is from taxation, pushing it out as deposits at about 6% is quite good business. Even so, with fiscal spending rising, these funds are likely to be withdrawn in the fourth quarter of 2011.

Sergei Ignatiev, central bank governor

Consolidation push

Russian growth is moderate at 4.5% to 4.8% while inflation forecasts are coming down with estimates now in the 6% range. The other big banking issue in Russia is the sheer number of banks and the need for consolidation. Mandated increases in capital levels and other measures have already brought the total number of banks down by more than 20% and there are further capital increases on the way.

Mr Ignatiev says: “We still have a large number of banks although the number is decreasing. Some six years ago we had 1300, now we have 1000. From July 2012, we will increase the minimum capital requirement from $3m to $6m, and out of the 1000 banks, 150 banks have lower capital than this. Many of those banks intend to increase their capital to the new required level, in other cases banks will merge or may lose their licences.

“Or their status could be downgraded to credit institutions that do not have the right to perform all types of banking operations. I am not an advocate of taking administrative measures to force a reduction in the number of banks in Russia. Our country is vast, and some of those smaller banks do have worthwhile niches. They operate in remote areas and if they closed down it would not beneficial. Originally the reason to reduce the number of smaller banks was that some were engaged in tax evasion, smuggling and money laundering.

"Quite often a small bank was cheap to buy and would get bought solely to be used for all kinds of inappropriate operations. We had to close down such banks and that contributed to the reduction in the number of banks.”

Eurozone concern

Like most central bank governors around the world, Mr Ignatiev is extremely concerned about the instability in the eurozone. His comments made in September seem just as relevant as The Banker went to press in late November.

“I am extremely concerned about developments in the eurozone," he says. "I understand how difficult and complicated the problem is but from the purely economic point of view, the overall situation in the eurozone is not that bad. If we look at the debt to gross domestic product or at the deficit the situation in the eurozone is generally better than in the UK or the US. The problem is largely political and I was absolutely sure that politicians would be able to come to an agreement. But so far we do not have clear signals that the politicians have come to an agreement. This affects our exchange rate, capital outflows and the Russian banking system.”

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Read more about:  Central & Eastern Europe , Russia