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Russia’s ruble is in trouble. The currency has plunged to its lowest rate against the dollar since the weeks after the outbreak of war against Ukraine. On Wednesday, the ruble hit 110 against the dollar for the first time since March 16, 2022. The currency has recovered slightly, to 108 against the dollar this morning, but in Moscow people are worried.
There are no good remedies for the Russian economy’s malaise apart from ending the war
Russians who lived through the tumultuous years after the collapse of the Soviet Union know all about the dangers of currency devaluation. While, clearly, things aren’t as bad as they were in the 1990s, the long memories of this period haunt Russians. This is a country where the currency has lost a huge chunk of its value in the past quarter of a century. It’s no surprise that, as a result, people follow the exchange rate closely and associate it with the economy’s overall health.
The current devaluation is far from catastrophic, but it’s a sign of a sick economy, suffering from both the enormously costly war against Ukraine as well as western sanctions.
The immediate trigger for the ruble’s drop this week came from the United States. On November 21, the outgoing Biden administration sanctioned some fifty Russian banks and financial companies, including Gazprombank, which serviced payments for gas exports. This created a dollar rush. But make no mistake: the ruble’s devaluation has been on the cards for some time.
While Russian president Vladimir Putin had done his best to shake off sanctions against his country’s financial system, these are starting to bite badly. The share of the “unfriendly” currencies, which includes dollars, euros, pounds and every other currency issued by Ukraine’s allies, in Russia’s revenue from exports has declined from the beginning of 2022. As a result, there are far fewer dollars to buy, driving up the value.
Western sanctions also prevent carry-trade or a flow of cheaply-borrowed dollars into high-interest-bearing rubles. Previously, a drop in the ruble’s value increased import prices and, consequently, inflation, which the central bank combated with a rate hike. In the past, when the ruble was fully convertible, foreigners rushed into the Russian market following devaluations in anticipation of a rise in the Bank of Russia base rate. Now, this is simply not possible due to sanctions. Thus, this means there are even fewer dollars in the market.
The sanctions’ effects don’t end there. Since December 2023, when the US started targeting financial institutions servicing Russian exports and imports with secondary sanctions, the cost of cross-border operations has risen constantly. This has resulted in a rise in import prices and a decline in export revenue, thus tilting the exchange balance towards a weaker ruble.
Then came a strengthening of the dollar and a decline in oil prices following Donald Trump’s presidential victory, delivering Russia fewer bucks for every export barrel.
At home, fiscal spending increased in the fourth quarter as the government injected previously allocated but unused budgetary funds. It’s a regular occurrence, although this year’s numbers were higher than in previous years, creating an overhang of rubles.
In October, the government allowed exporters hungry for dollars for their operational activities to repatriate a quarter of their foreign exchange revenue rather than half previously. This deprived the market of even more dollars.
The sanctions against Gazprombank followed, along with a rising demand for dollars in anticipation of further shortages. The Russian currency tanked without the foreigners, with fewer dollars to buy and an oversupply of rubles.
The rate drop will raise inflation, the scourge of the central bank. Previously, a cheaper ruble would have boosted domestic output as consumers switched to homemade goods and services from more expensive imports. However, the Russian economy is overheated and lacks the capacity to increase production. So, the inflationary effect is higher than before 2022.
A 10 percent drop in the exchange rate can now be expected to raise inflation by about 0.5 percentage points, compared to around 0.2 in happier days. The Russian central bank, mandated with taming inflation, has few options to react.
It can’t hike interest rates very far from an already painful 21 percent, as this would risk causing non-military producers to slow to stagnation and flirt with bankruptcy. It can’t directly intervene in the foreign exchange market, as half of its reserves have been frozen since the outbreak of war in 2022, and its stash of dollars is much smaller.
At the same time, the bank doesn’t have the luxury of relying on China’s supply of renminbi. China has shown zero appetite for providing liquidity and swap lines to its ally.
So, the Bank of Russia has so far done the most straightforward thing: it temporarily stopped buying foreign currency from the market, as dictated by the Russian fiscal policy of moving additional oil revenue to the rainy-day National Wellbeing Fund. This provided some support to the ruble but didn’t remove either the causes of the devaluation or the threat of the inflation uptick.
The most reliable arrow remaining in Moscow’s quiver is for Putin to kindly ask exporters to sell more of their foreign exchange revenue for rubles. But that would deprive them of much-needed resources to finance their sales.
It’s becoming all-to-clear that there are no good remedies for the Russian economy’s malaise apart from ending the war; the mother of Russia’s problems.
