The very bonds that helped Russia’s central bank curb price growth during the oil boom may now be its best weapon against inflation fuelled by spending to soften a recession.
Bank of Russia Governor Elvira Nabiullina said June 10 she would dust off instruments that haven’t been used in five years to soak up the excess cash building in the financial system. She announced the plan to resume sales of short-term bills, known as OBRs, just as policy makers renew a cycle of interest-rate cuts that are themselves inflationary.
A lot has changed since the last time the OBRs were issued in 2011. Oil prices have more than halved, the economy is caught in its longest recession in two decades and international sanctions have cut off companies’ access to foreign markets. Yet banks are as flush with liquidity now as they were then because the government is ploughing so much of its rainy-day funds into the economy to limit a budget shortfall, that Nabiullina is concerned deposits at banks will soon outstrip those held at the Bank of Russia.
“The Finance Ministry running a deficit is creating problems for the central bank,” said Daniel Hewitt, a senior emerging-markets economist at Barclays. “That’s why they have to mop up liquidity.” By turning from lender to borrower, the Bank of Russia can effectively tighten policy in the background even as it loosens conditions in the foreground, he said.
As much as 700bn roubles ($11bn) of the OBRs could be sold to address the liquidity imbalance, according to estimates of Raiffeisenbank JSC in Moscow. While that figure is dwarfed by the 3.46tn roubles of bills sold by the Bank of Russia through 2011 during the last period of excess liquidity, Nabiullina faces a similarly daunting consumer price index today of 7.3%.
The central bank governor said she will sell “tens ofbns of rubles” of the bills in a pilot programme over the next two to three months on the same day the central bank lowered benchmark borrowing costs for the first time in almost a year. While inflation has slowed by more than half over the past year to 7.3% in May, an onslaught of cash in the financial system will make it harder for Nabiullina to attain her target of a 4% rate by 2017. The government plans to spend 2.1tn roubles from its Reserve Fund this year to cover the widest budget shortfall since 2010. The rouble advanced 1.4% to 63.9975 against the dollar on Thursday. Forward-rate agreements show that derivatives traders are predicting about 60 basis points of key rate reductions over the next three months.
“Domestic liquidity could be influenced mainly by the budget and reserve-fund spending,” said Oleg Kouzmin, chief economist for Russia at Renaissance Capital in Moscow and a former central banker. “That’s the most important component from the budget side.”
The bills will be sold only to banks that are at the root of the liquidity surge and their cash will sit on the central bank’s accounts until the bonds are repaid, according to Dmitri Petrov, an analyst at Nomura International in London. They will probably range in maturity from 30 to 180 days, he said.
OBRs will need to be competitively priced to persuade investors to choose them over traditional OFZs issued by the Finance Ministry, said Vladimir Miklashevsky, chief strategist at Danske Bank in Helsinki.