Ruble Cubed? Putin Puts Medvedev in Dilemma on Prices (Update1)

Ruble Cubed? Putin Puts Medvedev in Dilemma on Prices (Update1)

By Bo Nielsen and Emma O'Brien
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May 5 (Bloomberg) -- The world's biggest banks are advising their clients to load up on rubles in a bet that one of the first things Dmitry Medvedev may do after he's sworn in as Russia's president this week is to allow a stronger currency.

Merrill Lynch & Co., Goldman Sachs Group Inc. and Deutsche Bank AG predict gains of as much as 4 percent in the next six months. They say pressure will mount on the central bank to let the ruble appreciate to stem inflation even if it risks damping profits of oil and energy exporters, which according to Merrill Lynch fund more than half of the federal budget.

The last time Bank Rossii, which must submit proposed changes in monetary policy to the government, allowed the ruble to strengthen was in August, when the inflation rate was 8.5 percent. It's now 13.3 percent, five times the average of the Group of Seven industrialized nations. Two interest-rate increases this year failed to restrain consumer prices, and Russia ``isn't ruling out'' letting the ruble gain, Bank Rossii Deputy Chairman Alexei Ulyukayev said April 24.

``Ruble appreciation will continue to be a key anti- inflation tool given the limited domestic monetary instruments the central bank has at its disposal,'' said Ramin Toloui, a senior vice president at Newport Beach, California-based Pacific Investment Management Co., which manages more than $800 billion. ``That favors continued ruble appreciation.''

The central bank sets the price of the ruble against a so- called currency basket made up of 0.55 dollars and 0.45 euros.

It let the currency appreciate against the basket three times last year by a total of about 1.3 percent. The ruble traded at 36.8220 per euro and 23.7560 per dollar at 1:31 p.m. in Tokyo.

Surging Growth

Russia, the world's biggest energy exporter, has expanded an average of about 7 percent a year since President Vladimir Putin, 55, took office in 2000. During that time, the price of oil has risen almost fivefold to a record $119.93 a barrel. The economy will grow 6.6 percent this year, more than five times the 1.2 percent average of the G-7, according to Merrill Lynch.

Medvedev, 42, and the central bank are faced with the challenge of maintaining growth while stemming inflation. Consumer prices have surpassed the government's target every year since 2003.

Bringing down the inflation rate ``is one of our biggest priorities,'' Putin said during his annual press conference on Feb. 14. Putin will become responsible for the economy when he assumes the role of prime minister on May 8, the day after Medvedev's inauguration.

`Doing Everything'

``They have to demonstrate they are doing everything they can to stop inflation,'' said Vladimir Sokolov, former head of foreign exchange operations at the central bank and board member of VTB Bank Europe Plc, a London-based subsidiary of Russia's second-biggest bank. ``You need appreciation of 20 percent to get rid of the inflation problem for good.''

A 1 percentage point increase in the ruble against the basket would cut inflation by 0.3 percentage point, according to central bank calculations.

OAO Rosneft, Russia's largest oil company, has felt the sting of inflation mostly through rising equipment, infrastructure and wage costs, said Peter O'Brien, chief financial officer of the Moscow-based company. Salaries for welders in western Siberia have risen 200 percent in dollar terms since 2000, he said.

Inflation ``hurts,'' O'Brien said. ``If it persists, natural resource producers here will struggle to be competitive globally.''

Flip Side

The downside of a stronger ruble for Rosneft is that it may diminish profit because half the oil produced by the company is sold into the dollar-denominated export market, he said. Oil prices will fall to $90 a barrel by year-end, from $116.32 last week, according to the median estimate of 32 strategists and economists surveyed by Bloomberg.

``I can't see how the government can allow more appreciation,'' said Mark Mobius, executive chairman of Singapore-based Templeton Asset Management Ltd., which oversees $47 billion in emerging-market equities.

While Putin said the country needs to get inflation under control, he also urged the Cabinet on March 17 to pay ``close'' attention to the ruble's appreciation, which hurts the competitiveness of Russia's manufacturers abroad.

Goldman Sachs and Merrill Lynch, both based in New York, and Deutsche Bank in Frankfurt are bullish anyway. They recommend investors put money on the ruble.

``They can't bring down inflation at its current levels just with rates,'' said Yaroslav Lissovolik, Deutsche Bank's chief economist in Moscow. ``We should expect ruble appreciation.''

`Problematic'

Interest rates aren't effective in controlling inflation because Russia doesn't have a developed consumer-credit market, with mortgages and credit cards little-used outside larger cities, Lissovolik said.

Deutsche Bank expects the ruble to strengthen as much as 2 percent against the basket by the end of this year.

Russia's authorities ``have to accept a much higher rate of ruble appreciation than they have done before,'' said Ian Hague, a founding partner in New York at Firebird Management LLC, which oversees $3.6 billion and focuses on the former Soviet Union. ``It will be problematic but if it's the only way to deal with inflation it has to be done.''