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Russia: What monetary tightening?

Wed, May 16 2007, 08:59 GMT
by Lars Rasmussen

Danske Bank A/S

Russia’s central bank (CBR) yesterday announced that it would raise the minimum reserves requirement for banks as from July 1 in an attempt to limit money supply growth triggered by a recent acceleration in capital inflows. More specifically, it said that it would reserve requirements on non-residents' deposits at Russian banks in both Russian and foreign currency to 4.5% from 3.5%. Reserve requirements on individual's rouble deposits have risen to 4% from 3.5%.

Capital inflows have increased on higher foreign direct investment inflows and the greater influx of speculative capital Q1, as investors among others bought Yukos’ assets and shares in Russia’s second largest bank VTB. In response to the rise, the central bank has recently raised its forecast for 2007 net private capital inflows to USD35 bn from USD30 bn. Therefore, the deterioration in the current account surplus, as imports currently are accelerating sharply, will partly be offset by higher capital inflows in 2007.

As capital inflows increase the strength in external balances, it also increases demand for roubles. This explains the recent re-acceleration in money supply growth, which now is above 52% y/y. These levels of money supply growth are concerning the central bank as it wants to ensure inflation stays below 8% y/y (currently it is 7.4% y/y), which will be harder to achieve with accelerating money supply growth.

We believe that the effect of the action taken yesterday will be rather limited as the initiative will only reduce money supply growth by a few percentage points. In fact, we believe it would have been beneficial for the CBR to have used more direct measures such as letting the rouble appreciate against its dual currency basket, as that would have had a larger effect on lowering inflation.

Looking ahead to the rest of 2007, we believe that inflation will rise to 8% y/y. The CBR will not allow it to go above that level for a sustained period, and as it approaches 8% y/y we can expect it to let the rouble appreciate.

We expect that the CBR will allow roughly 2% appreciation for the rest of 2007, and given the stability in the currency we think that buying Russian bonds from a risk reward perspective looks fairly attractive - see Research Russia: Good reasons to buy rouble bonds, from April 26, 2007.

Published on  Wed, May 16 2007, 09:00 GMT