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| Image: NBC |
The ruble’s slide started following the Russian invasion into Ukraine, and the Western sanctions that followed it. In recent weeks though, the bottom has simply dropped off the ruble. At one point, the currency was down fifty percent for the year.
Russia’s crisis was triggered by the plummeting oil price, with crude as much as forty percent off its highs. Russia’s economy failed to significantly diversify: energy exports are responsible for half of government revenue and sixty percent of exports.
Oil was bound to fall. A glut of supply from American shale production coupled with weakening demand from China and other economies was inevitably going to depress the price of oil.
However, the issues with Russia run deeper than just oil. The ruble has fallen more than crude, and the malaise afflicting the Russian economy spreads far wider than the energy sector. Why is this? As Paul Krugman has pointed out, the current Russian currency crisis has many parallels with previous crises, such as Argentina in 2002, Indonesia in 1998, Mexico in 1995, and Chile in 1982, to name a few. The recurrent theme is large-scale borrowing from private corporations, with the debt denominated in a foreign currency, in this case dollars.
During a boom, the frailties of the system are not exposed, but in the words of Warren Buffet, "only when the tide goes out do you discover who's been swimming naked." Essentially, these dollar denominated debts leave the private sector extremely vulnerable to a financial crisis. In Russia, the adverse shock came in the form of a drop in revenues from oil exports. The subsequent drop in demand for the ruble led to a decrease in its value. Consequently, Russian firms, whose revenues are in rubles but have debts in dollars, suffered tremendous harm to their balance sheets, as the weight of their debts shot up in relation to revenues. This damaged the economy and undermined confidence, which, in a downward spiral, further depressed the currency. Russian companies together owe $670 billion in dollar denominated debts, money that will become nearly impossible to pay back should the ruble depreciate further.
A weak ruble also leads to inflation, as imported goods become more expensive. Inflation already stands at 10% percent, and may reach 15% in coming months. High inflation erodes the purchasing power of Russians, as their rubles are able to buy less and less goods and services.
In a bid to strengthen the currency, the central bank, in a surprise decision made in the dead of the night, raised interest rates from 10.5% to 17%, the largest single rise since 1998, when Russia defaulted on its debt. A higher interest rate generally strengthens a currency by enticing investors looking for better returns. However, high interest rates have the downside of stifling economic growth by discouraging borrowing and investment. Unfortunately for the Russians, the central bank’s rate hike didn’t have its intended effect. Although the interest rate will surely cramp growth, financial markets saw the move by the central bank as mere desperation, and after a brief rise, the ruble was punished, falling to an all time low following a brief rally.
Russia is now faced with stagflation, a lethal combination of stagnant economic growth and rampant inflation.
If there is any comfort for Russia, it is that the country has over $400 billion in reserves, built up during the years of high oil prices. The deputy finance minister, Alexei Moiseev, has said the government will commit to selling “as much as we need” to prop up the ruble. Over $70 billion have already been spent in supporting the currency. In theory, selling dollars to buy rubles will push up the currency by boosting demand for ruble in the market, whilst increasing the supply of dollars. The move is also meant to send a signal that the central bank will do whatever it takes to defend the currency, thereby discouraging speculation against the ruble. However, the efforts have not been sufficient to make a lasting impact on the exchange rate.
Many economists are also unconvinced that Russia’s reserves are readily available. Only about half of the money is estimated to be easily accessible, and a large portion of the reserves are thought to be tied up in illiquid long term investments.
Western sanctions have piled on the pain. Russia has had to set up a system to bail out companies cut off from Western financing, with the money coming from Russia’s sovereign wealth funds. This will strain Russia’s dollar reserves, thereby further limiting its ability to continue supporting the currency.
Generally, a country in Russia’s situation would turn to the IMF for emergency loans in exchange for economic reform. This is highly unlikely, as there is simply no chance that Putin would acquiesce in Western bailout terms. There are fears that the Russian government may, in desperation, impose capital controls. These prevent capital from leaving the country and limit convertibility of the ruble, so as to stop the currency from dropping any further. Capital controls would be a last ditch measure, and are certainly not advisable. They would destroy any last shred of confidence in the Russian economy and spook foreign investors.
Putin should pull out of Ukraine and ask the West to ease economic sanctions. This would stem the panic and offer a boost to the economy. However, it would be foolishly optimistic to expect such a rational decision from Putin—his pride wouldn’t allow it. Furthermore, the Russian public is overwhelmingly supportive of Putin’s actions in Ukraine.
The worst case scenario is that Putin becomes even more aggressive on the geopolitical front, in a bid to convince the Russian people that their economic problems are being caused by some external power. This outcome must be avoided at any cost.
Russia’s economic situation is dire, and it is almost inevitable that the country will slip into a recession. During a recent press conference, Putin said the “economy will rebound within two years.” If even Putin is willing to admit that the Russian economy will suffer for a while, stormy waters certainly lie ahead.
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