bne IntelliNews -
The Russian markets opened on December 1 to a catastrophe. The price of Brent crude oil fell below $70 a barrel, causing the ruble to drop heavily yet again.
There had been some signs that the Russian currency was beginning to claw back some of the ground lost this year, but another step-down in the price of oil to below the psychologically important $70 level kicked the legs out from under the nascent rally.
Against the dollar, the ruble exchange rate had dropped 9.3% by midday, taking it below the key RUB50/$ for the first time. You’d have to go back to January 1999 to find a similarly steep fall.
The currency started the year at RUB33/$ and has gone from the second best performing currency in the world to the worst, reported Bloomberg this year, losing over a third of its value.
But what is freaking traders out is that the Central Bank of Russia (CBR) is standing on the sidelines and has not intervened to support the currency. "I think the CBR has misread the script: instead of a free floating ruble we have a free falling ruble," said Tim Ash, head of emerging markets research at Standard Bank, in a widely quoted note that catches something of the panic.
Those that were dismissive of a $60 oil price in 2015 are already starting to look out of touch. The CBR has an $80 price in its pessimistic forecast for 2015, but already at the end of November was suggesting it will have to revise this number down. And the commentaries have started to bring up the $10 price that took Russia into the 1998 crisis.
Things are moving very fast now. The deputy governor of the CBR was being quoted this morning suggesting that inflation next year could rise to 10% in the first quarter. Unemployment, which ticked up slightly in October to 5.1%, will not be directly affected in 2015 if oil prices stay low, but the fall in real wages, which already started this autumn, is expected to accelerate as the Russian population begins to feel the effects of the crisis for the first time. Throughout the crisis that started in 2008 real wage rises have stayed ahead of inflation and were running at about 10% until recently, because of the historically low unemployment rates.
How bad will it get? bne IntelliNews columnist and head of Macro-Advisory Chris Weafer speculated two weeks ago that pure economic theory suggests the ruble should be at RUB42 to the dollar, but that was before oil prices lost another $10 in the meantime.
Much depends on what you think is driving the oil price lower. The Opec meeting in Vienna on November decided not to cut production levels, leading to speculation that Saudi Arabia has started a price war to drive the marginal shale oil producers out of the market. While companies like Russian oil major Rosneft say they can produce oil at a cost of as little as $5 per barrel, the cost of producing US shale oil is anywhere between $40 and $80, say experts. The idea is to put these producers under pressure. They have contributed to the lion's share in the increase in production in recent years in the US' "shale boom" but are not very profitable. Taking oil down to $60-70 and keeping it there for an extended period would bankrupt many of these producers or at the very least kill off their investment plans. This would eventually undermine supply and so drive prices up again.
The other reason being discussed for the fall in oil prices is the International Energy Agency (IEA) forecast that the demand for oil has slowed sharply.
Can Russia afford $60-$70 oil? The knee-jerk reaction has been that oil under $100 - the break-even price for the current budget plan - will cause the Russian economy to collapse. However, this doesn’t seem to be happening.
The irony is that the devaluation of the ruble creates more rubles for the budget as revenue is dependent on the oil price in dollars, but spending is in nominal ruble terms. This means the government is the biggest winner from a devaluation that simply creates more rubles to spend, albeit less valuable rubles. Although well over half of the Russian budget revenue is derived from oil taxes, it is currently running an unexpectedly large 2% federal budget surplus.
Another assumption is that Russia will burn up its hard currency reserves defending the ruble. But this is not happening either. Russia spent about $200bn of its international reserves in 2009 defending the ruble and managing a 30% devaluation, keeping the exchange rate inside the ruble trading corridor.
This time round it has spent an estimated $100bn managing this devaluation down by a similar amount. However, what changed in November is that the CBR decided to completely free the ruble a month earlier than planned. Currency traders have been expecting the CBR to step in as it has always done in the past, but it has stood resolutely on the sidelines and allowed the ruble to tank. The upshot is the CBR is not spending its reserves, which stood at $420bn going into this crash, or 1.7 years of import cover, way above the three months economists recommend.
"The total absence of the CBR is interesting since they more or less moved to a free float. The CBR now seems to be defending their FX reserves like a troll on a bridge," said Ash in a note to clients.
That was the point of freeing the ruble: it allows the Russian economy to absorb shocks more effectively - and oil falling $10 in a week counts as a big shock.
The hope is that the cheap ruble will eventually act as an economic stimulus once the dust settles. Indeed, the fall in the ruble already caused industrial production to jump by 5% in October. Agricultural production has had the added stimulus of the EU agricultural product ban imposed by the Kremlin earlier this year, which has helped the sector grow by 16.6%.
But none of these benefits will negate the pain of the fall. The spike in inflation will kill investment plans and hurt consumers, who will increasingly feel the pain of falling incomes from here on in. However, the double whammy of tanking oil prices and currency are unlikely to cause the Russian economy to crash as $10 oil did in 1998. During the worst of the 2008 crisis oil prices fell to around $40 and Russia bounced back from that without too much effort thanks to the devaluation effects and the recovery in the oil prices.
This time round it seems likely that oil prices will stay low for longer, especially if the Saudi conspiracy against shale theories have any truth to it, but even at $70-$80 oil Russia is no more than wounded. More importantly, not only will the Kremlin be forced to make the structural reforms it so obviously needs, it might actually want to do them.
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