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Let us note that during the acute phase of the crisis, that is between November 2008 and February 2009, which was characterized by a large-scale capital outflow and a non-stop price downfall for energy sources, the Bank of Russia allowed a gradual decline of the Rb. rate against the bicurrency basket. In the situation of a considerable fall of Russias forex revenues, the earlier exchange rate could have been sustained only over a limited period of time by wasting the international reserve assets. That said, as the Bank of Russia was depreciating the Rb. gradually, economic agents found buying forex a relatively low-risk and highly lucrative investment instrument, which led to an increasing demand for forex and the need to spend an increasing amount of the international reserve assets.

We believe in the circumstances a one-time depreciation of the Rb. with a subsequent pegging of the new declared level was the best modus operandi, as it would have enabled the CBR to avoid a further waste of reserves and to lower inflationary expectations. We question just the moment picked for a sharp devaluation of the Rb it can be suggested that in order to save the gold and forex reserves one could have opted for this move far earlier than in early 2009.

As a result, in all between December 2008 and February 2009 the real effective rate of the Rb. slid by 16.3% (see Fig. 5). But, driven by the stabilization on the Russian and global financial markets in the spring 2009 and the subsequent price rise for energy sources, the real effective rate of the Rb. renewed its rise and by October had won back over 40% of its value lost due to the earlier drop. Once investors appetite for risk increased, the USD/Euro rate began to descend, and as a consequence, between March and December the official USD/Rb rate tumbled by Rb. 5.48 by late December 2009 the USD/Rb exchange rate was 30.24 vs.

35.72 as of February 28, 2009. Meanwhile, the Rb. has grown relative to the bicurrency basket1 the value of the bicurrency basket slid by 3.90Rb between March and December from 40.05Rb. to 36.16 Rb. As a result, the Euro/Rb. rate in the late December was 43.39.

The bicurrency basket constitutes a CBRs forex policy operational benchmark, with the proportion of the Euro in the basket currently accounting for 45% and, accordingly, 55% that of the USD.

RUSSIAN ECONOMY IN trends and outlooks Note: While calculating the Rb. real effective exchange rate, 100= the level as of January Source: the CBR, the authors calculations.

Fig. 5. Indexes of the Rb. Exchange Rate Between January 2005 December So, the CBRs forex policy in the crisis period has basically been smoothing down exchange rate fluctuations without creating obstacles to fundamental changes of exchange rate.

More specifically, in the second half 2009, the amplitude of the exchange rate fluctuations was over 15%. By increasing the exchange rate volatility, the CBR creates disincentives for economic agents to play on the forex market. The CBR is going to stick to this tactic in the medium term, too. However, it should be noted that in the event of a further price rise for energy sources and renewal of a large-scale capital inflow, the Rb. will find itself under a considerable upward pressure and the CBR may once again start buying forex in order not to let the Rb. nominal rate surge. In such circumstances, the monetary policy will de-facto replicate the pre-crisis one, which once again will give rise to bubbles on the financial markets, unless the government succeeds in creating additional mechanisms of sterilization of an excessive money supply.

In addition to the contraction of the balance of current account, one of the pivotal trends in the dynamic of indicators of the nations 2009 balance of payments was the dynamic of net capital outflow from the non-financial sector, which by results of the year hit USD 52.2bn. (in 2008, stirred by the crisis, the respective figure was 132.8bn) (see Fig. 6). Meanwhile, the dynamic of the private capital flow was uneven during the crisis. Between the 3rd quarter and the 1st quarter 2009 the net private capital outflow accounted for USD 186.6bn. In the 2nd Section Monetary and Budgetary Spheres quarter 2009, there was noted its insignificant inflow worth a total of USD 4.2bn, which once again was replaced by a -32.2bn outflow in the 3rd quarter of the year. In the 4th quarter 2009, against the investors growing confidence in stability of Russias economy (at least, in the short run) and their desire to make money on the appreciation of the Rb, the private capital inflow accounted for USD 11.1bn.

