* Russian rouble, oil price seen diverging
* Bets grow rouble will fall below 41 versus euro/dlr basket
* Recession, deficit, banking woes weigh
By Sebastian Tong and Sujata Rao
LONDON, Aug 20 (Reuters) - The consensus that Russia's rouble moves in lock-step with oil has begun to fray with some investors betting the economy's underlying weakness could burst the official trading band even with commodity prices rising.
Russia set the band at 26-41 against a euro/dollar basket in late January, after months of controlled rouble devaluation that cost some $200 billion, or a third of its reserves, to adjust to weaker oil prices and the global economic downturn.
But the rouble remains one of the worst performing
currencies in an emerging sector that has rallied since March.
It has lost 8 percent against the basket this year despite a
doubling in crude
For graphic, click on: http://graphics.thomsonreuters.com/089/UK_RSNOIL0809.JPG
Against the dollar, the rouble has fallen 3 percent this
year
That spells trouble for Russia's corporate sector -- already battered by a withdrawal of much foreign investment and still weighed down by massive foreign debt that gets more expensive the weaker the rouble gets.
Moscow has said it will continue to draw on its reserves -- the world's third-largest at over $400 billion -- to keep it within its official 26-41 trading band to the euro/dollar basket, as long as oil does not fall to $30 per barrel. But even with crude around $70 a barrel, some investors are betting that Moscow will gradually widen the trading band it defined in January.
"Oil is of course important but I don't think any other economy has seen the same degree of fiscal deterioration that Russia is going through," said Philip Poole, head of emerging markets research at HSBC.
Russia is grappling with its worst recession on record and is planning to borrow $58.6 billion abroad over the next three years to help recapitalise a banking sector which is struggling under bad loans estimated to hit a quarter of its portfolio.
The economy overall is expected to contract 10 percent this year and analysts forecast capital outflows to reach around $66 billion this year.
SHORT-TERM BET
Over half the maturing bonds of Russian firms are in foreign currencies such as the dollar and euro. Coupon and principal repayments on these bonds peak in the next April-June quarter next year at over $8 billion, data from Thomson Reuters show. [ID:nL140063]
"If the rouble weakens, the burden of debt increases. That is also why they have to manage the currency," said Societe Generale emerging markets strategist Gaelle Blanchard.
The rouble now trades at 37.7 versus its basket
The rouble's three percent slide versus the basket since the start of July has attracted Investec currency fund manager Werner Gey Van Pittius who said the unit was undervalued at present levels.
"We are positive over the short term of three to six months but over the longer term the risk factors are great as the economy faces heavy commodity reliance and an unsustainable fiscal deficit," he said.
A Reuters poll at the end of July found that analysts expect the rouble to weaken from current levels to an average of 40.05 to the basket in a year's time. [ID:nLAG003620]
But another poll showed analysts also expect the crude price to average $72.67 a barrel next year [ID:nLO182859] and some analysts say the risks of further devaluation are substantial.
"If the underlying financial situation is really bad...I don't think they will wait for oil to go to $30 a barrel. The question will arise long before that," said Beat Siegenthaler, chief strategist emerging markets at TD Securities.
SHIFTING GOAL POSTS
Russian officials have stressed there is no reason for a further devaluation in the rouble, which has fallen a third against its euro/dollar basket since last August.
But a weaker rouble is an increasingly attractive option for a $1.7-trillion economy that analysts say has yet to diversify away from overrelying on energy and commodity exports.
is set to contract some 10 percent this year.
An editorial this month in Russian business newspaper Vedomosti argued for further exchange-rate weakening to augment the government's ability to cover its rising budget deficit through its hard-currency reserves, calling for the rouble to sink to 46 versus the dollar.
Last month, a Russian central banker said a rouble fall to 35 against the dollar from the current 32 "would not be frightening". [ID:nLF294354]
Although the euro's weighting was raised last February, the greenback remains the dominant component in the basket at 0.55 dollars to the rouble.
Russia's deputy economy minister warned this week that stable economic growth has yet to materialise and that it would not be achieved through domestic factors. [ID:nLI231300]
Industrial output, down by as much as 16 percent in the first half of the year, has stabilised but largely on export demand as domestic consumption has plummeted. [ID:nLH537939]
"The central bank and Kremlin remain very mercantilist...and if oil falls and stays low and there are more NPLs (non-performing loans) at banks, they will address growth with foreign-exchange weakness," said Bhanu Baweja, head of emerging currency and fixed income strategy at UBS.
"The market is justifiably worried about the Russians changing the goal posts again." (Reporting by Sebastian Tong and Sujata Rao; editing by Patrick Graham)