Ben Aris in Moscow -
After controlling the ruble-dollar exchange rate for more than two decades to ease the pain of the transition to a free market, on October 9 the Russia’s central bank finally let the ruble go. The Russian currency is now a fully floating currency, but it is also tanking as the Western sanctions start to bite and the economic slowdown deepens, causing some to predict another financial crisis is in the offing.
The Central Bank of Russia (CBR) has come in for a lot of flak over its handling of the latest ruble crisis. But looking bank to 2009, the last time the ruble dropped, and not much has changed.
Russia had its "Minsky moment" in the week beginning on November 7 when the currency went into free fall to the point where it is down about 30% so far this year against a basket of currencies, the CBR has spent about $100bn managing the ruble lower and oil prices are now below $80 a barrel for the first time in years – five years to be exact.
"Free float? More like a free sink: ruble now close to 54 on a basket basis – quite incredible, and where is the CBR? The basket was at 39 in June! This is a huge, huge move. Five figures (10%) this week," Tim Ash, head of emerging markets research at Standard Chartered, wrote in November. "The CBR policy response has been confused. It was trying to manage the currency weaker initially, but then finding that they were being a bit too successful, and that they had created a vicious cycle and panic. We saw the emergency rate hikes, which failed, intervention, which failed and now a lack of clarity as to what the new FX regime is. Why bother keeping the exchange rate bands as they are totally ineffective?"
The ruble went through almost exactly the same crash in February 2009. "Since the ruble began its dramatic slide in value in August, I have been bombarded with the same question from nervous investors, confused journalists and even my mother: What is happening to the ruble?" wrote Alexey Moisseev in February 2009, then chief economist at Renaissance Capital, and now deputy finance minister.
In that month, the ruble fell some 30%, the most in six years, the CBR spent about $100bn managing the currency lower, and oil dropped into the $40s. "As an economist (and a good son), I told them that the devaluation of the ruble is the natural result of the new realities of the world economy and the sharply lower price of oil,” wrote Moisseev. “Then I quickly launched into a critique of the Central Bank's approach of step-by-step devaluation of the ruble, which has cost the country $100bn in reserves, raising the total reserve loss since the beginning of the crisis to $210bn."
So today’s moves represent a full-on meltdown? Well, not so fast. A few months later, Moisseev was admitting that maybe he had been too hard on Russia's central bank. "What is needed, I and other economists insisted somewhat self-righteously, is for the Central Bank to step aside and allow a dramatic one-off devaluation," Moisseev argued. "Today more and more economists, including myself, are eating our words to a certain degree. We have to admit that the Central Bank's gradual devaluation policy has largely been vindicated. Yes, it has been costly in terms of reserves, but it looks to have succeeded in insulating the population from the kind of economic shock and pain they have experienced more than once in Russia's modern history."
The parallels between the two episodes are almost exact, except oil prices are about twice the level now that they were in the worst of the post-Lehman's debacle, and the CBR has today freed the ruble, whereas in 2009 the so-called currency corridor was maintained for another five years – albeit widened by 5 kopeks each time the CBR was forced to spend about $350m intervening to keep the currency inside its pre-determined band.
Prone to panic attacks
Russia remains prone to panics because of its recent history. The crash of 1998 is still fresh in most people's minds and the even worse crash of 1991 is also well within living memory. In 2008, Russia's economic growth went from 7% growth to a 7% contraction in a matter of months. The population has been robbed of its life savings through devaluation and hyperinflation at least twice in the last two decades, so it is no wonder they rush to the exchange kiosks whenever the ruble looks shaky. They did in 2009 and they did so again this time round.
The first panic buying of dollars appeared in March when the currency began to fall – sales of dollars reached $4bn that month, four-times its normal volume, peaking in November when some exchange offices said they ran out of cash dollars. Likewise the local press is reporting a boom in the sales of SUVs and apartments as Russians try to put their spare cash into something tangible that will hold its value in a crash.
