Case: Russian Ruble Roulette The Russian ruble has experienced a multitude of re
ID: 1216034 • Letter: C
Question
Case: Russian Ruble Roulette
The Russian ruble has experienced a multitude of regime shifts since the opening of the Russian economy under Perestroika in 1991. After some years of a highly controlled official exchange rate accompanied by tight capital controls, the 1998 economic crisis prompted a movement to a heavily managed float. Using both direct intervention and indirect intervention (interest rate policy), the ruble held surprisingly steady until 2008. However, all of that stopped in 2008 when the global credit crisis, which started in the United States, spread to Russia. As illustrated by Exhibit A, the impact on the value of the ruble proved disastrous.
Russian Crisis of 1998
As illustrated in Exhibit B, the ruble continued to slide (appreciating) against the basket throughout 2009 and into 2010. The dual-currency band was continually adjusted— downward—in an effort to put a “moving floor” underneath the currency. Finally, in late-2010, the ruble stabilized.
As part of its regular program to allow the ruble to grow as a global currency, the distance between the upper and lower bands has repeatedly been increased over time. Starting with a floating band (the spread between the top and bottom band in Exhibit B) that was only 2 rubles per basket value, the band was expanded to reach 7 rubles eventually. The ruble’s new-found relative stability was rewarded in October 2013 when the Bank of Russia announced that it was expanding the neutral “no-intervention” zone from 1 ruble to 3.1 rubles. This was followed by an announcement in January 2014 that the Bank would begin moving to end daily intervention, with a plan to stop all intervention sometime in 2015. If, however, the ruble did hit either of its bands, the Bank did acknowledge that it was prepared to reenter the market to preserve stability.
The impetus for moving to a freely floating ruble was to both allow the changes in the currency’s value to “absorb” global economic changes and allow the central bank to increase its focus on controlling inflationary forces. Russian inflation has been stubbornly high in recent years, and with the U.S. Federal Reserve announcing that it would be slowing/stopping its loose money policy in the wake of the financial crisis of 2008–2009, inflationary pressures were sure to continue. But then the regime shift plan began to unravel.
2014: Western Sanctions and the Price of Oil
“External shocks” is a phrase few central bankers ever want to hear. In the spring of 2014, however, that was exactly what the Russian ruble experienced. In March 2014, the European Union, the United States, and a host of other Western industrial countries imposed political and economic sanctions on Russia in opposition to its aggressive activities in Eastern Ukraine and its annexation of Crimea and Sevastopol. This had an immediate impact on restricting Russian exports, as well as shutting down some major foreign direct investment projects in Russia. However, the external shocks were not limited to sanctions. Beginning in the summer of 2014 the price of crude oil (Brent Blend crude is the predominant world price of oil) started falling. Oil was Russia’s primary export; the country, the government, Russian business, all relied heavily on oil and gas export earnings to fund their economy. The pressures on the ruble—which many termed a commodity currency because Russia relied so heavily on oil—intensified.
As illustrated in Exhibit C, the ruble’s fall began to accelerate in the fall of 2014. Sanctions were starting to impose real costs, the price of oil was falling faster and faster, and capital began to flee Russia. By December, the Russian central bank estimated that more than $130 billion in capital had already left Russia, and another $120 billion in capital outflows were expected in 2015. On December 15, on what became known as Red Monday, the ruble lost more than 10% of its value.
Now a new concern rose which all emerging market currencies faced with devaluation and depreciation: could the country pay its foreign currency debts in the near future? It was estimated that Russian borrowers of all kinds, government, and business, faced more than $120 billion in hard currency foreign debt (primarily dollars and euros) in 2015 alone. Russian businesses of all kinds, including some of the world’s largest oil companies, were now restricted from borrowing internationally. So they borrowed domestically, pumping out ruble-denominated debt at a breakneck pace. What would that mean for borrowers and debt-holders in the coming years? The Bank of Russia’s plan to implement a long-term currency strategy, which had been put in place back in 2009, now appeared to be something of a train wreck.
The Bank’s original theory—that by increasingly targeting inflation rather than the value of the ruble, the long-term economic prospects for Russia and the ruble would be improved— made sound economic and financial logic in a world of $100/bbl oil and no Western sanctions. Many inside and outside the Bank now wondered if the ruble could ever move from being a simple “emerging market currency” to a currency of value, a reserve currency.
Case questions
1. How would you classify the exchange rate regime used by Russia over the 1991–2014 period?
2. What did the establishment of operational bands do to the expectations of ruble speculators? Would these expectations be stabilizing or destabilizing in your opinion?
3. Would Western sanctions alone been devastating to the ruble’s value, or was it the plummeting price of oil that had the larger impact?
Explanation / Answer
Answer 1:
The exchange rate has been managed floating type. This is because bands are fixed within which there is no Central Government intervention. If the value of exchange rate lies beyond this band value or on the boundary of the bands, then Central Bank will intervene.
Answer 2:
It increased the scope of speculation as the exchange rate moved towards floating system by increasing the band width. The expectations were stabilizing.
Answer 3:
Though Western sanctions had devastating impact on the rubble value but the decline in the price of oil which is the major exporting commodity of Russia had greater impact leading to fall in the value of rubble.