The Russian ruble has recently experienced a significant downturn, raising concerns about the stability of the Russian economy. In late November, the ruble saw a sharp 8.5% drop in a single day, briefly hitting levels of 114.5 rubles against the US dollar – figures reminiscent of the economic turmoil experienced in March 2022. While it slightly recovered, the currency still registered an 11% decrease over the week, prompting discussions about the underlying causes and potential consequences, particularly in relation to currencies like the euro.
The immediate catalyst for this decline was a fresh wave of sanctions imposed by the United States. However, a deeper look reveals a confluence of structural issues that have been gradually weakening the ruble’s position.
One of the key triggers was the US sanctions announced on November 21, targeting approximately 50 Russian banks with connections to the international financial network. Crucially, this included Gazprombank, a financial institution vital for processing international payments, especially for Russia’s gas exports. This action immediately spurred a demand for dollars as businesses and individuals sought to secure their assets amidst growing uncertainty. This situation, however, was not entirely unexpected and had been building up over time.
Several pre-existing economic factors contributed to the ruble’s vulnerability. Firstly, the US dollar has been on an upward trend against a basket of global currencies. Simultaneously, global oil prices have been under pressure, particularly after Donald Trump’s US Presidential election victory. Markets interpreted this as a signal for potentially stronger US economic growth and increased oil production, impacting global energy markets and, consequently, the ruble, which is tied to Russia’s energy revenues.
Domestically, increased government spending in the fourth quarter also played a role. While typical for this period, the spending levels this year were notably higher than in previous years. This surge in ruble expenditure led to an excess supply of rubles in the foreign exchange market, naturally weakening its exchange rate against currencies like the euro and the dollar.
Furthermore, a decision in October by the Russian government to reduce the mandatory repatriation of foreign exchange revenue for exporters to 25% contributed to an anticipated decrease in the supply of foreign currencies, including euros and dollars, within the Russian market. This anticipation further fueled demand for these currencies, putting downward pressure on the ruble.
Adding to these pressures, the cost of conducting international financial transactions has been steadily increasing. This is a direct consequence of tightening sanctions against intermediary entities involved in both trade and finance related to Russia. The result is higher import costs and reduced export earnings, creating an imbalance in the exchange rate dynamics that favors a weaker ruble against both the euro and dollar.
Finally, the imposition of new sanctions acted as the tipping point. It triggered a surge in demand for dollars and euros as market participants anticipated further currency shortages and increased economic instability. This combination of rising demand and constrained supply exacerbated the ruble’s decline against major currencies.
CEPA report cover: Examining geopolitical strategies and economic impacts, not directly related to euro to ruble exchange rates but reflecting broader international policy analysis.
The weakening ruble has significant implications, most notably the potential for increased inflation. Historically, a drop in the ruble’s value would attract foreign investment, as international investors would buy rubles at a lower rate, anticipating a future increase. It would also stimulate domestic production as consumers shifted from pricier imports to locally produced goods and services.
However, the current context is markedly different. The Russian market is largely inaccessible to international capital due to geopolitical risks and sanctions. Moreover, the Russian economy is already operating at a high capacity, leaving limited scope to significantly increase domestic production to offset import costs. Consequently, the inflationary impact of a ruble depreciation is expected to be more pronounced than in pre-2022 scenarios. A 10% decrease in the ruble’s exchange rate could now lead to approximately a 0.5 percentage point increase in inflation, compared to about 0.2 percentage points in more stable economic times.
The Bank of Russia faces limited options to effectively manage this situation. Reducing its foreign currency purchases, as dictated by fiscal policy related to channeling additional oil revenues into the National Wellbeing Fund, is one available measure. However, more aggressive interventions are constrained.
Raising interest rates significantly from the current 21%, already considered painfully high, risks further stifling the non-military sectors of the economy, pushing them towards stagnation and potential bankruptcies. Direct intervention in the foreign exchange market is also challenging due to the central bank’s limited reserves of dollars and euros to defend the ruble. Furthermore, relying on China for renminbi liquidity and swap lines is not a viable option, as China has shown reluctance to provide such support.
Perhaps the most readily available tool for the Russian government is appealing to exporters to sell a portion of their foreign exchange earnings for rubles. While this could potentially halt the ruble’s slide, it shifts the burden onto exporters. Many exporters are already transitioning away from dollar and euro transactions to rubles to mitigate sanctions risks, leaving them with fewer foreign currency reserves to sell and still requiring these currencies for their own international operations.
In conclusion, the recent weakening of the Russian ruble against currencies like the euro and dollar is a complex issue driven by a combination of new sanctions and pre-existing structural vulnerabilities within the Russian economy. The potential for increased inflation and the limited policy options available to the Bank of Russia present significant challenges for the Russian government in the near term. The effectiveness of relying on exporters to stabilize the ruble remains uncertain, highlighting the precarious economic situation Russia faces.
