by Zac Tate
The rouble has weakened by 50% against the dollar this year, 22% this month and 11% yesterday, leading the Central Bank of Russia to raise interest rates today to 17%. The rise comes amidst a backdrop of falling oil prices, the effects of geopolitical sanctions and the growth of protectionist trade policies.
1. The rouble is in free-fall
Russia’s slow transition to free-floating exchange rates should be welcomed, but it would be foolish to assume that the Kremlin’s decision last month to abolish its policy of pegging the rouble to both the dollar and the euro is motivated by a commitment to markets.
In 2008, during the financial crisis, the rouble depreciated by 40% and the CBR had to spend a third of its reserves propping it up. Russia can simply no longer afford to peg the rouble to the dollar and the euro. According to Anders Aslund at the Peterson Institute for International Economics, Russia’s international reserves, which stood at $421 billion on November 14, fell by $103 billion in the last year and are likely to fall by another $100 billion next year, partly because the country has to make repayments on some of its $678 billion of external debt.
After having used $80 billion this year alone to defend the currency, the bank limited interventions to $350 million per day last month, which triggered a three-day plunge and the ongoing crisis in confidence in the currency. Oil prices, that today fell below $60 a barrel for the first time since 2009, have been a major driving factor, with 68% of Russia’s total export revenue and 50% of its federal budget last year derived from oil and natural gas sales. The free-falling rouble will feed on itself as the economy weakens, investors begin to get wary about capital controls, and private firms struggle to refinance their debt. The FT reports today that Rosneft had to raise 625 billion roubles last week from local banks in advance of an upcoming foreign bond payment.
2. Rising interest rates kill the economy
There are two methods by which a central bank can prop up its exchange rate. The first is by direct intervention, creating artificial demand by selling its international reserves – assets that are held in foreign currencies. This has become increasingly difficult for Russia, because of its $421 billion in reserves, $172 billion are held in either the Reserve Fund or the National Wealth Fund, both of which are controlled by the Ministry of Finance and are either deposited in banks or invested out. The CBR could continue to prop up the currency but only by running the risk of a nation-wide banking crisis.
This leaves the second option of attracting funds back by setting higher interest rates, and today the CBR has announced an enormous rise in rates from 11.5% to 17%. It is difficult to know whether this shock-and-awe defence of the rouble will get the desired response, with rising inflation (9.1% in November) and US and EU sanctions effectively shutting Russia out of global capital markets. Early indications suggest the currency has hit a new low at 78 roubles to the dollar, and a 100 to the euro. Today, you can buy a rouble for one euro cent.
But the latest rate hike raises the cost of servicing debt by almost 50%, which will not only deter investment and affect businesses struggling with cash flow but will do little for ordinary Russians, who are facing food inflation of 12.5% as a consequence of Putin’s import ban.
The World Bank cut its growth forecasts for Russia to below 0.7% and 0.3% for the next two years respectively, but assumes oil prices at $80 per barrel. If oil prices continue to slide, the Russian government will start to run into budgetary troubles that could affect military spending and public support for its geopolitical excursions. Even the CBR estimates that the economy will shrink by up to 4.7% next year if oil stays at $60 a barrel.
3. Putin’s trade policy cuts off Russia’s nose to spite its face
Russia needs a trade surplus to replenish its international reserves and meet its debt obligations. The state is set to pay $150 billion in debt remittances this year, funded in part by its $60 billion current account surplus. It can’t rely on its cheaper currency to boost exports because of its pariah status in international markets, creating an uncertain business environment.
Russia responded to Western sanctions by returning to Soviet style self-sufficiency in food. Despite Putin’s attempts to grow trade relations with the other BRIC economies, Russia simply cannot afford to close itself off from the US and the EU, which together represent 45% of global GDP. Professor Peter van Bergeijk of the Erasmus University in Rotterdam believes a new trade cold war between Russia and the West would cost Russia over 12% of GDP in lost trade.
4. Crony capitalism and elitism make life miserable for the ordinary Russian
Legatum Institute’s most recent prosperity report reveals that 81.5% of Russians believe government and business corruption is widespread, and only 34.1% have faith in the judicial system.
It’s been ten years since the government confiscated the Yukos oil company and subsumed it into Rosneft. It’s not surprising therefore that Legatum find that only 65.9% are satisfied with freedom of choice. A lack of enterprise seriously holds back Russia’s potential. The country ranks 62nd in the World Bank’s latest Ease of Doing Business Rankings, and the Global Entrepreneurship Development Institute puts it 36th in Europe for enterprise, awarding 21/100 for product innovation, 23/100 for competition, and 24/100 for risk acceptance. It also gave Russia one of the lowest scores for internationalisation (9/100), characterising the country’s increasingly insular attitude to business.
A proposed bill now backed by the government and Vladmir Putin’s United Russia party aims to compensate those whose foreign assets have been confiscated under recent sanctions imposed by the United States and Europe. As pensions are cut back to fund it, Leonid Bershidsky reports for Bloomberg View that “citizens are openly being treated as property by the state,” citing regrets from Valery Zorkin, Constitutional Court Chairman, over the abolishment of serfdom in 1861.
5. Russian demographics are improving but still dire
At the end of the Cold War, Russian fertility rates collapsed and the population fell by six million. Putin’s aversion to immigration as a solution to demographic change places a heavy burden on women. He has stopped short of reinstating Stalin’s Mother Heroine award for Russian women who produce more than ten children, but his $53 billion pledge in 2011 to increase the birth rate appears to have borne fruit. Yet Sergei Zakharov, a demography specialist at the National Research University, believes the effect will be short lived as the very small post Cold War cohort reach reproductive age. And despite Putin’s support for a labour code which bans women from 456 occupations, female employment has remained high since the fall of the Iron Curtain.
As Russian society ages it faces three choices. One is to be open to the world, to its people and its markets – a policy that supports prosperity; the second is to build partnerships with other authoritarian regimes such as China – a policy that supports tyranny; and the third is to withdraw from the rest of the world under some rose-tinted loyalty to Kievan Rus – a policy that supports nothing.