July Ruble/FX Flows

Due to a combination of negative and rather temporary factors, the ruble looks undervalued. We expect it to regain ground in July.During most of June, the ruble outperformed its peers, supported by high FX selling from the CBR (under the budget rule) and from exporters, which were paying rather high annual dividends. However, at the very end of the month, the ruble tumbled 3% due to a combination of several negative factors. Mainly, it had to do with renewed geopolitical risks, which recently had been almost fully priced out of the ruble. The trigger was recent reports on Russia's alleged activities in Afghanistan, which led to certain US politicians calling for new sanctions against Russia. In addition, the ruble took a hit in Tuesday's mild risk-off move, itself attributable to the second wave of coronavirus in the US and possible conversion of up to $1 bln in Rosneft dividends by foreign shareholders.We believe these factors are rather temporary. First, calls for sanctions have not found support from the White House or Senate Republicans, while the bill proposed by Democratic Senator Robert Menendez yesterday contained targeted measures against particular Russian entities, individuals, but not financial assets. Thus, we would expect a gradual de-escalation in geopolitical tensions, as we have witnessed in the past, which should push the ruble 1-2% higher.As for the second wave of Covid-19 in the US, the turn away in one way or another from easing lockdowns will definitely slow the US economic recovery but should not reverse it. So, as long as other major economies like China and Europe manage to keep the virus under control and continue to quickly recover, the US second wave is not a great threat for EM currencies, while the dollar will likely depreciate against DM peers, which should support the ruble.Dividends will be even more supportive for the ruble in July than in June, although some negative pressure is possible on days of high conversions into FX, for example by depository receipt issuers. At the end of July, Russian exporters are scheduled to pay about R800 bln of dividends and about R400 bln of taxes, while FX purchases related to dividends being converted we estimate at about R240 bln (of them R160 bln or $2.3 bln are related to depository receipts). So, flow-wise the ruble will be very well supported in July, which should push it to 68 by month-end. However, given the oil price recovery in June, CBR FX sales will significantly decrease in July, falling to R50 bln for the month or $30 mln daily, almost five times less than in June. This could temporarily pressure the ruble next Monday, when the volumes of these operations will be officially announced, but we think that the increase in exporters' FX offer will far outweigh during the month.