Pity the governor of the Bank of Russia (BoR). A competent technocrat, she is being vilified as an enemy of the motherland for "failing" to defend the ruble and raising interest rates. The fact of the matter is that when currencies collapse because of capital flight, which is the case in today's Russia, there is no point in throwing official foreign exchange reserves down the drain. The BoR has been painstakingly arguing that the Russian banking system is in good shape despite the ruble's recent collapse, that there is plentiful dollar liquidity, and there have been no requests for emergency funding.
The BoR's communication strategy has been flushed down the drain by President Putin's statement this week that the country's sovereign wealth fund should be used to recapitalize the state banks. On the face of it, and in different geopolitical circumstances, such a statement would have been a mouth-watering invitation to go long the ruble, Russian bank shares and bonds and to short CDS spreads. In the event, what the President unwittingly conveyed to investors is that the reason banks are not asking for BoR help is because they are probably short of collateral. Clearly, financial market theory was not on the curriculum when the President studied at the KGB academy.
When a currency is weakening because of capital flight, which is the case in today's Russia, the ultimate response must be to impose capital controls. The thin end of the wedge has already been inserted, via moral suasion on exporters to convert the foreign currency earnings into rubles. There is no earthly point in recapitalizing banks if the new funds are going to evaporate into capital flight.
Stay short. This is not the time to be catching falling knives. Russia will likely pay its foreign debts, but that debt will be available for purchase much more cheaply than today in the weeks ahead.
