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#15 - JRL 7061
OPINION: (Unwelcome) Mr Strong Rouble
Contributed by Alexei Zabotkine, Chief Economist, UFG

MOSCOW, Feb 12 /Prime-TASS/ -- For the first time since the 1998 financial crisis, the Russian authorities have officially adopted a policy of a strong currency. CBR Chairman Sergei Ignatiev said yesterday that in targeting 10-12% inflation, the Central Bank was ready to accept real effective exchange rate (REER) appreciation of 4-6% in the course of 2003.

Thus, the concerns about a bias towards the rouble's strengthening and the risk of an excessively tight monetary policy that we have been expressing since October have now proved to be justified.

Mr Ignatiev's statement reversed the currency policy stance which has prevailed since the 1998 crisis, which was to an extent blamed on the rouble being overvalued in the mid-1990s. This does not come as too much of a surprise - our initial concerns date back to 4Q02, when the authorities first started to demonstrate an unhealthy fixation with their (somewhat ambitious) 10-12% inflation target for this year, while the rouble/US dollar nominal exchange rate had stabilised in nominal terms. Since then, the CBR has continued to tighten its monetary stance - even prompting an interim liquidity crunch in the Russian banking system in the third week of January - which has resulted in nominal depreciation against the US dollar slowing to 31/4%, while Russia's CPI inflation is running at 14% against just above 2% in the US. Thus, the rouble's real appreciation against the US dollar is already running at 7% annualised and has every chance of moving into double-figure territory.

It is true that, during 2002 and, probably, during 2003 as well, the strengthening of the euro against the US dollar has helped to partially mitigate the impact from this real appreciation on the competitiveness of Russian producers. The real effective exchange rate - which measures the real exchange rate's movement against a basket of currencies of Russia's trading partners - was down 4% in annualised terms as of end-January. That said, this relief should be seen as a one-off benefit (its effects are likely to wear off within six months of the euro's appreciation faltering), which has a very uneven impact across the various sectors. Indeed, while being of great assistance to domestic producers of tradable goods (roughly 1/3 of Russia's imports come from the Eurozone) it is of limited help to Russian exporters, whose revenues are predominantly US dollar-linked.

At first glance, the 4-6% REER appreciation outlined by Mr Ignatiev would only take the rouble's REER back to early 2002 levels or slightly above them. Moreover, greater currency stability - and Mr Ignatiev's guidance effectively implies that the nominal rouble/US dollar rate will indeed stay flat through (at least) end-2003 - may even promote a considerable switch from US dollar into rouble assets inside the Russian economy, driving domestic interest rates to new historic lows (actually, this process has been under way for a while; long-dated OFZs already yield below 12%) and thereby triggering a domestic credit boom, which may boost Russia's growth this year. Quite a bullish outcome, it would seem...

However, the medium-term risks of the CBR's new policy stance should not be underestimated either. Firstly, unless the CBR gets the dosage of monetary tightening right (so far, the track record is at best mixed) the new policy may undercut the cyclical acceleration that we expect in 2004. Secondly, the credit boom may turn out to be unhealthy, as (a) the banks are not quite ready to increase the scale of their credit operations and (b) the supervisory capacity of the CBR is still weak. Thirdly, since it is unlikely that the authorities will be able to reduce inflation any further in 2004-5, when the regulated tariff realignment process should be markedly accelerated, the credibility of the policy may be undermined, making the CBR's challenge even more difficult in those years. Therefore, choosing between the two evils - currency appreciation and inflation - we continue to prefer inflation. Price stability is a noble goal, but only if relative prices in the economy are already sufficiently aligned. Rocking the boat that is Russia's economy due to a political fixation will only cause unnecessary turbulence.

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