Revisiting a Revitalised Russia

Photo: EPA-EFE

Two years ago, things looked dire for Russia’s horse-riding, bear-wrestling, tiger-hunting president. Vladimir Putin’s Russia was teetering. The country had entered a deep recession, its currency had plunged, and inflation was rampant. But how things have changed since then. A recent cover of The Economist featured Putin’s authoritative visage, his figure decked in regal clothing: the new tsar. His country’s economic future is far from assured, but things are looking up, with the country exiting its 2014-2016 recession. In this article, we look back at Russia’s economic and currency crisis. 

The ruble’s slide in 2014 began after the Russian invasion of Ukraine, and the Western sanctions that followed it. By the end of 2014, however, the currency’s was plummeting at an alarming rate. At one stage, it was down fifty percent for the year against the US dollar. Moves of even a few precent up or down are considered significant in currency markets. 

Russia’s crisis was triggered by the plummeting price of oil, with crude as much as forty percent off its highs. Russia’s economy had failed to significantly diversify: energy exports were 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 put an end to commodities boom that had defined the years before. 

However, the issues with Russia ran deeper than just oil. 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 had 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, most frequently in US dollars.  

These dollar denominated debts leave the private sector extremely vulnerable to financial shocks. 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 were in rubles but whose debts were 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 owed $670 billion in dollar denominated debts, placing companies in situations of great fiscal peril.

A weak ruble also led to inflation, as imported goods became significantly more expensive in terms of the local currency. At its height, inflation in Russia went well into the double digits. High inflation erodes the purchasing power of Russians, with their rubles able to buy fewer goods and services. Furthermore, it creates an environment of economic uncertainty that deters critical long-term investment from companies. 

In a bid to strengthen the currency, late in 2014 the central bank made a surprise dead-of-the-night decision to raise interest rates from 10.5% to 17%—the largest single rise since 1998, when Russia had defaulted on its debt. A higher interest rate generally strengthens a currency by enticing investors looking for better returns. However, they also have the downside of stifling economic growth by discouraging borrowing and investment. Unfortunately for the Russians, the central bank’s rate hike did not immediately have its intended effect. Although the rate hike did cramp growth, financial markets saw the move by the central bank as nothing more substantive than mere desperation; following a brief rally, the ruble was punished, falling to an all time low. Russia was then faced with spectre of stagflation, a lethal combination of stagnant economic growth and rampant inflation.

If there was any comfort for Russia, it was in the country’s reservers of over $400 billion, built up during the years of high oil prices. The deputy finance minister, Alexei Moiseev, declared the government’s commitment to selling “as much as we need” to prop up the ruble. Tens of billions were 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. Many economists were 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 piled on the pain. Russia 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 exerted a further strain on Russia’s dollar reserves, thereby further limiting its ability to continue supporting the currency. 

Generally, a country in Russia’s situation would have turned to the IMF for emergency loans in exchange for economic reform. This was always very unlikely, with little chance that Putin would acquiesce in Western bailout terms. There were fears that the Russian government would, in desperation, impose capital controls. These prevent money from leaving the country and limit convertibility of the ruble, thus stemming any further drop in the ruble. Capital controls would have been a last ditch measure, and are certainly not advisable. They would have destroyed any last shred of confidence in the Russian economy and spook foreign investors. 

Ultimately, Russia did not have to seek assistance from the IMF to stabilise its economy. The government settled on a flexible exchange rate policy, mitigating the possibility of a speculative attack and crisis of confidence that could have occurred if the government had tried to aggressively defend the ruble through capital controls. World Bank analysis also credits a round of expenditure cuts and budget rebalancing by the government as being positive influences on the economy. Further, banks were recapitalised by the government, with the money injected into the system to avert a potential collapse of the system. Finally, the economic recovery was also assisted by a partial recovery of oil prices and budgetary changes that reduced the sensitivity of the economy to lower oil prices. 

Russia’s economic situation was dire in late 2014, and many commentators thought that the country was bound for a lengthy period of economic stagnation. Putin insisted that the economic would “rebound within two years.” He was right. And luckily for the strongman, international political events played to his favour, allowing him to project power both domestically and internationally. The country is no longer in crisis mode, and Putin has emerged with an even firmer grip on power.