Rouble: Embarking On A Depreciatory Trajectory

Short-Term View

With the Russian rouble trading at RUB32.38/US$ at the time of writing, we expect the unit to head towards RUB32.80/US$ by end-2013, meaning the multi-year technical resistance around RUB33.00/US$ will hold off over this time frame. Supportive of this trend will be the resumption of market expectations for quantitative easing tapering, which will dampen demand for emerging market assets across the board. However, stemming further depreciation of the currency by end-2013 will be the recent inclusion of rouble-denominated sovereign debt into Barclay's Global Aggregate Index starting in force from March 2014. This will bolster the unit as investors expect local government bonds to appreciate in price.

However, we expect worsening economic fundamentals to see the unit breach the RUB33.00/US$ level in early 2014 and embark on a sustained depreciatory trajectory in 2014-2015, averaging RUB33.70/US$ in 2014 and RUB34.50/US$ in 2015. The main reasons for rouble weakness are the deteriorating trade balance, tepid demand for Russian financial and real assets, and a likely rate cut in 2014 by the central bank in a bid to shore up the flagging economy. Further momentum behind the downward pressure on the rouble will come from the Central Bank of Russia (CBR)'s ongoing transition from a managed float regime towards free floating currency and inflation targeting by 2015, as well as a more accommodative stance in 2014-2015.

Breaching Multi-Year Support in Early 2014
Russia - Russia - RUB/US$ Exchange Rate
BMI RUSSIA CURRENCY FORECAST
Spot Short-Term 2014 2015
RUB/US$, eop 32.38 32.80 33.70 34.50
RUB/EUR, eop 43.76 42.13 41.40
CBR Policy Rate, % eop 5.50% 5.50% 5.25% 5.00%
Source: BMI

Short-Term View

With the Russian rouble trading at RUB32.38/US$ at the time of writing, we expect the unit to head towards RUB32.80/US$ by end-2013, meaning the multi-year technical resistance around RUB33.00/US$ will hold off over this time frame. Supportive of this trend will be the resumption of market expectations for quantitative easing tapering, which will dampen demand for emerging market assets across the board. However, stemming further depreciation of the currency by end-2013 will be the recent inclusion of rouble-denominated sovereign debt into Barclay's Global Aggregate Index starting in force from March 2014. This will bolster the unit as investors expect local government bonds to appreciate in price.

Breaching Multi-Year Support in Early 2014
Russia - Russia - RUB/US$ Exchange Rate

However, we expect worsening economic fundamentals to see the unit breach the RUB33.00/US$ level in early 2014 and embark on a sustained depreciatory trajectory in 2014-2015, averaging RUB33.70/US$ in 2014 and RUB34.50/US$ in 2015. The main reasons for rouble weakness are the deteriorating trade balance, tepid demand for Russian financial and real assets, and a likely rate cut in 2014 by the central bank in a bid to shore up the flagging economy. Further momentum behind the downward pressure on the rouble will come from the Central Bank of Russia (CBR)'s ongoing transition from a managed float regime towards free floating currency and inflation targeting by 2015, as well as a more accommodative stance in 2014-2015.

We expect Russia's current account surplus to continue to narrow over the next few years and head into negative territory by 2017 on the back of worsening trade balance. Merchandise exports have posted negative growth rates over the past five quarters from double-digit growth rates in the pre-crisis era. This has been driven mainly by tepid demand from Europe and especially Eastern Europe, Russia's traditional export destination. Even though we expect demand for Russian exports to gain momentum in 2014, this will be more than offset by declining hydrocarbon prices, with our Oil & Gas team forecasting urals prices to be US$106.20/bbl in 2013, US$102.00/bbl in 2014, and US$101.00/bbl in 2015.

Furthermore, demand for Russian assets will remain tepid as the structural deficiencies of the economy - unpredictability of the regulatory environment, questionable independence of the judiciary, and inefficiency of the bureaucracy among others - will continue to obstruct more robust levels of foreign direct investment inflows. The sizeable rise in FDI in Q113, at US$39.4bn is likely to be an outlier, as suggested by the much more modest US$16.6bn of inflows in Q213 with the 6-quarter moving average showing FDI in H113 at 2006 levels.

Further depreciatory pressure on the currency will stem from the historically high levels of net private capital outflows, as traditionally Russians have tended to park savings abroad. Acquisition of foreign assets by the domestic non-bank sector grew by 32% y-o-y in Q213, and we see little reason for this trend to reverse any time soon due to the unpredictability of the business and political environment.

Our expectation for a rate cut by the CBR in 2014 is another source of rouble weakness going forward. Although CBR's new leadership has adopted a hawkish stance since taking the helm in summer 2013, we believe they are overplaying the hawkish rhetoric in a bid to demonstrate political independence. As such, we expect the flagging economy to tip the balance in favour of a rate cut in 2014, which will see the new main policy rate, the repo rate, fall to 5.25% in 2014 and to 5.00% in 2015 from 5.50% at the time of writing ( see 'Monetary Easing Delayed Until Early 2014', October 31).

The gradual transition of the Central Bank of Russia's managed float exchange rate policy towards a free-float and inflation targeting regime will, in our view, eliminate another potential source of rouble strength. The CBR maintains a corridor for the rouble against a euro and US dollar basket (45% euro, 55% dollar), which at the time of writing is RUB32.40-RUB39.40, and is aimed at smoothing the volatility of the unit. The band automatically moves upward by RUB0.05 if the daily amount of foreign exchange intervention needed to defend the rouble from selling pressure exceeds US$400mn. Conversely, the band moves downward by RUB0.05 if the CBR needs to buy more than US$400mn to stem further appreciatory pressure on the unit. The fact that the authorities have shifted the band upward eleven consecutive times since August 2013 is testament to the mounting selling pressure on the unit. We expect this trend to accelerate as the authorities gradually abandon the managed float regime and float the unit by 2015.

Risk To Outlook

Risks to our bearish outlook on the rouble are steps towards liberalisation, which would ramp up foreign investors' demand for Russian assets, and structural reforms, which might reverse net private capital outflows, driving rouble appreciation. Moves in this direction would prompt us to re-evaluate our outlook on the unit; however, we do not see the political will for such reforms emerging any time soon.

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Sector: Country Risk
Geography: Russia
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