The Central Bank of Russia (CBR) put through a whopping 350bp rate hike at an emergency monetary policy meeting on August 15, hiking the prime rate that is designed to put a floor under the collapsing value of the ruble.

Currency trading on the Moscow Exchange on August 15 opened at RUB96 per dollar after peaks of RUB101 the day before the CBR announced an extraordinary meeting on the rate. After the decision of the CBR the ruble briefly strengthened to 95.5, but soon returned to 98, The Bell reports.

Russia’s leading economic media anticipated that the CBR would raise the rate by at least 150bp, from 8.5% to 10% – there is little macroeconomic sense in a smaller step –  so the 350bp was a lot more decisive than expected.

The ruble has been weaking all year due to a combination of factors, including falling oil and gas revenues, a shrinking current account surplus, ballooning state military spending and low interest rates, amongst other things. Moreover, some analysts have speculated that the CBR has allowed the ruble to sink on purpose, as that generates more rubles for the budget and so helps close the budget deficit.

The CBR was forced to act after the ruble crashed through the physiological important RUB100 to the dollar mark on August 14, causing widespread condemnation. An attempt to prop the ruble up last week, when the CBR said it would halt currency purchases for the rest of the year, had no effect, forcing CBR Governor Elvia Nabiullina to take more decisive action this week.

“The Russian central bank’s 350bp interest rate hike, to 12.0%, at today’s unscheduled meeting is likely to be followed by further increases in the coming months. But there’s little the central bank can do in the short term to stem the ruble’s decline without some strict currency controls or FX intervention,” Liam Peach, an emerging market economist with Capital Economics, said in a note.

The ruble has lost 27% of its value year to date and is the third-worst performance currency in emerging markets this year. The central bank has come under withering criticism recently, even by other senior Kremlin officials and the state-owned TV channel talk hosts.

Officially, the CBR has blamed falling export revenues and rising imports for the weakening of the currency. Other analysts point out that the CBR was in a position to shore up the currency earlier with interventions or rate hikes – and the CBR did unexpectedly hike rates in July – but that it also appears the regulator has been massaging the ruble lower to support the budget, as a weaker ruble generates more spending cash.

Twenty minutes before the dollar broke through the RUB100 to the dollar mark in the afternoon of August 14, TASS published an article by presidential aide Maxim Oreshkin in which he flatly accused the Central Bank of weakening the ruble on purpose and stated that the Russian economy needs a strong national currency. Oreshkin said the CBR had cut rates too fast and that had resulted in the overheating of the economy that CBR Governor Elvira Nabiullina has also complained about. Oreshkin concluded that by keeping rates low, the CBR has been printing money via the backdoor.

In addition, the shrinking current account surplus has certainly played a big role in weakening the ruble, but ballooning military spending has also played its part.

“Economists do not argue with the fact that one of the reasons for the collapse is the low rate of the Central Bank; but at least no less a contribution to it was made by the explosive growth of government spending and the transfer of the economy to a military footing,” The Bell said in a comment on the exchange rate dynamics.

 

Slow moving crisis

Russia’s central bank called an extraordinary meeting on August 15 after the ruble crashed through the level of 100 to the dollar for the first time since March of last year as Russia’s war in Ukraine drags on and international sanctions hit trade.

Policy makers will publish a statement on the key rate at 10:30 a.m. after the meeting, the Bank of Russia said in a statement, without giving any further details.

The central bank put in a surprise 100bp hike in July, taking the prime rate to 8.5% – the first increase since the 1000bp emergency hike by Nabiullina in the first days of the war last year to stop the collapse of the ruble.

According to Chris Weafer, the founder and CEO of Macro Advisory and former head of research at multiple Moscow-based investment banks, the CBR has been weakening the ruble’s value on purpose in order to help Russian Finance Minister Anton Siluanov close the budget deficit, which soared to RUB3.3 trillion in April, well above the RUB2.9 trillion that is in this year's budget plan.

While a falling current account surplus has weakened the ruble, Weafer argues that the CBR has full control over the foreign exchange markets and can easily manipulate them.