Source: the CBR; the IET calculations.

Fig. 6. Dynamic of the Net Capital Outflow in 2003The 2009 unofficial capital outflow (capital flight) (Fig. 7) also dropped significantly vs.

2008 and accounts, by our estimates1, for some USD 21bn, or at 38.5bn. less than in 2008.

Accordingly, the proportion of capital flight in the nations foreign trade turnover slid from 7.8% in 2008 to 4.2%.

We calculate capital flight with the use of the IMF methodology, according to which it constitutes the sum of trade loans and down payments, not received on time export proceeds and goods and services not supplied against money transfers by import contracts and net errors and omissions.

RUSSIAN ECONOMY IN trends and outlooks Source: the CBR; the IET calculations.

Fig. 7. Dynamics of the Capital Flight in 2004As for other peculiarities of the 2009 balance of payments, it is worth noting a remaining high proportion of revenues from energy sources in export of goods. The price downfall for energy sources in the late 2009 exposed the vulnerability of the nations balance of payments.

The oil prices recovery in 2009 and the Rb. depreciation allowed Russia to stabilize its balance of payments, but, with the situation in the economy gradually improving, import began to recover, too. That said, given that between the 2nd and 3rd quarters 2009 the pace of its recovery has been falling behind the one of export, in the 4th quarter of the year the import increase rate practically accounted for 24%, while that of export - just for 15%. Should the tendency persist further on, the positive balance of current account may renew its plunge, which, other conditions being equal, would create a downward pressure on the Rb. exchange rate.

However, it should be noted that traditionally, the 4th quarter is the period of seasonal import hikes, and given the current economic stagnation, a further rapid growth in import appears unlikely.

As to the balance of capital account, in the medium term, the dynamic of capital flows to a significant degree will be driven by the situation on the global financial markets. Should the trend of a gradual recovery of the world economy persist, one may expect a net private capital inflow in Russia by results of 2010.

2.1.4. Main Steps in the Monetary Policy Whatever moves the CBR was undertaking to ensure the financial systems stability, they can be provisionally split into two groups- namely, the interest rate policy and other measures.

Speaking of the CBRs interest rate policy in 2008-2009, it can be further broken into two stages. At the first stage, the CBR has been raising the refinancing rate four times (Nov 12, Section Monetary and Budgetary Spheres Dec 1, 2008; Feb 2 and 9, 2009). That said, prior to the first raising of the refinancing rate in the crisis period the CBR had lowered rates on a series of liquidity lending instruments without changing the refinancing rate. The move was made in pursuance of facilitation of the access to liquidity for commercial banks. As a result of the four consequent moves, the refinancing rate rose from 11 to 13% annualized and the CBRs lending rates to commercial banks were raised by a comparable value.

Underlying the increase in the interest rates largely was the CBRs desire to increase costs of the resources credit institutions attracted from the Bank of Russia and subsequently invested in forex assets. As a reminder, since January 23, 2009, the CBR set the upper margin of the technical band of the bicurrency basket at the level of Rb 41/USD and declared its readiness to maintain the rate by the margin for a minimum of several months. Meanwhile, already on January 30, after the tax payment period was over and banks had free Rbdenominated liquidity at hand, the value of the bicurrency basket was over Rb. 40. Given that yet back in November 2008 the value of the bicurrency basket was below Rb. 30, buying forex became a very lucrative direction of investment for the domestic economic agents. Expectations of devaluation were fueled by low oil prices that engendered fewer forex revenues in the country and the capital outflow from emerging markets. At that juncture the CBR decided to constrain the banks capacity for buying forex by increasing for them costs of attraction of Rb.-denominated resources. This move was simultaneously aimed at demonstration of the CBRs commitment to keep the Rb. exchange rate at the selected level, which contributed to a fall of forex buys by economic agents and the subsidence of speculative activities on the forex market. Given that the CBRs resources have increasingly been playing a greater role in the domestic credit organizations liabilities (see sub-section 2.1.1), the policy indeed helped lower the attractiveness of forex purchases against the background of statements made by the CBR leadership that a dramatic contraction of import between late 2008 and early 2009 enabled it to balance the current account of the nations balance of payments.

