Ruble Traders Testing Central Bank

The ruble tumbled to 36.41 to the U.S. dollar in trading Monday, breaking through the Central Bank's target exchange rate less than two weeks after Chairman Sergei Ignatiyev announced that the ruble would not sink below 36.

The drop appeared to be part of an attempt by speculators to test the Central Bank's resolve to support the ruble, and analysts predicted that the bank would now do everything in its power to keep the currency within its declared trading band.

"If there's no move in the oil price and the barrier is lifted, I think the credibility of the regulator would be significantly undermined and some extraordinary action would be required," said Mikhail Galkin, an analyst at MDM Bank. "Credibility is of paramount importance for any central bank."

The Central Bank set the official exchange rate for Tuesday at 36.17 rubles to the dollar and 46.04 to the euro.

Ignatiyev told the State Duma on Friday that the Central Bank would continue to defend the weak end of the currency's trading band — set at 41 rubles against a dollar/euro currency basket on Jan. 22 — by raising interest rates and limiting commercial banks' access to refinancing.

The ruble is traded against a basket of about 55 percent dollars and 45 percent euros. The Central Bank has said 36 rubles to the dollar corresponded to 41 to the basket if the euro is $1.30, but the euro has since weakened to $1.27, changing the parameters. The ruble came less than half a percent from the 41 mark on Monday, trading at a low of 40.80 against the basket.

The ruble's decline on Monday was only driven by "a desire to touch the boundary and understand where the Central Bank sees the equilibrium," said Marina Vlasenko, senior CIS credit analyst for Commerzbank.

The Central Bank did not intervene in trading Monday, traders said.

The ruble has lost 23.44 percent of its value against the dollar since the Central Bank began incrementally widening the trading band against the dollar/euro basket in mid-November. The Central Bank buys and sells currency to limit the ruble's fluctuation and its negative effects on Russian exporters.

On Friday and Monday, the Central Bank cut the amount offered in its daily repo auctions — where banks place bids for short-term government loans — by 100 billion rubles ($10.5 billion). With 375 billion rubles on offer instead of the previous week's 475 billion rubles, Monday's bids outnumbered the loan supply by more than 50 percent.

To discourage banks and other market players from turning to foreign currencies, the Central Bank is also taking other measures, including raising rates on fixed-rate repos and lombard notes, cutting the amount of funds it provides through overnight repo auctions and providing a negligible 50 billion rubles for an unsecured lending auction this week.

"The Central Bank has no need to spend a lot of reserves if they do everything correctly," said Yevgeny Nadorshin, chief economist at Trust National Bank. "They will have to keep liquidity tight and contain expectation for further devaluations."

While the Central Bank so far has only taken nonadministrative measures — such as decreasing liquidity and increasing rates — to deter speculation, it could begin intervening administratively to maintain the 41 level, Galkin said. "I think it's going to be a serious battle if anyone tries to challenge this level. The brave guys [who continue speculating] will face resistance," he said.

The Central Bank's measures to control liquidity signal a departure from its earlier tactic of simply dipping into the reserves to defend the ruble. The bank has spent more than one-third of its foreign currency reserves to prop up the ruble in recent months. Reserves currently stand at $386.5 billion, down from $426 billion one month earlier and well below $598.1 billion in August.

While it is critical for the Central Bank to defend the boundary in the short term, it may not always have the luxury to do so, said Vlasenko from Commerzbank. "If the pressure continues after some correction in the medium run, the Central Bank may reconsider the range," depending on where the oil price falls, she said.

In the short term, the bank will have to worry about raising repo rates too sharply because an abrupt increase would be detrimental to the local debt market, which is already suffering, Vlasenko said.

There is also the risk of a currency bubble, as many banks that have swapped their rubles for dollars will need rubles for tax payments, she added.

To break a lending standstill in the banking system, First Deputy Prime Minister Igor Shuvalov told the Duma on Friday that banks receiving government refinancing assistance must increase their loan portfolios by at least 2 percent every month.