Tuesday, August 7, 2007

Russia, Rouble vs Petroleum

From Bloomberg today:

Russia's Putin Favors Ruble Traders to Slow Inflation

Russian President Vladimir Putin's plan to keep inflation from accelerating depends on favoring foreign- exchange traders over the country's oil and gas companies.

Putin will probably allow the central bank to double the ruble's pace of appreciation this year because he has few options outside the foreign exchange market to rein in consumer prices, according to strategists at Bank of America Corp. and UBS AG. Russia's 8.5 percent inflation rate is three times faster than any other Group of Eight country.

Rising prices threaten Putin's 80 percent approval rating and may reduce his influence after he leaves office in March. While a stronger currency would cut import prices, it also erodes profits from sales of oil, natural gas and minerals when converted into rubles. Russia is the world's largest energy exporter.

``The stronghold that Putin has on the popular vote will be challenged if inflation becomes an issue,'' said Timothy Seymour, chief operating officer of Red Star Asset Management, a hedge fund in New York with 80 percent of its portfolio in Russian assets. ``The ruble will rise.''

Russia's central bank, which controls the ruble's price, let the currency appreciate twice this year against a benchmark of dollars and euros by a total of 1 percent. The ruble now trades at 25.5593 per dollar. The basket consists of 45 percent euros and 55 percent dollars.

Bank Expectations

The ruble will gain 2 percent against the basket until year- end, boosting the currency 4.3 percent to 24.5 per dollar, said Zurich-based UBS, the world's biggest money manager. The currency will rise to 24.7 per dollar this year, according to estimates by Charlotte, North Carolina-based Bank of America, the second- biggest U.S. bank by assets.

The ruble should be about 40 percent higher, New York-based Merrill Lynch & Co., the third biggest U.S. securities firm, said.

``The ruble is undervalued,'' said Kenneth Rogoff, an economics professor at Harvard University in Cambridge, Massachusetts, and the former chief economist at the International Monetary Fund. ``Attempts to keep the currency pegged are putting great upward pressure on inflation.''

Consumer prices, led by a 26 percent rise in crude oil this year, have risen three straight months, surpassing the government's 8 percent target in June. Wages increased 15.2 percent in June from a year earlier, sparking a 14.7 percent rise in retail sales, Russian Federal Statistics Service data show.

Buying Dollars

The economy expanded 7.9 percent in the first quarter, the fastest pace in six years. Record capital inflows of $67 billion this year and revenue from energy sales has forced the central bank under Chairman Sergey Ignatiev to buy dollars to control the ruble's rise, leaving the nation with $417 billion in reserves, behind only China and Japan.

A 1 percent appreciation of the ruble cuts the inflation rate by 0.3 percentage point, according to central bank estimates. That would limit funds available to energy companies for investment by as much as 2 percent, according to Merrill Lynch. Energy sales accounted for 22 percent of Russia's $1 trillion economy last year.

Putin, a 54-year-old former KGB agent, has overseen average annual economic growth of 6.8 percent in his seven years as president, the most among major European countries. The price of oil tripled to a record $78.77 last week from about $24 a barrel at the end of 2000. Taxes from energy sales account for more than half of federal revenue, according to Merrill Lynch.

Public Opinion

Preserving the public's approval is important if Putin wants to influence the choice of his successor, according to Rory MacFarquhar, a Moscow-based economist at Goldman Sachs Group Inc., the world's largest securities firm by market value. Putin is constitutionally barred from serving a third consecutive term.

``Although Putin won't be in the presidential seat he plans to be in control of the country,'' MacFarquhar said.

Inflation reached 127 percent in 1999, the year after former President Boris Yeltsin defaulted on $40 billion of domestic debt and let the currency devalue. Putin has said he plans to cut inflation to about 5 percent by 2010 and make the economy one of the world's five biggest by 2020.

Foreign investors lured by the sale of state assets have poured the record $67 billion into Russia this year, according to the Economy Ministry. Money supply rose 53.3 percent in June as the central bank printed rubles to buy dollars flowing across the border.

Putin's Dilemma

Raising benchmark interest rates above the current 10 percent would only lure more money into Russian assets, said Oliver Weeks, an economist in London for New York-based Morgan Stanley. Lowering rates would encourage consumers to spend and not save.

``It's a dilemma,'' said Steve Hanke, a professor of applied economics at Johns Hopkins University in Baltimore. ``If inflation runs away, it certainly won't help Putin. The central bank is worried higher interest rates will entice more inflows.''

The rise in commodity prices has ``placed a lot of pressure on the ruble to appreciate,'' said Mark Mobius, who overseas $42 billion in emerging-market stocks as managing director at Templeton Asset Management Ltd. in Singapore. He holds $3.5 billion in Russian stocks. ``The ruble will probably appreciate further.''

Raphael Marechal, who helps manage $4.4 billion in emerging- market bonds at Fortis Investments in London, plans to boost holdings of ruble bonds by 50 percent this year to profit from the ruble's accelerating gains.

``The central bank has to let the ruble appreciate,'' Marechal said. ``It has no other tool to fight inflation.''

Oil Producers

Russia isn't the only oil producer to suffer from inflation as crude, traded in dollars, hits record highs. Kuwait allowed its dinar to strengthen twice by a total of almost 2 percent last month after ending the dollar peg in May as a weak dollar boosted the prices of imports.

Oil producers have surpassed Asian central banks as the largest pool of global savings, accumulating an estimated $500 billion in 2006 alone, according to research by Newport Beach, California-based Pacific Investment Management Co. The firm, a unit of Munich-based Allianz SE, manages the world's biggest bond fund.

State-run OAO Rosneft, Russia's largest oil producer, said profit declined 25 percent in the first quarter as the ruble rose 11.7 percent adjusted for inflation against the company's trade partners. The company will invest $5 billion this year to improve its oil fields.

Putin said at a Cabinet meeting on April 9 that the ruble shouldn't ``undercut'' manufacturing, according to the government's official Web site. ``This deserves special attention,'' he said.

`Under Pressure'

Russian carmakers are already struggling as sales of imported cars jumped 60 percent to 510,000 units in the first half of this year. Textile production fell 4 percent in June from a year earlier.

Putin ``is under pressure from manufacturers,'' said Maxim Oreshkin, chief analyst at OAO Rosbank in Moscow, Russia's ninth- largest bank by assets. ``For them, a stronger currency is a real problem,'' said Oreshkin, who worked for the central bank from 2002 to 2006.

The ruble is up 20 percent against the dollar since a record low of 31.96 in 2002. The currency is 9.6 percent stronger than it was before the 1998 default, when it fell 50 percent on a trade-weighted basis, according to an index removing inflation published by JPMorgan Chase & Co. in New York. The ruble last traded at 25.4672 as of 11:24 a.m. in London.

``It would be a failure for Putin if inflation increases,'' said Anders Aslund, a senior fellow at the Peterson Institute for International Economics in Washington who served as an economic adviser to the Russian government from 1991 to 1994. ``People are tired of inflation, and Putin is extremely cautious to maintain his popularity.''

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