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Resurgent Russia prepares for convertible rouble
http://www.ft.com/cms/s/97c20938-07d5-11db-9067-0000779e2340.html
By Neil Buckley in Moscow

Published: June 30 2006 03:00 | Last updated: June 30 2006 03:00

Memories of Russia's default on $40bn of domestic debt eight years ago, when people queued outside banks to withdraw roubles that were plummeting in value, have barely faded from the national psyche.

Yet, remarkably, with coffers swollen by oil selling at $70 a barrel, Russia will tomorrow lift all currency controls on the rouble and make it fully convertible. Everyone will be able to move roubles freely out of and into the country, foreign and offshore investors will be able to open rouble bank accounts, and restrictions on rouble fixed-income investments will disappear.

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It is a highly political and symbolic step. Brought forward by six months from the original deadline, it comes two weeks before Russia hosts the Group of Eight summit in St Petersburg, and days after the country reached agreement to pay off, ahead of time, its remaining $22bn (€17.5bn, £12.2bn) debt to the Paris Club of creditor nations.

The move will announce "that Russia is a serious global player," says Al Breach, research director at UBS in Moscow. "It has now graduated to being a normal, if not developed, at least upwardly developing, country."

Russia is saying "it is stable, it is open, and ready for money coming in".

The lifting of currency controls is also part of a campaign to burnish the rouble's once shattered image and challenge the dollar's supremacy - an economic parallel to Moscow's efforts to counterbalanceUS dominance in foreign policy.

Senior officials including President Vladimir Putin have even called for the rouble to become a reserve currency, to the surprise of international investors.

Russia's lower house of parliament has given preliminary approval to a bill slapping instant fines - their size not yet determined - on ministers and senior officials who quote figures in dollars that could be quoted in roubles. It would also stiffen fines on businesses displaying prices in foreign currencies, as many started to do during the hyperinflation in the 1990s that followed Russia's initial liberal reforms.

"The rouble is on the move," quipped Vladimir Zhirinovsky, veteran ultra-nationalist leader in the Russian parliament. "Next stop, Berlin."

But rouble convertibility has strong fiscal underpinnings and big economic consequences. It is backed by $250bn in foreign exchange reserves and $70bn in a stabilisation fund stuffed with windfall oil tax revenues.

While the Putin administration's political record is under scrutiny ahead of the G8 summit - and rising oil and gas prices have been a massive stroke of luck - economists say its fiscal management has been exemplary.

The expected mushrooming of rouble bond, credit and debt markets should in turn help Russia move to the next stage of economic regeneration. It is shifting from recovery - improving productivity of existing industrial capacity - to investment-led growth through developing new capacity.

By enabling companies, and state and quasi-state entities, to fund investment in roubles, development of the domestic capital market could help Russia start renewing its decrepit infrastructure.

Convertibility should also enable Moscow to shift in two or three years from a monetary policy based on exchange rate management to an interest-rate managed policy, in line with most developed countries. That was previously impossible since lack of confidence in the rouble made the dollar the main instrument of Russia's capital markets.

As always there are significant risks. Big inflows of funds could lead to an overheating economy or stoke inflation that, at close to double figures, Russia is still struggling to contain.

Analysts, however, note that the Russian authorities have scope to let the rouble, already up 4 per cent year-on-year against a basket of international currencies, appreciate further to offset the inflationary pressure. But a stronger rouble will make exports more expensive, increasing the pressure on Russian manufacturers already struggling to maintain competitiveness, even if their borrowing costs should be cut by convertibility.

As Deutsche UFG, another Moscow investment bank, points out, the reform also ups the stakes for Russia's economic policy makers: if they make a mess of things, mobile capital could desert the country en masse.

And yet, with the rouble rising and the ability before long to take roubles abroad and change them therefor local currency, convertibility could lead to afinal important switch. Russians, many of whom have long favoured salaries in dollars, may start demanding that their employers once again pay them in humble roubles.

Copyright The Financial Times Limited 2006