Edward has a very useful summary of the situation here, but we need not go much beyond the immediate news this week to learn that Russia inevitably is moving towards a devaluation of the currency (and then I imagine a series of interest rate cuts to get exports going in the non-energy sector).  The numbers are really quite extraordinary. Since August the total outflow from Russia's capital market has, so far, amounted to a staggering $190 billion according to Bloomberg. It does not take much advanced arithmetic here to realize that even if Russia is in possession of a healthy portion of foreign exchange reserves such a buffer can melt away within a matter of month if investors collectively decide to pull out. Or to put it in a Macro Man package; defending the Rouble at this point in time amounts to a h'll of alot more than mere pisstaking to mess up hedgies' punts on the Rouble. 

As a consequence, the devaluation of the Rouble appears to be anything but certain since it simply makes no sense to keep on defending the Rouble's peg to its current basket. In this context, it is true that Russia's central bank announced today that rates would go up a full 100 basis points, to 13%, from December in an attempt to shore up inflows. Yet, this may also be an initial step to lock in a high level of interest from which to lower once a devaluation (scrapping of trading etc) is announced. Hungary's example a few weeks ago in relation with the plan to secure Swiss denominated consumer and mortgage loans might be a yardstick here.

 

Spot the Pattern?

While Russia definitely will mount an example to follow for other emerging economies (not least in Eastern Europe), it seems that as the money flows out and as economic momentum is winding off significantly many emerging economies are beginning to look south with respect to interest rates.

Emerging market central banks may follow Hungary, Turkey and Malaysia in lowering interest rates to support faltering economies even as investors shun assets in developing nations, TD Securities said. In the past week, the Turkish, Hungarian and Malaysian central banks have carried out unexpected cuts to their key rates. Poland’s central bank today reduced its key rate a quarter point, to 5.75 percent, while 15 of 20 economists in a Bloomberg survey predicted rates would be left unchanged.

As the lira, forint and the ringgit have held up, policy makers in Mexico, South Africa and Brazil, the next in line to meet in coming weeks may be more tempted to ease rates, Beat Siegenthaler, the London-based chief strategist for emerging markets at TD Securities, wrote in a note to clients.

Now, as Mr. Siegenthaler also points out and as I would strongly reiterate the danger is of course that the currency plummets completely as the central bank begin to ease the nominal rate. This is important not least in the context of Hungary and Ukraine where the central bank has to balance a knife's edge and ultimately is left to the whims of foreign punters. Such is the situation, in fact, across the entire Eastern European edifice and in this respect I would strongly agree with Nouriel Roubini's comment as quoted by Bloomberg;

“The currency is overvalued in nominal and real terms,” Nouriel Roubini, the New York University professor who predicted the current financial crisis two years ago, said in a Bloomberg Television interview in Moscow. “How to move to a more flexible exchange-rate regime is going to be one of the most important policy challenges to avoid a hard landing.”

I would apply this reasoning on a broad range across Eastern Europe, or as Stiegthaler puts it in a more polemic tone;

The recent examples “may signal to other central banks that they can get away with rate cuts,” Siegenthaler said.

So what exactly will Eastern European (and indeed their fellow colleagues in other EM economies) be able to get away with here? Not a whole lot I imagine which is also why I really hope that the IMF manages to play its hand wisely since the way in which we move from A to B will likely be up to the way the fund is able to knit together a working solution at the same time as the central banks maintain their credibility. It is important here to take the real economic forecast into account here. The latest tableau d'horreur in the context of Eastern Europe came from Ukraine where the government now forecasts a 5% contraction next year. This is depression territory which is also why a currency crisis would be devastating.

In Hungary, things do not look much rosier either and together with Ukraine the economy is competing fiercely for the ill-wanted position as the most exposed economy in Eastern Europe. Meanwhile in other erstwhile sturdy CEE economies interest rates also seem set to come down.