August 07, 2007

Putin favors ruble traders over oil profits

Tuesday, August 7, 2007

New york - Bloomberg

Russian 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 Corp. and UBS AG.

Russia's 8.5 percent inflation rate is three times faster than any other Group of Eight country.

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. Russia is the world's largest energy exporter.

“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.”

Russia's central bank, which controls the ruble's price, let the currency appreciate twice this year against a benchmark of dollars and euros by a total of 1 percent. The ruble now trades at 25.5593 per dollar. The basket consists of 45 percent euros and 55 percent dollars.

Bank expectations:The ruble will gain 2 percent against the basket until year-end, boosting the currency 4.3 percent to 24.5 per dollar, said Zurich-based UBS, the world's biggest money manager. The currency will rise to 24.7 per dollar this year, according to estimates by Charlotte, North Carolina-based Bank of America, the second-biggest U.S. bank by assets.

The ruble should be about 40 percent higher, New York-based Merrill Lynch & Co., the third biggest U.S. securities firm, said.

“The ruble is undervalued,” said Kenneth Rogoff, an economics professor at Harvard University in Cambridge, Massachusetts, and the former chief economist at the International Monetary Fund. “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, Russian Federal Statistics Service data show.

Buying dollars:The economy expanded 7.9 percent in the first quarter, the fastest pace in six years. Record capital inflows of $67 billion this year and revenue from energy sales has forced the central bank under Chairman Sergey Ignatiev to buy dollars to control the ruble's rise, leaving the nation with $417 billion in reserves, behind only China and Japan.

A 1 percent appreciation of the ruble cuts the inflation rate by 0.3 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 Russia's $1 trillion economy last year.

Putin has overseen average annual economic growth of 6.8 percent in his seven years as president, the most among major European countries. The price of oil tripled to a record $78.77 last week from about $24 a barrel at the end of 2000. Taxes from energy sales account for more than half of federal revenue, according to Merrill Lynch.

Public opinion:Preserving the public's approval is important if Putin wants to influence the choice of his successor, according to Rory MacFarquhar, a Moscow-based economist at Goldman Sachs Group Inc., the world's largest securities firm by market value.

Putin is constitutionally barred from serving a third consecutive term.

“Although Putin won't be in the presidential seat he plans to be in control of the country,” MacFarquhar said.

Inflation reached 127 percent in 1999, the year after former President Boris Yeltsin defaulted on $40 billion of domestic debt and let the currency devalue. Putin has said he plans to cut inflation to about 5 percent by 2010 and make the economy one of the world's five biggest by 2020.

Foreign investors lured by the sale of state assets have poured the record $67 billion into Russia this year, according to the Economy Ministry. Money supply rose 53.3 percent in June as the central bank printed rubles to buy dollars flowing across the border.

Putin's dilemma: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 New York-based Morgan Stanley. Lowering rates would encourage consumers to spend and not save.

“It's a dilemma,” said Steve Hanke, a professor of applied economics at Johns Hopkins University in Baltimore. “If inflation runs away, it certainly won't help Putin. The central bank is worried higher interest rates will entice more inflows.”

The rise in commodity prices has “placed a lot of pressure on the ruble to appreciate,” said Mark Mobius, who oversees $42 billion in emerging-market stocks as managing director at Templeton Asset Management Ltd. in Singapore. He holds $3.5 billion in Russian stocks. “The ruble will probably appreciate further.”

Raphael Marechal, who helps manage $4.4 billion in emerging-market bonds at Fortis Investments in London, plans to boost holdings of ruble bonds by 50 percent this year to profit from the ruble's accelerating gains.“The central bank has to let the ruble appreciate,” Marechal said. “It has no other tool to fight inflation.”

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