Central Bank eases its grip on the national currency

At the  same  time  the Central Bank of Russia has  reduced to $350m  from  $1bn  the  volume of  accumulated  interventions  shifting  by 5 kopeks  the  currency trading  band. The  Bank of Russia  has  noted in its  statement  that  it  plans to  complete  the  transition to a floating  currency exchange  rate by the  end of 2014.

Therefore, the  regulator  has reverted  back to the  course of  further  easing its  grip on  the  currency  exchange  rate. In general, the Central Bank’s policy  may  lead  to  devaluation of the national  currency subject to external  macroeconomic changes, namely drastic fall of crude  oil prices and  growth in  capital  flight.

Prior  to the  crisis of  2008-2009 the  Bank of Russia  was  committed to a  policy of  fixed ruble exchange  rate. The  dual-currency  basket  (including  the US dollar and the Euro)  has been  the  benchmark of  the  currency  policy since 2005. The  structure of  the dual-currency  basket  has been  established at $0,55 and 0,45 Euro since  February 8, 2007.  The  exchange  rate  was  allowed  to  float  within  a narrow  band  range, but  actual  value of the dual-currency  basket  changed very  insignificantly.  For  instance, in the  period of 2006 to H1 2008  the value of the dual-currency  basket  varied  4% or  less.  Considering  that  the  balance of payment on the  current account  of the Russian Federation  remained  positive,  the Bank of Russia  had  to buy  considerable  amounts of foreign  exchange to be  able  to  maintain a  stable exchange rate.

The Stabilization Fund,  which was  established as early as   2004,  was  used as instrument  of  sterilizing  excessive  money  printing.  This  helped  lim it  the money printing,  which is determined by  the  purchase of  FX revenues  from  exports of crude  oil and natural  gas amid  growing global  prices of energy  resources.

Restrictions  on capital cross-border  movement were  removed completely  in the middle of 2006.  A stable exchange  rate and  high rates  in the  internal  financial  market  made the Russian currency attractive  for  speculators,  thereby  enabling  more than $145bn  of  net capital  inflow over two and a half years elapsed  between  2006-2007 and H1 2008.  At the  same time the  Bank of Russia  found  it  impractical  to  carry  out  an independent  monetary policy  subject  to a fixed  currency  exchange  rate and free movement of capital (“Impossible trinity”).  If  excessive  inflow of  foreign currency  amid  high prices of crude oil was  sterilized  using  the resources of  the  Stabilization Fund,  the foreign capital  inflow  led to printing  more  money  and  interfered with  the  control over  inflation.  Furthermore,  high  rate  of  inflation  strengthened  the  ruble exchange  rate in  real  terms  amid  stable  nominal  exchange  rate.

The  crisis of  2008-2009  revealed  once  again  the  disadvantages of  both  horizontal and downward  (in a period of “gradual” devaluation of the  ruble)  trading  band. The Bank of Russia  spent  more than $200bn  to support the exchange rate of the  national  currency within  the  five  months  elapsed  between September 2008 and  January 2009.  Since then the  regulator  has  decided  to  gradually give up  the  support  of  stable exchange rate and switch to  the targeting inflation  regime.

The  width of the  trading  band  of  changes in the  value of  the dual-currency  basket (currency trading band) increased to Rb 7 in the middle of 2012 from Rb 2 early in 2009. At the  same  time  the volume   of accumulated  interventions  shifting the range of the trading band was  reduced.

Early in 2014  the  range of the  trading  band was  shifted  by 5 kopeks after  a total of  $350m  interventions were  made. In March, however,  the Bank of Russia lifted  this  value  to $1,5bn  due to  anticipated  instability  in the  foreign exchange  market  resulting from  the political  tensions in  Ukraine,  thereby  slowing  down  markedly the devaluation of the ruble  exchange  rate  early in March 2014.

Mikhail Khromov, leading expert of Gaidar Institute’s Center for Structural Research