The Central Bank should put a limit on refinancing the banking sector

A few days ago the Ministry of Finance (Minfin) of Russia published its plans on the purchase of foreign exchange to replenish the Reserve Fund. The Minfin and Federal Treasury will buy fr om the Central Bank of Russia foreign exchange in an amount equivalent to Rb 3,5bn to able to collect Rb 212,2bn of extra federal budget oil and gas revenues for the Reserve Fund before the end of May 2014. The foreign exchange market has responded to the news with another crash in the ruble exchange rate.


Having announced its plans to buy foreign exchange from the Central Bank in the depth of foreign-exchange crisis, the Minfin announcement. First, this could have been done later, second, regular announcements of such plans may trigger extra rush in the foreign exchange market, pushing up further the demand for foreign exchange. This may increase adverse devaluation expectations among market participants and individuals.


The current foreign currency crisis has been caused by an external factor, i.e. foreign exchange migration from emerging markets to mature markets. This trend however has been diminishing. Furthermore, neither European nor US stock markets are stable for the time being, i.e. the ongoing uptrend is facing volatility.


At the same time, I think that a foreign exchange speculative attack in Russia is of short-term nature, because such attacks end sooner or later, and this particular one should end as well. No doubts that the US dollar strengthening against the ruble is of speculative nature. There is a vicious circle: banks purchase foreign exchange, borrow ruble-denominated loans from the Central Bank to gain purchase foreign exchange. This may constitute a threat for the sustainability of the banking system.


The current situation may develop as follows. Either the ruble will keep weakening against other currencies, or the banking system will face a liquidity crisis. The Central Bank of Russia should lim it the amount of refinancing of the banking system. I think that under the circumstances this crisis could be addressed administratively through an agreement with the five largest banks so that they pursue a more prudent policy towards purchasing foreign exchange and maintaining ruble liquidity in order to maintain stable settlements in the banking system.


Having encountered devaluation of the national currency, many central banks in the developing countries decided to increase interest rates. For instance, in January 2014 the Bank of India raised the key interest rate from 7.75% to 8%, the South-African Central Bank did the same from 5% to 5.5%, and the Bank of Turkey increased the overnight credit interest rate from 7.75% to 12%, the 7-day credit interest rate from 4.5% to 10%. As a result, the Turkish lira has strengthened by 3% against the US dollar since February 2014, 1.9% against the ZAR Rand, 0.7% against the Indian rupee. Over the same period the ruble has lost 1.5%, the worst currency among the currencies of 24 developing countries.


 However, there is no point to increase interest rates to support country’s national currency. Theoretically, the currency risk is accompanied by devaluation of the national currency and/or drastic shrinkage of reserves, and/or increase in interest rates. Therefore, on paper, increasing interest rates all the same is treated as maintaining a foreign exchange crisis. This is a manmade measure aimed at using high interest rates to create extra demand for the national currency and weaken the demand for a foreign exchange. The national currency exchange rate can be maintained the same way, spending the reserves. In other words, all these measures are not designed to cope with the currency risk, because it is maintained deliberately in any case.


 Vedev A. L., Director of the Center for Structural Research