Reacting to persistent jitters on world financial markets, Russia's Central Bank announced on 10 November that it will raise interest rates and alter its ruble policy next year to ward off any speculative attacks on the currency.
Central Bank chairman Sergei Dubinin said the temporary interest rate hike, combined with a more flexible exchange-rate policy, would shore up investor confidence in Russia, following the crisis on world financial markets over the past two weeks.
Dubinin said at a joint news conference with First Deputy Prime Minister Anatolii Chubais that, as of 11 November, the Central Bank will raise its key refinancing rate, which guides interest rates, to 28 percent from 21 percent. He said the tightening of monetary policy is a temporary move designed to protect the ruble, which has come under pressure owing to recent upheavals on the financial markets.
Dubinin added that the Central Bank's decision to change its ruble policy in 1998 will bolster trust in the currency. Under the new policy, the Central Bank will abandon its ruble corridor, allowing the currency to fluctuate by 15 percent in either direction of a so-called pivot rate. That rate will be set at 6.1 rubles to the U.S. dollar and will inch up to 6.2 rubles to the dollar from 1998-2000.
The new policy coincides with the government's plans to lop three zeroes off the ruble beginning on 1 January 1998, making 1,000 old rubles equal to one new ruble.
Russia has kept to a crawling-peg exchange-rate policy since 1995, allowing the ruble to devalue gradually against the dollar in line with inflation. The government, which has successfully brought down rampant inflation, is targeting a rate of 5-7 percent in 1998.
Dubinin said he expected the ruble to devalue by 2-5 percent in 1998, depending on inflation. He tried to dispel fears that the new ruble policy would lead to major fluctuations in the exchange rate, saying the Central Bank's hard-currency reserves stood at a healthy $22.6 billion as of 1 November. "No leaps of the currency-exchange rate will be allowed," he said. "Neither today, nor tomorrow, nor on New Year's Eve will there be a dramatic devaluation."
But a Central Bank statement acknowledged that the ruble could come under pressure, alluding to trends in other emerging markets such as Brazil and South Korea. Analysts said the bank's decision essentially to widen the band in which the ruble trades could lead to greater volatility but that the move to a more flexible exchange rate regime would send the right signal to speculators.
Peter Boone, an economist at Brunswick Capital Management, said the wider band means the Central Bank may allow the ruble to depreciate in the case of a speculative attack. But he said given Russia's strong economic fundamentals, the ruble would withstand any such attack and quickly bounce back.
Boone said Russia's decision to adopt a more flexible ruble policy is a response to currency problems in other emerging markets, such as Southeast Asia, where rigid exchange rate regimes have attracted the attention of speculators. "It spells the end of very tightly controlled exchange-rate regimes in countries open to foreign capital flows," he commented.
In addition to raising the refinancing rate, the Central Bank also said it would increase its Lombard rates, used for lending to commercial banks, and increase the hard-currency reserve requirements for commercial banks to 9 percent from 6 percent, beginning on 12 November.
The move contradicts the government's previously stated aim of reducing interest rates to free up funds for desperately needed investments in the economy. But Dubinin and Chubais said the temporary interest rate hike is necessary to help lure back funds into the government treasury bill market, which has been hard hit by the worldwide flight from emerging market assets.
As Chubais put it: "Russia is not an island cut off from the rest of the world." He said the hike is a temporary measure designed to shield Russia from the crisis on international financial markets and will be reassessed once markets stabilize.
Economists applauded the government's decision to raise interest rates, saying it will help stem the flow of funds out of treasury bills. Brigitte Granville, chief Russia economist at J.P. Morgan in London, said a currency crisis might have occurred if the Central Bank had not tightened monetary policy. Foreign investors, who want to leave the treasury bill market, need to sell rubles and buy dollars, putting pressure on the ruble to devalue.
Several emerging market economies, such as Brazil and Ukraine, raised interest rates, making Russian treasury bills look less attractive to foreign investors. Although the interest rate hike caused treasury bill prices to plummet, the government hopes the higher yields will tempt investors back, when it issues new bills.
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