• ACI Russia

08/14/1998 14:21:16 Defending the rouble: Russia's options

By Gill Tudor

LONDON, Aug 14 (Reuters) - With the Russian economy on the

ropes and rumours of a rouble devaluation flying thick and fast,

Russian policy makers face a clamour of conflicting opinions on

how to manage the currency.

A call on Thursday by financier George Soros for Russia to

adopt a currency board system and devalue by 15-25 percent

further turned the screw on the rouble.

But while few other market players agree that a currency

board would ease Moscow's problems, analysts are split between

those who say devaluation has become inevitable and those who

urge Russia to hold steady at all costs.

"It is time to let the rouble go," David McWilliams,

emerging markets analyst at Banque Nationale de Paris in London,

said in a briefing note on Friday.

"The internal arguments against a devaluation in terms of

stability, hyperinflation and banking crises are well founded...

but in the light of interest rates persisting at 150-200

percent, the cost of rouble stability on the economy at the

present exchange rate looks to be simply too high."

Other disagree, saying devaluation is not necessary and

would shatter domestic confidence, the creaking Russian banking

system and any semblance of political stability.

"They have to hold the line," said Tim Ash, an economist at

West Merchant bank in London. "If they devalue they'll set back

reform by at least 10 years."

The rouble is currently allowed to fluctuate in a broad

medium-term trading band of 15 percent above or below a rate of

6.2 to the dollar. The central bank also sets a daily mini-band

edging slowly lower over time to offset inflation, similar to a

crawling peg.

The central bank will usually protect the mini-band by

intervening in the market if necessary, although in this week's

turbulent conditions the rouble has spilled outside it. At 1115

GMT on Friday the currency was bid at 6.35 to the dollar, well

outside the day's mini-band of 6.27/6.31.

Russian President Boris Yeltsin insisted once again on

Friday that the rouble would not be devalued and reiterated his

support for reformist Prime Minister Sergei Kiriyenko.

Russia's battered stock market rebounded by 15 percent after

this week's panic-selling, but the local bond and currency

markets remained very choppy, with cripplingly low liquidity.

Analysts say the list of options (both probable and

improbable) facing the government looks something like this:

-- hang on to the status quo and weather the storm, possibly

with the help of more cash from the global community

-- devalue by a set percentage and adjust the trading band

-- devalue by allowing the rouble to float freely

-- devalue and adopt a crawling peg

-- devalue and adopt a currency board

The currency board idea has few takers. A currency board

would fix the rouble to the dollar or euro by at least matching

notes and coins in circulation with hard currency reserves.

But critics say Moscow would not be willing to surrender so

much control over monetary policy, while a currency board could

fuel punitively high interest rates and create opportunities for

both foreign and domestic speculators.

McWilliams argued that one-off "step" devaluations had

failed in emerging markets in recent years, and in their current

mood the financial markets were unlikely to find credibility in

Russian pledges to defend any set parity.

"Our central view is that the rouble will be allowed to fall

to find its own level and that the authorities will opt for a

free-float rather than any other type of target," he said.

Richard Gray, head of emerging markets research at Bank of

America, said he thought the government was more likely to opt

for an inflation-linked system of "sloping bands" akin to a

crawling peg, similar to the way Brazil manages the real.

"I think the rouble will end up lower, but it's likely to

get there through a form of controlled depreciation," he said.

Some proponents of devaluation say letting the rouble tumble

in the short term could lead to medium-term strength.

"If they do devalue sensibly, with a lot of reserves and a

sensible move of 20 to 30 percent, there's no reason why Russia

shouldn't go down and then pop straight up again," said Geoffrey

Dennis, emerging market strategist at Deutsche Morgan Grenfell.

Ash said Russia could still resist devaluation although it

would need extra financing from the international community --

probably over $10 billion -- in addition to the $23 billion

rescue deal agreed in July with the International Monetary Fund.

"If they can get through the next year they're going to

emerge far better positioned, and the Russian economy will be

stronger," Ash said. REUTERS

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