Why is the rouble weakening?

The Russian rouble saw the worst loss at 2.1% against the euro since the start of this week (13.5% loss YTD). Against the US dollar the Russian currency’s heaviest loss was 1.3% since 6 October 2014 (22.5% YTD). We have seen that both macro fundamentals and sentiment have been sharply turning against the rouble since summer 2014 despite the central bank’s hawkish monetary policy.

As the USD has strengthened significantly against the major and EM currencies since summer 2014, the oil price has continuously fallen, diving under USD100/bbl for Brent early September 2014. Through 2012-2014 our view on the rouble and the oil price has been the following: correlation disappears as Brent price which is moving close to Urals stays between USD100-120/bbl. At those levels other factors had a bigger impact on RUB than just the oil price: dollar liquidity abundance, risk sentiment, geopolitics and seasonality. However, the new old correlation has come back (see Figure 1).

Despite the rapid decline in the oil price since early summer 2014 (-20.4%) under USD91/bbl, Brent’s average price is around USD105/bbl YTD, which allows the Russian budget to run a comfortable surplus and the current account surplus to grow further in 2014 as percentage of GDP on weakening rouble and falling imports (see Figure 2). Yet, we see Russian fiscal stability at a serious risk if the average oil price stays at USD90/bbl or goes lower over the next 12 months.

Weak macro weighs over geopolitics

Geopolitical risks are still present for the rouble and the Russian economy. This means that new sanctions against Russia and Russia’s counter-sanctions can arise anytime. Such an environment keeps the largest consumers of FX in Russia nervous as those cannot be sure FX is easily and cheaply available on new possible financial sanctions. We have seen that local banks and corporations have been actively squirreling foreign currency. We have estimated that total external debt maturing by the end of 2015 exceeds USD150bn. Yet, by the end of 2014 just sanctioned entities are due to pay USD15bn of FX debt, but the amount is rising considerably in 2015. Till now the increased demand for FX has been driven through FX swaps pushing rouble swap rates quickly down. To cover the need, Russia’s central bank has introduced an FX swap mechanism promising more FX though FX repo (seven and 28-day) in the near future.

Another reason for the rapidly weakening rouble are RUB’s active shorters as fundamentals of Russian economy are not supporting the currency. The economic environment has been deteriorating as fixed investments have fallen 2.5% y/y in January-August 2014 and private consumption growth is slowing down on accelerated inflation after the food imports ban was introduced. The Russian economy grew just 0.8% y/y in August 2014 and we expect GDP to shrink 0.3% y/y already in 2014, posting -1.8% in 2015 as accelerated capital outflows and tight monetary policy continue to weigh on both supply and demand side.

To mitigate the rouble’s fast devaluation Russia’s central bank has actively sold FX this week (mostly USD we believe), shifting the trading band for the dual currency basket further up (see Figure 4). The latest shift reported was executed on 8 October, moving the band to 35.85-44.85. The amount of FX sold in the last three days climbed to USD1.8bn. We believe that the central bank is not against a steadily weakening rouble as the rouble’s real effective exchange rate remains strong, but what scares the central bank is the speed at which devaluation is happening. Thus, further FX interventions will weigh on the country’s gold and FX reserves. At the same time, the major rating agencies do not see any bright future for Russian economic growth in the near future. We continue to reiterate that further rating downgrades are possible in the current environment of Western sanctions.

Overall, we remain bearish on the outlook for the Russian rouble and we expect it to remain under some pressure going forward. We continue to expect the rouble to weaken faster against the USD than against the EUR. We continue to recommend keeping elevated short-run hedge levels, especially for the USDRUB.