Once the state of affairs on the financial markets began stabilizing, the CBR started to gradually soften its monetary policy. Specifically, between April and December 2009, the CBR lowered interest rates seven times, with the refinancing rate ultimately being brought down from 13% to 8.75% annualized, while rates on the CBRs operations were down at 3.54.5 p.p. Underpinning these moves was a drastic deceleration of the pace of lending to the real sector against the background of a lowering inflation. The inflation deceleration enabled the Bank of Russia to lower the costs of resources disbursed to commercial banks without a serious change of the value of the rates in real terms, as the nominal rates were maintained at a level roughly equaling that of inflation.

The decline in interest rates was also fueled by the renewal of influx of forex revenues in the country due to the price rise for Russias main exports and stabilization of the economic situation worldwide. In the event of a further slowdown of inflation, the CBR may once again lower its interest rates. But we believe an overly drastic softening of the monetary policy in the current circumstances appears unjustified, as it may once again trigger escalation of inflation against the backdrop of the growing budget deficit. Plus, it should be borne in mind that high credit rates banks set for the real sector mirror not only costs of attraction of financial resources, but high credit risks associated with the uncertainty of the future economic dynamic. Hence, renewal of lending to the real sector will become consequent to stabilization of Russias economy and the recovery of the external demand.

RUSSIAN ECONOMY IN trends and outlooks Let us also note that in the crisis period, the CBRs interest rates for the first time ever have grown into an effective monetary policy instrument. That was the result of the growth of the share of the CBRs credits in commercial banks liabilities, as for them the CBRs resources in the crisis conditions formed practically a sole source of relatively inexpensive funds. Meanwhile, it proved impossible to boost the domestic money supply by purchasing forex by the CBR, either, due to a large-scale capital outflow out of the country and the price downfall for major Russian exports. In other words, the CBRs monetary policy has increasingly become similar to that of the developed nations central banks that manage the situation on the monetary market by means of interest rates. The CBRs ability to pursue this policy in the future will be determined by the situation on the domestic forex market (the absence of considerable fluctuations in forex flows in and out of the country) and the Bank of Russias readiness to allow fluctuations of the Rb. exchange rate and to transit to the inflation targeting regime.

As for the CBRs non-interest policy, the shortage of liquidity in the banking system in the autumn 2008 compelled the CBR to undertake a series of extraordinary moves aimed at preclusion of the rise of instability in the national banking sector.

Thus, on October 10, 2008, the State Duma promulgated an act that granted the CBR with the powers to disburse unsecured loans to Russian commercial banks. Such loans can be extended for the term of 6 months to credit organizations whose credit rating is not below a set level. The measure was aimed at supporting the national banking sector that had found itself in a dire situation because of a large-scale capital outflow from the country, a sizeable external debt (under growing expectations of devaluation) accumulated over the previous years, and the crisis in the real sector. Until the adoption of the new act the CBR had been able to disburse loans to Russian commercial banks against securities, forex, receivables under loan agreements or credit institutions guarantees. But as the banks were in a great need in credit resources, they lacked assets against which they could receive a loan from the Bank of Russia.

At that juncture the granting of the possibility to the CBR for disbursement of unsecured loans enabled it to support Russian banks, albeit the move increased risks of an inequitable conduct by the banks that were recipients of such loans. With the financial markets stabilizing, the credit institutions debt to the CBR was gradually declining. As of January 1, 2010, their aggregate debt before the CBR was Rb. 190 bn, or down by Rb. 1.6trln over the whole 2009. Let us note that in order to maintain the banking systems stability it proved possible to support just a handful of large banks. Most Russian credit institutions de facto are not engaged in the classical banking. Rather, they are engaged in schemes related to optimization of taxation, which allows one to tolerate their bankruptcy without serious ramifications for the whole domestic financial system.

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