The Great Ruble Sell off Doesn't Make Sense. Ruble's Actually a Buy
- Oil doesn't carry quite the overriding importance for Russia it is commonly believed
- The ruble is by now greatly unervalued
- Russia's central bank is pursuing a wise, non-interventionist course
This article originally appeared at David Stockman's Contra Corner
The Russian ruble has been in panicked free-fall, not unlike the oil price. Last night the Russian central bank reacted by hiking its interest rates, not in baby steps, but rather in giant strides. This was incidentally the second rate hike in just four days and the fifth this year. From the press release:
“From 16 December 2014 the Bank of Russia Board of Directors decided to raise the Bank of Russia key rate to 17.00 percent per annum. This decision is aimed at limiting substantially increased ruble depreciation risks and inflation risks.
From 16 December 2014 in order to strengthen the efficiency of monetary policy loans secured by non-marketable assets or guarantees for 2 to 549 days will be provided at a floating interest rate, set at the Bank of Russia key rate level, increased by 1.75 percentage points (up to the present these loans for 2 to 90 days were provided at fixed rate).
Moreover, for further expanse of credit institution ability to manage their foreign exchange liquidity it was decided to increase maximum allotment amount for28-day FX REPO auctions from 1.5 to 5.0 billion USD and to conduct 12-month FX REPO auctions on weekly basis.”
Overnight liquidity provision goes from 11.5% to 18%, 3 month rates go from 10.75% to 17.25% – click to enlarge.
The reason for this was the aforementioned panicked sell-off in the ruble, which looks like this over the past nine months:
Does this move make much sense? We actually don’t think so – oil is certainly very important for Russia’s economy, but a recent study of the Russian economy (pdf) concludes that the energy industry actually contributes only 16% to total economic output in Russia.
The reason why people in the West are somewhat less aware of what Russia produces is that it is exporting a lot to former Eastern Bloc satellites and former Soviet Republics. Some Russian products are also well-known and well-liked in the West though, such as e.g. Kaspersky anti-virus software (which works like a charm).
Moreover, Russia’s money supply growth has been slowing quite sharply in recent years (admittedly we are not up-to-date on what has occurred in this respect in the most recent months).
Here are two charts by Frank Shostak depicting Russia’s true money supply growth and the growth rate of the Russian central bank’s balance sheet – these charts are a bit dated by now, the end point is in mid 2014 – still, one can clearly see that the trend has been toward a sharp slowdown in monetary inflation.
Russia’s central bank balance sheet growth, y/y – click to enlarge.
Rosneft and Foreign Debt Woes
However, a friend pinged us with the following background information:
“On Friday Russian Oil giant Rosneft issued 625 Billion Rubles in new bonds that apparently were immediately bought by the Russian CB.
It’s known that Rosneft is due some big payment in USD to cover debts it incurred in buying TNK-BP. In 2013 it borrowed $55 Bln, some of it apparently short term.
So on Monday the market thought that Rosneft had a big wad of Rubles ready to buy $10 Bln worth of the USD, so everyone tried to front-run it, so the Ruble collapsed.”
We can conclude from this that the ruble is not exactly the world’s most liquid currency. The South African Rand incidentally also has a tendency to occasionally make such large moves.
In the meantime, Bloomberg has also picked up the Rosneft story, and apparently Russian banks provided Rosneft with a large bridge loan, while Russia’s central bank quickly made Rosneft bonds eligible as collateral in refinancing operations, so that the banks could immediately get liquid again.
Similar strategies were employed by Russia in the 2008-2009 crisis, when the oil price collapsed from the nearly $150 to a mere $30. Russia’s “rainy day fund” did not participate in the Rosneft bond issue, but did buy some Gazprom preferred shares a while back.
“Russia’s most-indebted company slapped by sanctions, OAO Rosneft, raised $10.8 billion on the local market this week in an operation financed by the central bank.
