Central bank’s currency interventions encourage speculations in exchange rate

The Russian national currency, like the currencies of major developing countries, keeps devaluing steadily. The ruble exchange rate has been pressured by both geopolitical risks and further cuts on monetary easing programs in the U.S. economy, and fall in prices of energy resources.

The Fed decided in mid September to reduce volumes of buying both mortgage and long-term treasury bonds, to $5bn and $10bn respectively. Therefore, since December 2013 , when the Fed initiated cutting of antirecessionary programs, monthly volume of buying financial assets has been reduced by $70bn. Under the circumstances, the Indian rupee exchange rate lost in January-September 2014 more than 5.4% of the value observed in the corresponding period last year while the Brazilian Real weakened more than 7%, the ZAR Rand and the Indonesian Rupiah lost 11.5% and 14.3% respectively.

The official exchange rate of the Russian currency in January-September 2014 lost 10.7% of the corresponding period last year. However, in H2 2014 the devaluation of the ruble saw substantially faster rates: in September the ruble exchange rate contracted 4.6% of the preceding period, only better than the February dynamics (5% of the proceeding period). The ruble exchange rate has steadily been weakening due to extremely slow economic growth in Russia, teetering on the brink of a recession, material geopolitical risks, as well as small ROI. The devaluation of the Russian currency further accelerated last summer because of falling prices of energy resources.

Following the stated goal, not only did the Bank of Russia widen in August 2014 the floating currency trading band to Rb 9, but it also eased the value of accumulated interventions, resulting in automatic shift of 5 kopeks, to $350m from $1bn.

Additionally, the Central Bank discontinued foreign exchange interventions within internal ranges of the currency trading band. Nonetheless, the currency trading band limits established on the 18th of August at Rb 35,40 and Rb 44,40 remained unchanged for a period of more than 1/5 months. For more than three months the regulator didn't undertake foreign exchange operations, including those on replenishment or spending of Federal Treasury resources of sovereign funds denominated in foreign currencies.

Therefore, the established boundaries of the currency trading band have helped dampen the impact of not only fundamental microeconomic factors governing the downtrend in the ruble exchange rate, but also speculation trends. At the same time, although the Bank of Russia previously could weaken the speculation-driven demand for foreign currencies within the currency trading band, since mid-August the regulator has conducted operations in the market only when the exchange rate broke through the lower or upper boundaries of the currency trading band, of which FX traders are well aware.

The Bank of Russia's intention to strictly adhere to the stated policy was tested shortly after the regulator published in September The Guidelines for the Single Monetary Policy in 2015 and for 2016 and 2017. The document states that "by the end of 2014, the Bank of Russia will complete the transition to a floating exchange rate regime ... abandon the use of acceptable values of the ruble-denominated value of the dollar-euro basket (currency trading band), but in case of an emerging threat to financial stability, the central bank can conduct operations in the foreign exchange market". On the 26th of September, the USD exchange rate for the first time exceeded Rb 39, gaining about 65 kopeks daily.

Nonetheless, the ruble value of the dollar-euro basket remained within the currency trading band (Rb 43,63). However, as early as the 30rd of September the USD exchange rate exceeded Rb 39,80 while the dollar-euro basket value raised above the upper boundary of the currency trading band. However, having confirmed its intention to impose no influence on the foreign exchange market in the absence of "threats to financial sustainability", the Bank of Russia gave up foreign exchange interventions.

The foreign exchange market responded instantly – the next day's (on the 1st of October) trading session opened with a 10 kopeks decline to Rb 44,31. However, on the 2nd of October, when the value of the dollar-euro basket increased to Rb 44,39, the Bank of Russia sold a small amount of $4m in the foreign exchange market.

Having resumed its foreign exchange interventions, the Bank of Russia predetermined the actions of foreign exchange market players. Having confirmed its presence in the foreign exchange market and readiness to counteract headlong strengthening of the U.S. dollar, the Central Bank supported speculative sentiments by showing market players when they should take profit, close their dollar positions, allowing them to attack with renewed vigor the Ruble from a lower level. Later the regulator had to undertake daily foreign exchange interventions, shifting the boundaries of the currency trading band.

All in all, during the first decade of October the Bank of Russia spent more than $4,2bn, shifting by 85 kopeks the boundaries of the currency trading band. At the same time, the regulator failed to prevent the Russian Ruble from devaluing.

The Bank of Russia should either substantially increase its presence in the foreign exchange market whereby keeping the dollar-euro basket value away from the upper boundary of the currency trading band and retaining the same at the level, or, having commenced the transition to a floating exchange rate, liberalize the same and allow the objectively increased economic agents' demand for foreign currencies to be recovered. Otherwise, with daily foreign exchange interventions the Bank of Russia would only support speculation-driven trends as most appealing and income-bearing financial investment instrument.

Anna Kiyutsevskaya, expert of Gaidar Institute