Russia raises interest rates to 17%, but rouble continues to plummet

16th December 2014

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The Russian currency has  fallen to 75 roubles to the US dollar after the Russian central bank raised interest rates from 10.5% to 17% yesterday in a bid to halt is decline.

The central bank’s move was designed to make it more attractive to hold roubles and prevent wealthy individuals and companies from taking money out of the country in favour of safe havens like the US dollar.

There was a bounce-back in the currency this morning, to 59 roubles to the dollar, but since then it has declined dramatically.

The rouble is the worst performing major currency so far this year having lost half its value against the US dollar, according to Hargreaves Lansdown, the adviser.

This has been prompted by sanctions against the Russian government in relation to the Ukraine, and the falling oil price, as the Russian government receives half its total revenues from petrol, according to the IMF

Hargreaves Lansdown calculates that the MICEX stock market index is down around 5% in local currency terms, but converted into Sterling this equates to a 50% loss for UK-based investors.

Laith Khalaf, senior analyst at Hargreaves Lansdown, said: “The Russian central bank has moved to battle stations to defend its currency. So far the move has not stopped the slide, and it may yet have negative effects on the Russian economy.

“International investors will remember how the currency crisis of 1998 and subsequent default on sovereign bonds brought Wall Street to its knees, via the exposure of the giant hedge fund, Long Term Capital Management.

“While the currency has significantly weakened this year, default by the government looks unlikely this time around because Russia has relatively low levels of government debt compared to GDP.”

Khalaf said that despite this, the Russian economy and companies do face serious problems and that raising interest rates will take a toll on a country which is already on the brink of recession.

He added that over the longer term, Russia’s vast natural resources are likely to prove positive. Like other emerging markets Russia also has a population which is expected to become wealthier.

He added: “For investors wanting exposure to Russia, a long-term horizon and a strong stomach are both an absolute must. It has been a painful year, but like all emerging markets volatility is to be expected.

“The stock market falls seen this year mean Russia has continued to be among the cheapest markets in the world, according to our analysis, though clearly there are reasons for this, and cheap markets can remain out of favour for a long time.”

A key factor to consider is the level of Russian sovereign debt denominated in dollars.  Khalaf said this is significant because it becomes much more expensive for the Russian government to pay off as the rouble falls.

However, he said, according to Wells Fargo, dollar-denominated debt of the Russian central government remains manageable, currently totalling around $38 billion, which requires around $6 billion capital and interest payments in 2015.

Meanwhile Russia has around $400 billion in foreign exchange reserves, and a relatively low debt-to-GDP ratio of around 10%, which is why Russian government bonds carry a BBB-rating from Standard and Poor’s (just inside the investment grade universe).

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