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08/14/1998 14:23:40 EMERGING MARKETS FX - Sober amid Russian scare

By Mike Dolan

LONDON, Aug 14 (Reuters) - A Russian devaluation makes

little or no economic or political sense for Moscow, analysts

said on Friday, but if such a move became unavoidable emerging

European markets would only suffer a short-term bout of

contagion.

An eerie calm descended on Russian and eastern European

markets on Friday as the Russian government insisted its

existing exchange rate policy would remain firm and as markets

took a slighlty more sober assessment of the risk of imminent

devaluation.

"There will be no devaluation -- that's firm and definite,"

Russian President Bosis Yeltsin said, reinforcing a series of

statements from government officials and the central bank.

Although the spot rouble remained outside the Russian

central bank's daily target band on Friday, interest rate and

equity markets recovered some of Thursday's extreme losses and

central and eastern European currencies held steady-to-firmer

too.

The South African rand, Mexican peso and Brazilian real all

held their own during the session.

Emerging Asian currencies were broadly higher, meantime, as

the beleagured Japanese yen regained a more solid footing about

145 per dollar.

Analysts said the Russian financial crisis was likely to be

a protracted one, however, that would continue to discourage

strategic foreign investors for some time.

But they said a rouble devaluation, recommended by fund

manager George Soros on Thursday, would solve none of the

underlying problems facing Russia and may actually exacerbate

them.

Russia runs a trade surplus, for example, and exchange rate

competitiveness is not the issue.

"Devaluation will only create bigger problems. It solves

nothing," said Arnab Das, emerging markets strategist at JP

Morgan in London. "If they devalue, they run the risk of

reducing what little confidence there is in the rouble, creating

a high risk of domestic currency substitution and high inflation

expectations."

Das said a devaluation would be very difficult to control in

this environment. The political price to pay of an uncontrolled

currency slide, renewed inflationary fears and a

re-dollarisation of the economy could be high ahead of Duma

elections in 1999 and presidential elections in 2000, he said.

"When was the last time you saw a smooth devaluation in an

emerging market with a short-term debt overhang?" he asked.

"We have been arguing for some time that restructuring of

the domestic debt market is the main risk and I think that's the

direction we're headed."

Analysts said the central bank is caught between providing

liquidity to the battered banking system and the currently

conflicting goal of maintaining the exchange rate peg.

In the end, further support from western governments for

Russian foreign exchange reserves may well be needed, combined

with allowing many institutions in the banking system to go to

the wall.

This would have less of an impact on the real economy than

there was in banking crises in Asia because most of the

instititutions in question are just financial market brokers and

intermediaries, not fully fledged banks.

But even the worse-case scenario in Russia is unlikely to

cause the same sort of financial market waves as the Asian

crisis did last year and will merely prolong the dire investor

sentiment that currently prevails in all high-risk assets,

analysts said.

A further dent to investor confidence world-wide would,

however, have inevitable knock-on effects on markets like South

Africa and Brazil and east Europe. But the economic and trade

linkages between Russia and central and eastern Europe are

nowhere near the interdependence between Asian economies.

Strong underlying economic and financial fundamentals in

countries like Poland would limit any downside. Other countries

with more immediate Russian economic and political links, like

Ukraine and possibly the Baltic nations, may suffer

disproportionately.

"I think a Russian collapse would hit the likes of South

Africa and Brazil as a function of its impact on emerging

markets sentiment across the board," said Paul MacNamara,

emerging markets economist at Bank Julius Baer.

"But this would be seen as part of the existing emerging

markets problem rather than some new trigger for yet another

crises."

"Everything looks pretty ugly at the moment...but places

like Poland still look less ugly than the rest."

Das at JP Morgan concurred.

"It's important to draw the distinction between a short-term

sell-off and the medium-term outlook," he said. "When the dust

settles, central Europe will come back because the fundamentals

are quite a bit different than in Russia."

Although Thursday's slide did weaken the Czech crown and

Polish zloty a touch, this was a retreat from highs rather than

a plumbing of new lows.

The Czech central bank even managed to slash its discount

rate to 16 percent from 19 percent during Thursday's wobble

without undermining the crown unduly in the process.

Traders said the crown is undergoing a justifiable retreat

that could see it slip further over the next couple of weeks to

support levels about 18.50 per mark from about 18.10 on Friday.

REUTERS

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