British readers may remember the occasion when markets forced sterling out of the European Exchange Rate Mechanism. That day is still known as Black Wednesday, but it should probably be known as Golden Wednesday, because it was the turning point in the UK’s fortunes. The devaluation of sterling and associated fall in interest rates was the monetary stimulus the UK needed to enable it to recover from the early 1990s property crash and recession. Famously, the UK’s finance minister at that time, Norman Lamont, was reported by his wife to be “singing in the bath” after announcing that the UK had left the Exchange Rate Mechanism (the UK did not have an independent central bank at that time). Ever since then, the UK has resisted every attempt to commit it to any form of fixed or managed exchange rate system – including the Euro, from which it has secured an opt-out. Long may this continue. As I have explained, joining the Euro would be disastrous for the UK. I think it would also be disastrous for Europe.
The second factor behind the downgrade in Russia’s rating to Baa2 is the negative impact on the government’s balance sheet of the gradual erosion of the country’s foreign-exchange (FX) buffers, resulting from capital flight, Russian borrowers’ restricted international market access and low oil prices. Even if trade and current account balances are temporarily strengthening, due in part to the 20% fall in the exchange rate this year, the current account surplus has financed only around 60% of the $85.2 billion of capital outflows in the first nine months of this year. The Russian government and Russian-domiciled entities have been largely shut out of the international capital markets since the second quarter. This has increased their demand for onshore FX liquidity and contributed to a $60 billion decline in the Central Bank of Russia’s (CBR’s) FX reserves to $396 billion since the end of last year, despite a current account surplus that the CBR estimates came to $52.3 billion in January-September.