Russia’s Economy Is Tanking but the Ruble Soared. Here’s Why.

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Russia’s central bank lowers interest rates, making the ruble less attractive

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Generally, currencies follow economies up or down. In Russia’s case, limited sales and government efforts to force purchases exacerbated this, in fact so much that it began to weigh on the economy.

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“I wouldn’t have expected it,” said Jane Foley, head of forex strategy at Rabobank. “But when you put capital under control, you’re not seeing anything real.”

Russia is taking steps to weaken the currency and the latest move could end the rally. On Thursday, Russia’s central bank cut interest rates from 14% to 11%, making the ruble less attractive. This caused the ruble to fall 6.7% against the dollar.

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Earlier this week, Russia eased capital controls that required companies to convert 80% of their foreign exchange revenue into rubles. Now they only have to replace half.

The Russian currency ended Thursday at about 65 rubles against the dollar, weakening this week from the level of about 55 rubles per dollar. Nevertheless, the ruble is significantly higher than the record intraday low of around 158 on March 7, according to data from Tulet Prebon.

Recently, the ruble has bucked the global trend of weaker currencies against the dollar, fueled by a rise in US interest rates and a stronger economy. The euro is down about 5.7 per cent against the dollar this year, while the British pound is down 6.8 per cent.

Economists and traders see the recovery of the ruble as artificial, partly due to Russia’s policies, and partly as a result of Russia’s large commodity exports and the effects of sanctions. In addition to raising rates and forcing companies to buy the ruble, Moscow limited the amount of dollars that Russians could withdraw from foreign currency bank accounts and prevented banks from selling foreign currency to customers.

The combination of sanctions, which reduced imports, and Russia’s commodity exports, which were fueled by higher prices, gave the ruble a further upward momentum. Russia also demanded from European countries to pay for natural gas in rubles.

Those efforts came at a cost. Immediately after the war the central bank doubled its prime interest rate to 20%, essentially rewarding people for keeping the ruble, but putting further pressure on the economy. Thursday’s rate cut was the central bank’s third since it raised rates.

A strong currency generally provides benefits to countries, including reducing inflation and making imports cheaper. But sanctions against Russia have devastated the normal dynamics. Russia cannot import much because of sanctions.

Inflation in Russia is also on the rise, with food prices rising by one-fifth from a year ago. Wages of Russian workers are not keeping pace, with real disposable income falling by 1.2% in the first three months of 2022 compared to a year ago. Economists expect the Russian economy to shrink by about 10% this year.

Meanwhile, the stronger ruble threatens to hit the country’s budget by undercutting the value of oil and gas tax revenues denominated in dollars.

As Russian energy companies convert foreign currency payments into rubles, a stronger currency means “you’re getting fewer rubles per dollar,” says Jason Tuve, senior emerging market economist at Capital Economics.

“From a public-finance perspective, all else being equal, a stronger ruble depreciates the local currency value of gas revenues recorded in the budget,” he said. “It comes at the same time that Russia is facing other pressures, from the cost of war in Ukraine to increased social spending.”

Before Thursday, Russia’s maneuvers to weaken the ruble had limited effect. However, Thursday’s rate cut lowered the ruble solidly for the week. Market watchers say that it is difficult for the ruble to move on the future path.

Many note that some investors are trading the ruble. Richard Benson, co-chief investment officer of London-based monetary fund manager Millennium Global Investments Ltd, said the company decided after the attack that it did not want to trade the currency. Soon thereafter several customers called and asked the firm not to trade it on ESG, or environmental, social and governance, grounds.

Ruble trading volume has also become difficult to understand. After the war broke out, the ruble market split for one value within Russia and in international markets. After the war, many Western banks stopped offering electronic quotes for buying and selling the ruble.

“The list of arguments for not trading the ruble is long,” said Robin Brooks, chief economist at the Institute of International Finance, noting the ongoing capital controls and sanctions. “Do I think it makes sense economically to ask the ruble to trade stronger than it was before the invasion? No.”

If Russia wants the currency to fall further, “they can liberalize capital flows and that thing will be very weak,” Mr Brooks said. “Of course they won’t do that.”

Caitlin McCabe [email protected] Feather

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