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FX Week: «A Russian Revolution»
Jurye Pimenov, senior FX dealer at the Central Bank of the Russian Federation, and Igor Souzdaltsev, project manager in financial markets at Investsberbank in Moscow, analyse the Russian rouble’s strength and its recent comeback after the financial crisis of 1998.
Increasing turnover in currency trading is an important indicator of growing confidence between market participants. The story of the Russian financial markets in 2005 was a good example of this. The average daily turnover of FX trades with the participation of Russian banks grew from $16 billion in Q3 2004 to $38 billion in Q4 2005. This proves that in 2005, the FX market restored the pace of development seen before the Russian liquidity crisis in the summer of 2004. We expect this up-trend to continue in 2006.
The Russian FX market structure is changing slowly because it is determined by the long-term agreements between Russian companies. USD/RUB deals, for example, made up 72% of market volumes in 2005 (up 1% from 71% in 2003), EUR/USD accounted for 19% (up 2% from 2003), while EUR/RUB was up 1% (the same as in 2003). Meanwhile, the share of other deals decreased to 8% in 2005, from 11% in 2003. We do not expect serious changes in 2006. However, the increasing importance of the euro for Russian importers, as a consequence of rising import operations, led the Central Bank of Russia (CBR) to change its FX policy. This involved the introduction of a ’bi-currency basket’ as the CBR’s operational guideline, at the beginning of last year. As explained by the CBR, the basket was used in 2005 to determine the price parameters on USD/RUB and EUR/RUB trades. During the course of that year, the share of euros in the basket grew from 10% in February to 40% in December.
This led some experts to refer to the CBR policy as ’euro-vision’. As CBR officials had often said, there were two major goals behind the introduction of the basket. The first was to bring the difference in volatilities between the EUR/RUB and USD/RUB closer. Traditionally the EUR/RUB volatility has been high, while volatility in the USD/RUB has been low. The second goal was to reduce the level of speculative FX operations in general.
Figure 1 shows the daily volatilities in USD/RUB and EUR/RUB calculated based on CBR fixing in the middle of the day. It is clear that at the end of 2005, the volatility indexes met at one point near the 0.2% mark.
As such, we can say the euro’s prospective in Russia for 2006 has improved. When the amount of trades in any currency is small, the volatility is usually high because it takes little effort to move it. Therefore, the introduction of a bi-currency basket and increased share of euro in this basket by the CBR, brought down volatility in EUR/RUB. This was despite the small amount of trades — which we consider to be a positive for the euro.
The only official CBR reference point for long-term internal foreign exchange policy is an index of the rouble’s real effective exchange rate (REER). This is calculated monthly by the CBR, on the basis of a group of 23 currencies that make up the major trade partners of the Russian Federation.
Figure 2 shows changes in the rouble’s index of REER calculated since 1995. It is obvious that this rate came back after the crisis of 1998, and is close to the pre-crisis level of 1997.
In 2005, Russia also saw the development of a derivatives market in FX swaps, futures and options — mostly on the country’s exchanges. We think that in 2006, the Russian
financial markets will undergo strong development. Some of these include the introduction of the Russian rouble symbol and the elimination of all controls over capital operations in Russia. The country will also see the introduction of rouble spot trading at major broking companies.