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. Last Updated: 07/27/2016

Russians Turning to Surging Euro

With the euro surging to two-year highs against the U.S. dollar, the ruble and Central Bank reserves are sliding in value and some panicky Russians are switching to the euro.

On the back of scandals swirling around U.S. giants WorldCom and Xerox Corp., the euro peaked at 99.90 cents to the dollar on Friday, its highest level against the U.S. currency since February 2000.

A handful of banks, anticipating a further strengthening of the euro, started selling euros last week at rates equal to or higher than the dollar.

"The demand for euros has increased dramatically over the past several days," said a cashier with the EnergoSberBank currency exchange office on Pyatnitskaya Ulitsa, which has one of the highest rates for euros in town, according to business information service RosBusinessConsulting. EnergoSberBank was selling 1 euro for 31.9 rubles on Friday, while its dollar rate was set at 31.57 rubles.

"Demand is exceeding supply and Russian banks are having difficulties meeting it," the cashier said. "As you might guess, people are making orders for quite significant amounts, as it is not a problem to change $100 for euros if you are going on vacation."

At least six banks -- Bank Moskvy, Rossiisky Bank Razvitiya, Ogni Moskvy, Sovinkom, Sfinks Bank, Belekonombank, Fram and BFT -- were buying euros at the same rate as the dollar Friday.

The economy is traditionally linked to the dollar, as most of its exports are priced in dollars. The federal budget is based on the ruble-dollar rate, and most external debts are nominated in dollars. Eighty percent of the Central Bank's reserves are nominated in dollars, while euros account for 10 percent and the rest is in gold.

At the same time, Europe has always been Russia's main trading partner, with food and clothes being among the major imports.

"In Russia's case, additional dollar weakness will mean first of all that the ruble will weaken against the euro while largely remaining unchanged against the dollar," said Philip Poole, head of emerging markets research at ING Barings in London.

"In the longer term, this will make noncommodity exports from Russia more competitive in the EU market. At the same time it will make imports sourced from the EU more expensive," he said. "In this respect, over time we will probably see the shift in the Russian trade pattern from importing from EU toward exporting to EU."

Additionally, a limited valuation affect will hurt the country's debt-GDP ratio. "Russia does not have a lot of euro-denominated debt," Poole said.

But while the macroeconomic effect of the dollar-euro battle for Russia will only be seen in the longer term, the Central Bank and ordinary people are already losing money.

Presidential adviser Andrei Illarionov said recently that the value of the Central Bank's reserves has shrunk by about $2.5 billion because of the rise in the euro's value.

According to some estimates, a 10 percent increase in the euro rate against the ruble means a $5 billion to $6 billion decline in Russia's trade balance. The euro has strengthened about 10 percent against the ruble since the beginning of the year.

Alexander Kolochenko, head of consumer banking with Raiffeisenbank Austria, said his bank last week was issuing an equal number of cards on euro accounts as on dollar accounts, while at the beginning of the year euro cards accounted for only 5 percent of the accounts.

"Also, many clients are coming and converting their dollar deposits into euros, even though they are losing on interest rates," he said.

"Russians are prone to panic," said Mikhail Matovnikov, deputy director general of the Interfax Rating Agency. "But in the short term, the euro is still less attractive as a means of savings than the U.S. dollar, and although it sounds unbelievable, ruble deposits are the most attractive instrument of them all these days."

But spreads on euro/ruble exchange rates remain very high at about 50 kopeks, compared to 1 to 5 kopeks for the dollar, as a result of high transaction costs, low liquidity and considerable currency risk, he said, adding that where the euro will end up is anybody's guess.

"Two months ago no one would have expected the euro to reach parity with the dollar, and likewise no one today can say what will happen in two months," Matovnikov said.