In December the price of Brent continued to decline moderately, but the USDRUB rate diverged from the previous near-perfect correlation with the price of Brent. First it moved down more sharply on 4 December, the day the president of Russia delivered his address to the Federal Assembly during which he, if anything, toughened further the previous rhetoric towards the West. After that the ruble recovered a bit and then continued on a moderate downward trajectory in the following days. However, on 15 December a collapse started and gained further traction the following day in spite of the Central Bank of Russia raising its main policy rate from 10.5% to 17.0% during the night. What could have been the cause of the collapse?
On 11 December the state-owned oil company Rosneft raised RUB 625 billion (about USD 10 billion) in a bond issue (Reuters) and some of the bonds were later reportedly used as collateral by the banking sector to obtain fresh ruble liquidity from the Central Bank of Russia (Bershidsky). Thus, the Central Bank of Russia apparently increased the monetary base by issuing money covered by new domestic securities rather than gold or foreign exchange reserves and this in a country already flirting with double digit inflation. According to the IMF, inflation in Russia reached 6.8% in 2013 while the forecast for 2014 is 7.4% and the actual might be higher than that. The above is likely to have raised inflation expectations further while the speed and the lack of transparency of the transaction provoked a loss of confidence on the domestic financial market. Sharply increasing demand for foreign currency caused the ruble to plummet.
The size of the foreign exchange reserves of the Central Bank of Russia gives a reason to believe that the current collapse of the ruble will not be as dramatic as the one in 1998 when during several weeks the ruble lost around two thirds of its value. However, for interventions in the currency market to have any chance to be effective the Central Bank of Russia now at the very least has to restrict domestic liquidity. This might result in interest rates rising further. The relatively low rates obtained by Rosneft have thus indirectly been subsidized at the expense of other borrowers paying much higher rates in the near future. Providing more monetary financing to government owned entities, even if indirectly, is a sure fast-track way to complete financial meltdown in Russia.
At the same time, a lot of damage has already been done and the loss of confidence is now spilling over into the retail market and will thus not be easy to contain. People in Russia are reportedly queuing to buy long term consumer goods and foreign currency to preserve the value of their savings. Many people are likely to still remember the 1998 inflation rate of 84% and be nervous about the prospect of inflation rising sharply from the present level. According to purchasing power parity, a higher inflation rate would also imply a greater rate of currency depreciation in the medium term.
It is thus clear that the amount of reserves required to contain the panic will now be much larger than the amount that would have been required to prevent the panic from starting in first place. The Ministry of Finance on 17 December committed USD 7 billion to help stabilize the ruble and at the time of writing of this post the USDRUB rate is back just slightly above 60. However, also in contrast to the situation in 1998 when Russia received help from international financial institutions such as the IMF, such help is unlikely this time. Thus, Russia stands alone and the ruble is highly likely to experience a volatile ride also going forward.
References
Bershidsky, Leonid. 2014. Why the Ruble Fell as Oil Rose. BloombergView. 15 December. http://www.bloombergview.com/articles/2014-12-15/why-the-ruble-fell-as-oil-rose
IMF. 2014. World Economic Outlook. October.
Reuters. 2014. Russia’s Rosneft sets coupon for issue of rouble bonds. 11 December.