Russia could not have done more to protect its economy and shore up the ruble. The problem is instead geopolitical
The Russian ruble was having a year that President Vladimir Putin would soon like to forget. The Central Bank of Russia did everything by the book to bring its currency ashore without imposing any FX controls and spooking out foreign investors. But as is said: anything that can go wrong, will go wrong.
At the start of 2014, you could of exchanged one US dollar for 33 Russian rubles, but in the end of the year the ruble made a record low, and at one point you could have exchanged about 79 rubles for one dollar. The ruble has also seen its biggest single-day decline. So where did Mr. Putin and the Central Bank of Russia go wrong? Quite frankly – nowhere.
The only mistake that President Putin and Russia made was to claim what they considered was their birth right – the Crimea. Things have gone downhill for Russia and its beloved ruble ever since the Crimea was annexed.
Russia was slapped with a number of sanctions by the West, which barred borrowers from refinancing their debt with European and American banks. As the ruble crumbled in the latter half of 2014, the biggest Russian companies, which had dollar debt payments due, were struck by the dollar’s evaporating liquidity.
Rosneft’ NK OAO (MCX:ROSN) issued bonds early December 2014 – worth 625 billion rubles – to refinance its dollar debts. The Kremlin came to the aid of the ailing state-owned giant, and made an indirect bailout by providing 700 billion rubles in a liquidity auction, and taking its securities as collateral. Rosneft is not the only corporation crumbling under the dollar debt. In 2015, Russian corporations were due to pay $120 billion to Western banks.
But what could of President Putin and the Central Bank of Russia do to defy Murphy’s Law?
At a time when the Kremlin was trying to defend its economy from Western sanctions, global oil markets crashed and crude oil plunged more than 40% in the second half of 2014. Oil and gas are Russia’s major exports – they account for three-fourths of its total exports. The Russian budget receives more than half of its revenue from proceeds of oil and gas exports.
As oil prices plunged, Russian authorities did what the world had learned from the East Asian currency crisis of 1997. In November, Russia ended the soft peg between the exchange rate of the ruble to the dollar/euro, and the central bank ended automatic interventions. A free-floating currency was the best tool CBR had to fend off speculative attacks, but it proved to be unsuccessful, and the ruble continued its journey south.
Russia came up with another textbook strategy to bring its economy afloat. The Russian economy, which is highly dependent on oil and gas exports, announced a 5% budget reduction in 2015-2017, to keep its expenditures in line with the health of the economy. However, this could not slow down the slumping ruble.
Russia announced on December 15th 2014– after New York close – that it had raised its key interest rates 6.5 percentage points to 17%. The central bank also raised its repurchase rate 6.5 percentage points to 18%, surprising analysts, investors, and traders. The impact, however, was short-lived, and the ruble could not even maintain its gains for 12 hours.
The CBR’s decision was exactly how a central bank should act without spooking foreign investors through FX controls. However, the move itself has several pitfalls. Analysts are expecting Russia to go into recession with a long period of no growth and contraction in the economy. Russia can only hope for Brent crude prices to come back in triple digits for immediate relief, which looks highly unlikely.
Russia, which itself is a creditor to the rest of the world, is crumbling under its own debt. Russian banks and companies had $600 billion debt that has to be paid to foreign creditors; of that, $120 billion is due in 2015. Rationally thinking, this should not be a problem for a country that has a net international investment position of $180 billion.
Once again, president Putin and Russia are faced with the disarming idea that anything that can go wrong, will go wrong. A substantial portion of the country’s assets are held abroad, which continue to remain inaccessible due to Western sanctions.
Russians themselves, who have more than 80% of their savings in rubles, are witnessing their deposits lose value every day. While yields on the Russian 10-year bonds had rocketed to almost 11%, Russian investors and savers were looking to park their money in stable investments – like properties in Dubai, London, or the Cayman Islands.
One such instance is the number of Russians who are heading to the UK. According to Home Office statistics and reports in The Sunday Times, during the first nine months of 2014, 169 investor visas were granted to Russians, up 69% year-over-year.
Other countries, foreign investors, corporations, and even the country’s own residents were fleeing Russia. What more could go wrong with Russia? The Russian banking system was showing signs of strain, and Russia bailed out Trust Bank for around $500 million. Trust Bank was a top 30 Russian bank, and had around $5 billion in assets. The CBR was giving the bank 30 billion rubles to keep its operations afloat.