Russia: Russian currency in turmoil due to a mix of sanctions, lower oil prices and overall economic weakness
December 2, 2014
The Russian Central Bank ended its currency interventions in the foreign exchange market prompted by a combination of worsening economic conditions, falling oil prices and failed attempts to defend the ruble. On 10 November, the Russian Central Bank announced the end of the use of the bi-currency basket bands, as well as the end of any currency interventions in the foreign exchange market. The Bank also stated that it had effectively begun the transition period toward a free-floating exchange rate and an inflation targeting regime. The Bank had planned to complete the transition at the end of the year but did so ahead of schedule. Nevertheless, the decision was not entirely unexpected as many market analysts believed that the Bank should begin the transition before year-end given that the heavy currency interventions aimed at supporting the free-fall of the ruble were leading to a rapid depletion of the country’s international reserves. From January through October of this year, Central Bank intervened with over USD 70 billion in the foreign exchange market.
The ruble registered turbulent fluctuations after the Central Bank announced that it was ending its interventions in the foreign exchange market. The Russian currency touched a multi-year low on 14 November when it traded at 47.20 RUB per USD, weakening 15.3% over the same day of the previous month and losing more than 40% of its value in annual terms. Russian monetary authorities stated, nonetheless, that they would maintain the right to intervene in a discretionary manner in the market in order to discourage speculative activities and they could also do so if swift fluctuations in the exchange rate were to threaten financial stability.
The weak ruble remains vulnerable to any change in the outlook for geopolitical developments, oil prices and investor confidence. A quick resolution to the crisis between Ukraine, Russia and the West does not seem likely in the foreseeable future despite the recent calm. The local elections that separatists in Donetsk and Luhansk held, which were explicitly endorsed by Russian authorities, violated the region’s “special status” as well as the Minsk agreement, calling into question whether the fragile peace process will hold. Under these circumstances, Western sanctions against Russia are unlikely to be reversed any time soon—in fact, a new round of sanctions could be imposed in 2015. This scenario will continue to negatively impact the economy.
In addition to prolonged sanctions, the outlook for lower oil prices will exacerbate Russia’s already weak economic conditions. At a meeting held on 27 November, members of the Organization of Petroleum Exporting Countries (OPEC) decided to keep the current oil output unchanged. The OPEC leaders’ decision has raised concerns in the international community as oil prices tumbled to a nearly five-year low shortly after the decision was announced. In addition, the ruble plummeted to yet another multi-year low after the announcement, and Russian Economy Minister Alexei Ulyukayev stated that the government will have to revise its estimate for the price of Ural oil, which is projected at USD 100 per barrel in the 2015 budget that was approved by the Duma on 22 November. Currently, the price for Ural oil is trading at barely above USD 70 per barrel. In recent days, however, Minister Ulyukayev stated that, since the price that matters for the budget is in rubles, the weakening of the ruble against the US dollar will compensate for a fall in oil prices.
The ruble has come under tremendous pressure recently due to a mix of weak economic growth, international sanctions, plunging oil prices and the unstable geopolitical backdrop. Most analysts agree, however, that the Russian Central Bank took the right decision in letting the ruble free float earlier than planned. Whether the market will adapt quickly to the new floating exchange rate regime remains to be seen.
Author: Ricardo Aceves, Senior Economist