“The weaker external accounts did play a role in determining the FX trend along with a shift in foreign trade away from US dollar and euro along with a seasonal rise in demand for foreign cash from Russians heading to Turkey and other tourist destinations,” Weafer said in an op-ed for bne IntelliNews. “But following a big squeeze in volumes of FX traded locally (the combined result of sanctions and capital controls imposed by the central bank), the Russian forex market has become extremely thin and very easy to manipulate.”

“Under these circumstances, the prime factor behind the ruble’s weakness is linked to an attempt by the monetary authorities to offer support to the country’s deteriorated fiscal position,” Weafer said. “This is particularly so since the ruble did not react to a significant improvement in Russia’s external position: it was reported that in July the price of Russian oil exports exceeded $60 per barrel for the first time since November 2022, while the size of the Urals discount to Brent narrowed to its lowest level since the introduction of the Western oil price cap. These developments mean that the volume of Russia’s exports is set to rise, while the country’s imports could start to shrink as a weak currency, rising inflation and more stringent fiscal policy put pressure on domestic demand.”

Inflation in July was 4.3% but it is accelerating: as of August 7, already 4.4% in annual terms, over the past three months, seasonally adjusted, it was 7.6%, while core inflation is already at 7.1%.

“The Central Bank will make further decisions on the key rate, taking into account the actual and expected inflation dynamics relative to the target, the process of economic restructuring, as well as assessing the risks from internal and external conditions and the reaction of financial markets to them,” the CBR said in its accompanying statement. It is widely expected to hike rates again in September.

Devaluations benefit the government as oil revenues in the budget are denominated in dollars, but their expenditure is in rubles; a fall in the ruble’s valuation against the dollar creates more rubles for spending on budget items even if those rubles are less valuable.

However, Nabiullina’s decision has not been popular and the drop to RUB100 to the dollar on August 14 was met by scorn from Russia’s media and criticism by senior figures in Russia’s liberal economic elite.

Kremlin economic aide Maxim Oreshkin lashed out at CBR in a rare op-ed for TASS for contributing to allow the ruble to slide – a tacit admission that the CBR could have prevented the devaluation if it had chosen to do so.

Putin’s chief economic adviser said: “the source of the weakening of the ruble and the acceleration of inflation is soft monetary policy… Russia needs a strong ruble, and policymakers have the necessary tools to normalise the currency value in the near future,” he said.

Along with Nabiullina and Siluanov, Oreshkin is a member of the liberal economics triumvirate that runs Russia’s financial and economic system.

Emergency meeting

If Nabiullina was engineering a slow fall of the ruble, clearly by mid-August the process started to run out of control as the public became more alarmed.

Nabiullina acted to shore up the ruble on August 9 by announcing the so-called budget rule would be suspended for a second time since the war started and that the CBR would halt all purchases of foreign currency on the domestic market for the rest of the year in an attempt to improve the value of the ruble. However, the move had no impact on the ruble and “failed to stabilise the currency,” according to a note released on August 14 by JPMorgan Chase & Co., which expected the central bank to raise its benchmark to 10% by the end of the year, up from its previous call for 9%.

Four days later, with panic rising, Nabiullina was forced to call for the emergency meeting, where an aggressive rate hike to put a floor under the ruble was widely anticipated.

The ruble immediately reversed losses after the emergency meeting announcement, trading up 1.8%, and broke back under RUB100 to the dollar , settling at RUB97.6625 as of 7pm in Moscow, Bloomberg reports.

Going forward, the central bank will continue to adhere to the floating exchange rate policy that Nabiullina controversially introduced early in the autumn of 2014 during the last currency crisis, when the ruble collapsed and broke above RUB90 to the dollar.

The free-floating ruble “allows the economy to adapt effectively to changing external conditions,” Deputy Governor Alexey Zabotkin told reporters at the end of last year, and more importantly allows the central bank to preserve its just under $600bn of hard currency reserves, which have come to symbolise Russia’s fiscal strength and ability to withstand even the most extreme sanctions.

Nabiullina's rate hike will bring some immediate relief, but analyst say the currency will remain under pressure for the meantime, as the tools available to the regulator are limited. 