The CBR tried to head off a panic with a large and unexpected rate hike of 1.5% at the very end of October – well ahead of the 50 basis points the market was expecting – but the ruble sailed downwards as if nothing had happened.
The lack of action on the CBR's part in November unnerved traders who were expecting a "big bazooka" moment, but also probably saved Russia a pile of cash. Economists say there is no point protecting the exchange rate if the fundamentals demand the exchange rate should go lower. Falling oil prices suggest the ruble should fall.
More to lose?
What next? Will the currency continue to collapse and spark a full blown financial collapse? Probably not, although economists, like in 2009, are striking a note of caution.
Chris Weafer, CEO of Macro-Advisory, points out that from a purely economic point of view the ruble has fallen much further than it should. "The ruble has gone from RUB40 [to the dollar] to almost RUB49 in a month, but in the same time the price of oil fell no more than 50 cents. From an economic point of view the ruble should rebound towards RUB40 to the dollar, but this isn’t about economics any more."
Fear has gripped the currency markets as uncertainty grows over oil production and prices. The International Energy Agency’s prediction that oil could fall further in 2015 as new supplies of crude from Libya come amid lower-than-expected oil demand, stands in stark contrast to the confident assertion from leading investment banks that oil prices will recover to $95 next year. Indeed, the Russian budget assumes an oil price of $95 and the CBR's pessimistic scenario says prices will fall to $80, but not less.
But Russia was grappling with all these problems in 2009 as well. One of the side effects of the collywobbles then was capital flight spiked to $130bn in 2009 – exactly the same amount that the CBR predicts will leave this year. And the uncertainty over where oil prices will go next is as old as the industry. "The problem is that it is much harder to predict with any certainty what the oil price will do in the short-term," Moisseev wrote in the first week of February 2009. "Earlier this week, it was down below $40. If it dipped close to $30, the Central Bank would effectively be forced to abandon its defense of the ruble. We expect oil to recover, and the exchange rate to recover along with it – to RUB29 to the dollar by the end the year. If, however, the oil price recovery takes longer than we expect, or worse, if it declines further, a free float of the ruble will become hard to postpone. At present, [central bank governor] Ignatyev is targeting a free float of the ruble in 2011, which in these chaotic times is so far off it feels like never."
This analysis applies as much today as it did then (if you add $40 to the oil prices and RUB15 to the ruble value). Except this time round the CBR has already freed the ruble. Does that make a difference? It should make all the difference. Weafer's point that the ruble has fallen a lot faster than the oil price means that Russia is, almost uniquely in the world, currently running a triple surplus.
Imports have been killed off by the collapsing ruble and the government ran a $151bn trade surplus over the first three quarters of this year, which should end 2014 even higher than in 2013.
A predicted budget deficit has also failed to materialise as the budget oil prices are set in dollars, but the nominal related spending from oil tax revenues (unadjusted for change in oil price) is fixed in rubles; the upshot is the government is one of the biggest beneficiaries from devaluation and is currently running a 2.1% federal budget surplus.
And finally the government is also running a $52bn current account surplus – double last year's level – because of the devaluation, which is on course to finish the year at about $90bn, according to Alfa Bank's chief economist Natalia Orlova. This almost completely offsets the expected capital flight.
Asks Alex Nice, an analysis with the EIU: "When was the last time a country with a structural current-account surplus and balanced budget experienced a currency crisis?" Indeed, of the six emerging markets vulnerable to devaluation, the EIU identifies Brazil, Turkey, South Africa, Indonesia, and India. Russia is the only one that has a triple surplus; all the others have large budget and current account deficits.
Still, none of this has been enough to reassure anyone. The wild card in the deck remains where the price of oil will settle and how long it takes for the currency to stabilise. The CBR is burning through cash to support the banking sector and with the largest Russian corporates cut off from the international capital markets for the moment, it is also the only significant source of funding for the entire economy. Russia can play this pain game for a while, but not forever.
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