The deal comes as Russian corporations struggle with foreign-currency debt after U.S. and European Union sanctions curbed access to international capital markets and the country’s economy heads for recession next year. Rosneft, which faces a $7 billion loan redemption on Dec. 21, obtained the central bank-backed deal after delays by the government over its request to tap the country’s National Wellbeing Fund.
Rosneft sold 625 billion rubles ($10.8 billion) of six- and 10-year notes yesterday at yields below those on equivalent Russian government securities. The Bank of Russia cleared the securities to serve as collateral in an unprecedented 700 billion ruble liquidity auction planned for Dec. 15, meaning bondholders will have access to central bank cash at a time money-market rates are at a five-year high.“Cut off from international refinancing, the company has to cover its refinancing gap by indirectly borrowing from the central bank,” Sberbank CIB analyst Alexey Bulgakov said by e-mail from Moscow today.[…]
Rosneft said it placed 225 billion rubles of bonds with an initial coupon of 11.9 percent and 400 billion rubles of debt with a floating coupon. The Russian government’s 10-year local-currency note yields 12.99 percent, the most in five years. The rate on Rosneft’s dollar securities due March 2022 increased 23 basis points 9.83 percent as of 6:05 p.m. in Moscow. The company’s shares gained 1.3 percent to 210.75 rubles, paring their drop in the week to 5 percent.
This year’s five interest-rate increases by Bank of Russia Governor Elvira Nabiullina, the ruble’s 43 percent drop against the dollar and no access to foreign capital limit refinancing options for Russia’s sanctioned companies.
Rosneft, the world’s biggest publicly traded crude producer by volume, has about $10.2 billion of debt coming due in the fourth quarter, including a $6.88 billion loan from foreign banks on Dec. 21, as well as $19.5 billion in 2015. The company has about $20 billion in cash and equivalents, according to its third-quarter earnings report.
Russian companies are of course eager to pay their foreign-currency debt in a timely fashion, even if sanctions are currently limiting their access to new financing. They undoubtedly want to stay in the good graces of foreign lenders.
However, we would also point out that an old saying applies here, something about who’s in trouble depending on whether one owes a few thousand or a few billions to one’s bank. Note by the way that the Rosneft share price shown below is not in ruble terms, but in euro terms. In ruble terms, most Russian stocks obviously look a lot better.
Once support broke, Rosneft’s share price was mercilessly whacked – click to enlarge.
Given that Rosneft will want to satisfy its foreign bondholders, it is not too far-fetched to make the connection between its need to buy dollars and the attempt of market participants to front-run it by selling the ruble.
The Rate Hikes in Perspective
It is a good bet that the ruble is by now egregiously undervalued, even in light of the oil price decline and economic sanctions.
Russia’s central bank is actually known for being quite conservative. Instituting massive rate hikes in such a situation is certainly a better approach than wasting foreign reserves in market interventions.
Hong Kong once hiked rates into triple digit territory for a little while to defend its peg against speculative selling. Obviously, the main objective is simply to increase the cost of carry for traders shorting the currency and at the same time make the currency more attractive to those looking for high yields.
It seems rather unlikely that Russia’s economy actually needs base rates between 17 to 18% right now, but as a preemptive measure to cool speculation against the currency, such rate hikes probably make sense. We suspect there will be more central bank moves to come before the situation calms down again – especially as the rate hikes have not had much of an effect yet (that is actually an understatement).
Situations like this one very often turn out to have been great opportunities in hindsight. Readers may recall the Russian crisis of 1998 – anyone buying shares and bonds in Russia when the news and the market action were at their very worst made out like a bandit in the end (those brave enough to wade in were eventually rewarded with absolutely stunning gains in this particular case).
Of course in a panic sell-off, (or its corollary, a blow-off move), being early by just a few days day can be pretty painful in the short run.
Nevertheless, this is one of those times when it seems to us that opportunity beckons for those able to stand the risk. There is probably no hurry, we will certainly keep a very close eye on developments.
Charts and tables by: BarCharts, Frank Shostak, 4-traders.com, Central Bank of Russia
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