“Today’s rate hike will only temporarily slow the bleeding. The ruble’s depreciation is a consequence of many factors moving against Russia all at once. The current account surplus has shrunk drastically due to a slump in energy prices and export revenues as well as a rapid rebound in goods imports. Russia will struggle to attract capital inflows because of sanctions. And there’s little ammunition for FX intervention – the central bank has some unfrozen renminbi assets and gold reserves, but the bar for using these is likely to be high,” says Peach.

Who's to blame? 

In all there are many factors that have contributed to the ruble's fall. “The number of rubles in the economy is growing, and against the backdrop of a decrease in the flow of foreign currency into the country (there are dozens of reasons for this, not even counting oil and gas sanctions – from an increase in the share of the ruble in export settlements to the outflow of money from Russians to foreign banks), this causes the ruble to fall,” The Bell commented in a note.

Nabiullina sees things a little differently. While Oreshkin says it was the CBR's low key rate that has in effect pumped cash into the economy, Nabiullina blames the high public spending, but points out that private demand has only grown this year, making the problem worse and needing action. To her credit she did put through the surprise 100bp rate hike in July and was widely expected to put though another one at the September meeting. (August is a holiday month).

“During the period of recovery growth” demand was supported mainly by the public sector (that is, high budget spending), and now demand from the state remains high, the head of the Central Bank said on July 21.

Consumer demand was subdued until the end of 2022, and it has intensified since the beginning of this year, due, among other things, to higher wages. Indeed, Oreshkin himself said in his op-ed that accelerating consumer borrowing, driven by rising demand, was a worry. It wasn't until the second quarter of 2023 that demand "accelerated further" due to the rapid expansion of lending, Nabiullina said, and the CBR has already acted to cool consumer borrowing, something that it always watches like a hawk.

This debate between low rates and high public sector demand as the cause of the ruble weakness is not simple to resolve, as both factors play into the equation.

Nevertheless, there are some obvious drivers for the ruble's fall. In addition to rising military spending, the falling current account surplus has also played a big role, in line with the traditional link between the profit a country makes from trade and the value of its currency. In the first seven months of the year Russia’s current account surplus fell by 86% year on year from record highs in 2022 to $25bn.

All three of the liberal team leaders have said that the situation with the current account surplus will improve in the second half of this year, which will have a material impact on the ruble's value and allow it to claw back some of the lost ground. As bne IntelliNews reported, the federal budget deficit fell by almost RUB1 trillion after revenues surged in June after oil exports were successfully rerouted from Europe to Asia in the first quarter of this year.

Russia’s current account surplus has fallen steadily this year

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However, Nabiullina’s efforts to close the budget gap by tanking the ruble do seem to have helped as, surprisingly, the deficit has fallen significantly in the last few months, even if it remains in deficit. (chart), (chart). The budget deficit hit its full-year target after the first ten days of March but in July was back under the 2% annual target at 1.8% of GDP after the budget earned RUB813bn ($8bn) of revenues in June.

During the remainder of the year the amount of extra proceeds from oil and gas sales will be another RUB800bn above a baseline level in the budget against the current deficit of RUB2.5 trillion, allowing the government to rely less on its wealth fund to cover the fiscal deficit, Zabotkin said.

Currently the National Welfare Fund (NWF) holds some RUB6.8 trillion in its liquid part – enough to cover the deficit twice over.

But much depends on what happens to the revenues from Russian oil and gas exporters, which declined to $6.9bn in July from $16.8bn in the same period last year, according to the latest central bank data.

Russia’s oil trade this year has been hurt by the imposition of the twin oil sanctions on December 5 and February 5 that forced Russian tankers to reroute from Europe to Asia – a four-month journey to close the loop. Revenues surged again in June, four months after the sanctions came into effect, suggesting that with the new trade route in place oil and gas revenues will recover, but that remains to be seen.

Another unknown factor is the rise of capital flight this year, caused by the sanctions. An easing of restrictions on moving money abroad has also led to accelerated capital flight as Russians race to shift funds into foreign accounts, Nabiullina admitted in the more recent monetary policy outlook for July.

“The weakening of the ruble is the result of the international screws tightening around the Russian economy, but also the cost of keeping the economy going,” Erik Meyersson, chief emerging market strategist at SEB AB in Stockholm, told Bloomberg. “Nobody wants to hold rubles, and the limited supply of foreign exchange from exporters weighs on the currency.”