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. Last Updated: 07/27/2016

Strengthening Ruble Defying Logic

Something weird is happening on Russian currency markets. Over the past three weeks the ruble has strengthened more than 12 percent, when logic seems to dictate that the currency should be losing ground fast.

The rally has arrested a fall that began immediately after that fateful August day when the government unhooked the ruble from its dollar peg and allowed it to slide. The currency quickly dropped more than 60 percent.

Upswings in September and October were short-lived, and their purpose was clear: to make life easier for Russian banks whose forward contract obligations to foreign investors matured in the middle of the month.

But this time the ruble has been steadily rising since Oct. 20, and on Friday the currency was quoted at 15.01 to the dollar, a 1.5 percent gain over the previous day.

Analysts credit the Central Bank with setting up this amazing rally when market forces left no way for the ruble to go but down.

"The main reason is all the administrative mechanisms ... which are driving the ruble in the opposite direction," said Thierry Malleret, chief economist with Alfa Kapital.

The Central Bank has made sure of a regular supply of hard currency by forcing exporters to sell half their hard-currency earnings on the exchange, but commercial banks cannot buy dollars from them except on behalf of importers, and imports have declined by two-thirds since August.

There are other factors, such as a regulation that became effective Nov 1. Banks that have bought dollars for imports are allowed to hold the money in their accounts for no more than seven days, and they must submit a list of clients whose requests for dollars they are meeting.

Dealers said this has excluded speculators who earlier managed to participate in special trading sessions reserved for exporters and importers.

"Banks still haven't found a way around this regulation," said Konstantin Svyatny, a dealer with Rossiisky Kredit Bank. Since Nov. 1, the ruble has gained 5 percent.

Analysts also believe the Central Bank is still trying to keep the dollar low for Nov. 15, when a fresh batch of currency forwards come due, but the manipulation is less obvious than in the previous two months, when the ruble jumped up sharply for two or three days and then went down. The obviousness of the maneuver irked many foreign holders of the forwards.

"The Central Bank has evidently decided not to produce a sharp movement of the exchange rate on the eve of the settlement date," said Alexei Zabotkine, an analyst with United Financial Group. "Instead it is gradually pushing the ruble up so that by the middle of the month the exchange rate will be 13 rubles to the dollar."

Zabotkine said he expects the ruble to start declining after Nov. 15, though not significantly. "We shall see a rate of 18-19 rubles to the dollar," he said, adding that the fourth quarter budget calculations are based on a rate of 17-20 rubles to the dollar.

Interestingly, the ruble's rise is taking place against a backdrop of rising money supply. The Central Bank has printed billions of rubles to issue cheap loans to banks, pay some arrears and finance the purchase of exporters' dollars on the exchange.

Russia's hard-currency reserves have increased from $12.3 billion on Oct. 6 when the dual system was introduced, to $13.6 billion on Oct. 30. This means the Central Bank has soaked up dollars, paying exporters with a flood of new rubles.

The government plans to use the Central Bank's reserves to pay off foreign debts.

However, the practice of printing rubles to increase hard-currency reserves is relatively harmless in Russia's heavily regulated foreign exchange market, Zabotkine said. If the Central Bank starts printing a lot of money to buy hard currency, all it will have to do to keep the ruble from falling will be to make exporters sell more of their revenues, the analyst explained.

Finance Minister Mikhail Zadornov said Thursday only 5 billion rubles ($333.1 million) has been printed so far to finance the budget deficit, but the Central Bank earlier announced that it had injected 55 billion rubles into the banking system to revive its liquidity. Most of that must have been printed.

No one is sure how much money has been printed already, and some analysts say that the government's target of 15 billion rubles by the end of the year is not even close to the actual emission they expect.

"Money printing may reach 130 billion rubles [this year], with a surge of inflation following," predicted Alexander Gubarev, an economist with CAIB.

Gubarev said the government needed money to keep its promises to pay off massive wage and pension arrears and to allow state-controlled Sberbank to pay the cheated depositors of commercial banks in December under a government deposit guarantee scheme introduced after the devaluation.

But the emissions made so far have yet to affect the economy, and a lag of several months is predicted before inflation - the inevitable consequence of money printing - kicks in. This is expected to happen early next year.

There are several reasons for the lag. Exporters spend the rubles they buy from the Central Bank on salaries and production inputs. Also, money poured into the paralyzed banking system is yet to hit the economy, analysts point out.

"When people can get their money out of the banks, inflation will rise drastically," Malleret said, predicting the ruble will end the year at 20-25 to the dollar.