“The best way to destroy the capitalist system is to debauch the currency.” – Lenin.

The Russian ruble has fallen by 28.5% in value vs. the US dollar since the start of this year and is down 39% since the start of the devaluation phase in early December last year. The exchange rate passed the psychologically important RUB100 to the dollar mark on August 14.

The trigger for the devaluation was the start of the EU’s ban on imported crude from Russia, from December 5, and the ban on imported oil products, starting February 5 this year. So far, there has been almost no impact on the currencies in Central Asia and the Caucasus, although the Uzbek som has started to slide over the past week.

In their recent communications, the Central Bank (CBR) and the Ministry of Finance (MinFin) stressed that the main reason for the ruble’s weakness is linked to a deterioration of Russia’s trade balance as exports have slumped due to lower dollar prices for Russian oil while imports have shown a fairly quick recovery.

The weaker external accounts did play a role in determining the FX trend along with a shift in foreign trade away from $ and € along with a seasonal rise in demand for foreign cash from Russians heading to Turkey and other tourist destinations. 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. 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 had 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.

The rebound in Russia’s oil export price in July has made it possible for the return of the MinFin to the local FX market as a buyer. The last time the government purchased FX for its reserves (NWF) was in January 2022. Then, after a brief period in late February 2022 when Minfin was selling FX to support the budget, the government withdrew from the FX market. It was only in January 2023 that the MinFin returned to the market with FX sales. Its cumulative FX sales this year have reached $7.2bn.  

With Urals oil currently settling at levels above $60 per barrel, the MinFin has to switch from selling FX to buying it if it maintains its adherence to the ‘budget rule’. Given the ruble weakness, there were some speculations in the Russian press that the ministry might choose not to enact FX purchases, as these are likely to result in further downward pressure on the ruble. The possibility of such a scenario has forced the central bank to announce on July 21 that it will match any possible FX purchases by the Minfin with sales of FX from its own reserves. Such a move is aimed at neutralising any negative effects that MinFin FX purchases could have on the ruble rate.\

Despite the ruble’s misfortunes, on August 3 the MinFin announced that starting from August 7 it will shift from selling FX from the National Welfare Fund to buying FX for the fund. During early July and early August daily FX sales from the NWF amounted to RUB1.7bn, or less than $19mn. From August 7 to September 6 the MinFin has announced that it will buy FX with daily purchases totalling RUB1.8bn.

A new wave of ruble devaluation along with the MinFin’s plans to resume purchases of FX prompted the CBR to sell FX, in line with the bank‘s earlier announcement.

On August 2, when MinFin was still a seller of FX, the CBR topped its RUB1.7bn in FX sales with an additional RUB2.3bn. This was also another factor that helped to halt a further slide in the ruble rate: closer to the evening of August 2 the ruble regained some of the lost ground, closing at RUB93.5/$ after hitting the RUB94.2/$ mark a few hours earlier.

Our view on the future FX trend remains unchanged: despite increased volatility and a new wave of weakness, we expect the ruble to trade close to RUB90/$at least until end-2023. A weak ruble should help to strengthen the fiscal position of the government in 2H23 and also offer strong support to Russian exporters, especially to oil and gas companies, which remain the largest payers of taxes to the Russian budget. We forecast that in 2023 the ruble rate will average RUB83.4/$ and its rate at YE23 could be at RUB90.6/$.

Knock-on effects

When the Russian ruble devalued steeply in March last year, there was an almost immediate knee-jerk decline in the other currencies; not so far this time. However, some currencies are expected to devalue vs. the US dollar in the coming months so as to be competitive against the ruble (Russia is a major trade partner for most countries) and to try to mitigate the impact on remittances from workers in Russia.

Some regional currencies will follow the ruble. The Kazakh tenge, the Uzbekistan Som, the Kyrgyz Som and the Tajikistan Somoni are all expected to fall (versus the US Dollar) because of ruble contagion. The Uzbeki som is the most exposed, but weakness is not expected to as much as for the ruble.

The ruble has lost 40% vs. the $ since early December. The ruble has started this week at RUB100/$, a loss of 29% since the start of the year and a near 40% drop since early December.

The lesser of the options to protect the budget. The ruble is now a managed currency and the reason the Central Bank has allowed the devaluation is because of the need to boost budget export taxes (in ruble terms). The ruble is expected to rally (towards RUB90/$) by year end, as the oil export receipts are recovering, but unlikely to rally more than this level.

The reaction from regional currencies has been very muted. So far, the currencies in Central Asia and the Caucasus, which have previously been closely correlated with the ruble movement, have shown little reaction, although in recent days the Uzbeki som has started to slide vs. the US dollar.

