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. Last Updated: 07/27/2016

Economists See End to Liquidity Squeeze

Over the last couple of weeks, banks have seen a liquidity squeeze similar to the one during the mini-crisis of 2004. Economists say the country's money supply suffered from a perfect storm of contrary financial winds. Nevertheless, the forecasters are predicting smoother weather over the next few weeks.

Normally, money flows into Russia in a fairly straightforward manner. The country's biggest exporters sell their oil and gas abroad, and the Central Bank obligingly helps them convert the petrodollar proceeds into rubles so they can pay salaries, taxes and other expenses.

By intervening in the foreign exchange market, the Central Bank reduces free-for-all demand for the ruble and keeps the currency from appreciating rapidly and hurting the profit margins of Russian exporters.

With rubles in hand, the likes of LUKoil and Rosneft dutifully gather up a large part of their oil revenues and pay them as taxes to the government. At the end of each month, Russia's liquidity temporarily dries up as banks forward these tax payments to the government. Suddenly, banks in need of extra cash have to pay a higher borrowing rate for short-term loans. Inter-bank interest rates shoot up, only to subside at the beginning of the next month, when the tax payments are over and liquidity starts to return.

But the spike in interbank interest rates at the end of October was the worst that the country had seen since the mini-crisis in the summer of 2004. The drop in oil prices to $58 currently from their high of $78.40 over the summer means less money is flowing into the country. Meanwhile, some of the tax bills from when oil prices were high came due, putting a further strain on liquidity.

"Right now companies are paying taxes on oil revenues that were received when oil prices were at the highest level," said Alexei Moisseyev, head of fixed income research at Renaissance Capital.

To make matters worse, speculators have been fleeing ruble-denominated investments for weeks as the currency's value dropped against the dollar -- the opposite of the long-term trend of a strengthening ruble. The drop in the ruble against the dollar was triggered mostly by the recent weakness of the euro against the dollar. Because of the way the Central Bank manages the ruble, a weakening euro automatically makes the ruble weaken against the dollar.

With liquidity drying up everywhere, the Central Bank halted its usual task of removing excess money from the banking system and was actually forced to add $3 billion in October, according to Alfa Bank.

Top banks usually have several methods of getting their hands on cash in a pinch, but small and medium-sized banks that needed money were forced to borrow it at 10 percent or more, much higher than the 2-3 percent interbank rates that have become standard.

Luckily, most economists said liquidity would return to the banking system as the inevitable influx of oil revenues continued. What's more, government agencies that have been hoarding cash all year will start spending heavily because of the government's bizarre use-it-or-lose-it budgetary policy. Finally, several strategists have said the foreign exchange market viewed the euro's weakness against the dollar as temporary.

"It's the expectation of this appreciation that's likely to lead to greater inflows of capital targeting a strong ruble," said Yaroslav Lissovolik, chief economist at Deutsche UFG.