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. Last Updated: 07/27/2016

Putin Likely to Strengthen Ruble

VedomostiShoppers at a checkout counter in a Pyatyorochka store. Consumer prices have risen for three straight months.
President Vladimir Putin's plan to keep inflation from accelerating depends on favoring foreign exchange traders over the country's oil and gas companies.

Putin will probably allow the Central Bank to double the ruble's pace of appreciation this year because he has few options outside the foreign exchange market to rein in consumer prices, according to strategists at Bank of America and UBS.

The consumer price index rose by 0.9 percent in July, the Federal Statistics Service said, after a gain of 1 percent in June, with food prices the main culprit behind the rise. The July figure brings price growth in the first seven months of the year to 6.6 percent.

"Summer inflation is meant to be lower, so this is not a good print," said Al Breach, chief economist at UBS in Moscow.

Breach calculated year-on-year inflation was running at 8.7 percent -- official figures are due later -- and threatening to miss this year's government inflation target of 8 percent.

"It demonstrates they've got a really serious inflation issue at the moment -- it's accelerating," Breach said.

Rising prices threaten Putin's 80 percent approval rating and may reduce his influence after he leaves office in March. While a stronger currency would cut import prices, it also erodes profits from sales of oil, natural gas and minerals when converted into rubles.

"The stronghold that Putin has on the popular vote will be challenged if inflation becomes an issue," said Timothy Seymour, chief operating officer of Red Star Asset Management, a hedge fund in New York with 80 percent of its portfolio in Russian assets. "The ruble will rise."

The Central Bank let the currency appreciate twice this year against a benchmark of dollars and euros by a total of 1 percent.

The ruble will gain 2 percent against the basket until year's end, boosting the currency 4.3 percent to 24.5 per dollar, UBS said. The currency will rise to 24.7 per dollar this year, according to estimates by Bank of America.

The ruble should be about 40 percent higher, Merrill Lynch said.

"The ruble is undervalued," said Kenneth Rogoff, a former chief economist at the IMF. "Attempts to keep the currency pegged are putting great upward pressure on inflation."

Consumer prices, led by a 26 percent rise in crude oil this year, have risen three straight months, surpassing the government's 8 percent target in June. Wages increased 15.2 percent in June from a year earlier, sparking a 14.7 percent rise in retail sales, State Statistics Service data show.

Record capital inflows of $67 billion this year and revenue from energy sales has forced the Central Bank to buy dollars to control the ruble's rise, leaving the nation with $417 billion in reserves, behind only China and Japan.

Money supply rose 53.3 percent in June as the Central Bank printed rubles to buy dollars flowing across the border.

A 1 percent appreciation of the ruble cuts the inflation rate by 0.3 of a percentage point, according to Central Bank estimates. That would limit funds available to energy companies for investment by as much as 2 percent, according to Merrill Lynch. Energy sales accounted for 22 percent of the economy last year, and taxes from energy sales account for more than half of federal revenue according to Merrill Lynch.

Preserving the public's approval is important if Putin wants to influence the choice of his successor, said Rory MacFarquhar, an economist at Goldman Sachs. "Although Putin won't be in the presidential seat, he plans to be in control of the country," MacFarquhar said.

Raising benchmark interest rates above the current 10 percent would only lure more money into Russian assets, said Oliver Weeks, an economist in London for Morgan Stanley. Lowering rates would encourage consumers to spend and not save.

The rise in commodity prices has "placed a lot of pressure on the ruble to appreciate," said Mark Mobius, managing director at Templeton Asset Management in Singapore. "The ruble will probably appreciate further."

Oil producers have surpassed Asian central banks as the largest pool of global savings, accumulating an estimated $500 billion in 2006 alone, according to research by California-based bond fund manager Pacific Investment Management.

State-run Rosneft, the country's largest oil producer, said profit declined 25 percent in the first quarter as the ruble rose 11.7 percent, adjusted for inflation, against the company's trade partners.

Putin said at a Cabinet meeting in April that the ruble should not "undercut" manufacturing, according to the government's web site. "This deserves special attention," he said.

The country's carmakers are already struggling as sales of imported cars jumped 60 percent to 510,000 units in the first half of this year. Textile production fell 4 percent in June from a year earlier.

Putin "is under pressure from manufacturers," said Maxim Oreshkin, chief analyst at Rosbank. "For them, a stronger currency is a real problem," Oreshkin said. (Bloomberg, Reuters)