Inflation is a major concern. Partly this is because their relatively stronger currencies (vs. the ruble) help bring inflation lower while a steep devaluation would add to inflation pressures.

Central banks are waiting to see what Russia does. Also, the Monetary Authorities across the region are mindful of how quickly the ruble rallied in May-June last year and are being cautious until there is greater certainty in the ruble trend.

Some currencies will have to follow. Some countries are very exposed to the ruble and while they have delayed following the devaluation, will be under increasing pressure to do so from now:

Remittances. Uzbekistan, the Kyrgyz Republic, and Tajikistan are the most exposed to worker remittances and are seeing a big decline in local currency terms this year. They are under growing pressure to devalue to protect vulnerable household incomes.

Trade. Kazakhstan, Uzbekistan, and Armenia are most exposed in terms of trade and their relatively stronger currencies are hurting competitiveness. They will have to adjust “soon.”

Impact on growth expectations. The reduction in remittances is impacting consumer spending and financial sectors in Uzbekistan, the Kyrgyz Republic and Tajikistan. All three have seen growth expectations cut for 2023 because of the stronger-for-longer currencies.

The currencies most likely to see some devaluation, from the current level, are:

Kazakhstan tenge: Kazakhstan shares an open trade border with Russia and is a major trade partner. In 2015, the Kazakhs had to devalue steeply to stay in line with the weaker ruble because consumers crossed the border to buy durable goods in particular. But the devaluation will not be as steep as seen with the ruble because the government is struggling to bring inflation lower and is targeting inward investment from countries in the US, Europe, the Gulf and China, so a more stable currency is an advantage.

Kazakhstan does not have a major exposure to remittances from workers in Russia, so this is much less of a consideration than for other “stans”. The bulk of the money coming from Russia in 2022 and 1H23 is capital brought by Russians escaping the military draft.

Kyrgyz som: Also part of the Eurasian Economic Union (EEU) but imports food and energy from Russia, so the stronger som also helps the Kyrgyz Republic with inflation management. It is expected to devalue but also only slowly. The major issue is the negative impact on remittances, which account for between 30% and 33% of GDP.

In 1H23, the remittances from Kyrgyz workers in Russia fell by 32% year on year ($871mn versus $1.28bn in 1H22).

Uzbekistan som: Uzbekistan is the recipient of the largest flow of migrant remittances from Russia in monetary terms, and in 1H23 the volume is estimated to have accounted for 21% of GDP. Russia is also Uzbekistan’s second-largest trade partner and a major market for vegetable exports.

The government cannot afford to have the som strengthen too much vs. the ruble because of the loss of trade competitiveness and because of the impact on the economy from the drop in the value of remittances, in local currency terms.

According to the report of the Central Bank, in the first quarter, the monthly dynamics of transfers was higher y/y. From January to April, the inflow of remittances increased by 21% to $3.1bn. About 87% of the amount received during this period came from Russia. The increase was because of a 72% increase in the number of migrant workers moving to Russia (an additional 630,000 people), so the additional ruble volume compensated for the currency weakness.

However, in the second quarter, the volume of transfers almost halved compared to the previous year, from $5.06bn to $2.85bn. In June, the dynamics of receipts worsened even more – the volume of transfers is 2.26 times lower than it was in this month of 2022.

Russia remains the main source of remittances. It accounted for about 80% of the total revenue for the six months.

The head of the Central Bank, Mamarizo Nurmuratov, predicts that by the end of the year, the volume of transfers will be in the region of $11-11.5bn, which is 32-35% lower than in 2022. The decline in revenues from Russia will also be associated with the devaluation of the ruble, he said.

Tajikistan somoni: Remittances from Russia account for 32% of GDP (n 2022) – although some estimates say this could be as high as 51% – so the strengthening of the somoni relative to the ruble hurts overall growth and the consumer sectors and household incomes.

The Institute for Demographic Research (Russia) reported the number of Tajik migrants in Russia by mid-year was 3mn. The entire population of Tajikistan is 10mn people, that is, a third of the country's population has already moved to Russia.

Armenian dram: Remittances account for 19% of GDP (2022), with the bulk from Russia. Last year the total was higher because of capital brought into the country by Russians escaping the military draft risk.

Russia is a major trade partner for Armenia, buying agricultural produce and machinery, so while the government will try to maintain dram stability to control inflation and attract foreign investment, it will have to manage a devaluation in the autumn for competitiveness reasons.

Georgian lari: Total remittances account for 16.3% of GDP (2022) and with a significant amount from Russians coming to Georgia to escape the draft risk. Trade with Russia has been muted for the past ten years so this is less of an issue.