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TEXT-Fitch:Russia demonstrates exchange rate flexibility benefits

(The following statement was released by the rating agency)

Oct 11 - Greater exchange rate flexibility is giving Russia a more effective buffer against volatile oil prices and other external shocks, Fitch Ratings says. Russia's experience provides an example to other sovereigns in the CIS of the benefits of exchange rate flexibility. Nevertheless, rapid moves towards fully floating currencies are not without risks.

Russia's move towards a more flexible exchange rate has lessened the direct link between changes in oil prices and changes in Russia's budget oil revenue. This offers some protection against sharp oil price falls because the rouble and oil prices have been highly correlated. Compared with 2008, Russia is materially less exposed to external shocks, although it remains vulnerable to a severe, sustained fall in oil prices.

Combined with monetary tightening (the Central Bank of Russia unexpectedly raised its key interest rates on 13 September), it has also helped keep inflation in check and curb capital outflows. Further fiscal and structural reforms would reduce vulnerability to oil prices and the consequent volatility in growth and inflation relative to 'BBB' peers.

A track record of operating a flexible exchange rate policy while the central bank keeps a lid on inflation could improve financial stability. This would be ratings positive.

Ukraine has indicated that it will increase exchange rate flexibility in the medium-term, as recommended by the IMF. This could help keep inflation low, reduce dollarisation and the risk of financial instability, boost exports and - as in Russia - provide a cushion against external shocks. The National Bank of Ukraine has already allowed the exchange rate to weaken by 2% since January.

Pressure against the hryvnia, which has led the National Bank of Ukraine to intervene to support it, or a move to greater exchange rate flexibility, could lead the currency to depreciate 10% by end-year. A full float would risk an overshoot, potentially pushing up inflation and borrowing costs, and increasing the burden of external debt, to the detriment of the sovereign credit profile. The Outlook on Ukraine's 'B' long-term rating is Stable.

Our Positive Outlook on Kazakhstan's 'BBB' rating reflects the prospect of further strengthening of the sovereign balance sheet, and a relatively strong growth outlook based on increased oil and mining output. Nevertheless, as we have previously noted, the de facto peg of the Kazakh tenge to the dollar has meant that the country's monetary and exchange rate policy framework has not had a great track record in delivering macroeconomic and financial stability. Policymakers eye the Russian rouble closely and are unlikely to allow a significant and lengthy deviation in the bilateral exchange rate.

The economic outlook for Russia, Ukraine and Kazakhstan, and their exposure to commodity prices, was discussed by Charles Seville, director in Fitch's Sovereign ratings group, at the agency's Emerging Markets 2012 conference in London yesterday, one of a series of Emerging Market events being held in Europe this week and New York and Sao Paulo next week.

((Bangalore Ratings Team, Hotline: +91 80 4135 5898 satish.kb@thomsonreuters.com, Group id: BangaloreRatings@thomsonreuters.com, Reuters Messaging: satish.kb.thomsonreuters.com@reuters.net))