Thursday, July 24, 2014


Russia

Explainer: The Ukraine Crisis, The Ruble, And The Russian Economy

By Charles Recknagel
The Russian ruble has plummeted to a record low against the U.S. dollar as the Ukrainian crisis revives Cold War-style tensions. Here are four things to know about the ruble's fall, and where things might go from here.

How much has the Russian ruble fallen in recent days?

Russia's ruble fell to a record low of below 36.4 to the dollar and below 50 to the euro for the first time on March 3.

Lars Christensen, head of emerging markets analysis at Danske Bank in Copenhagen, says a big reason for the fall is foreign investors' perceptions of Russia are changing as the Ukrainian crisis deepens.

"There is a fear among investors that Russia is moving away from the West. Whether or not that should be called a new Cold war is controversial but, at least, investor sentiment is influenced by the fact that we are seeing a cooling down of relations between East and West. And obviously in such an environment you would see less foreign direct investment into Russia," Christensen says.

How much of the ruble's slide is directly due to the Ukrainian crisis is impossible to say. The currency has already lost 10 percent of its value since the start of the year because of decreasing interest among foreign investors in emerging markets in general.

Igor Nikolayev, director of Russia's FBK Institute of Strategic Analysis, a private auditing firm, says: "Regardless of possible sanctions and of this incredible escalation of the conflict, the ruble already was falling and weakening. The current events are just acting as a catalyst accelerating the ruble's weakening."

Nevertheless, the sharp drop on March 3 was enough to jolt Russia's Central Bank into action. Foreign-exchange traders in Russia say the Central Bank sold up to $10 billion to stem the ruble's fall. The report has yet to be confirmed by the Central Bank, which only makes its interventions public after a two-day lag.

How much farther is the ruble expected to fall?

For now, the question is impossible to answer. One reason is that the Central Bank has never made it clear at what point it would consistently defend the currency.

When the ruble began its slide at the start of the year, it was widely considered to be overvalued against foreign hard currencies. The Central Bank has repeatedly set trading bands for the ruble, only to move them again in a weaker direction, as it lets the ruble find its own level in a controlled fall.

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But the pressure of the Ukraine crisis could make it even harder now for Russia to decide where to stop the ruble's slide.

Christensen notes that the farther the ruble falls, the more expensive it becomes for the Central Bank to protect it.

"We saw in 2008, in connection with the Georgian conflict and the financial crisis, that the ruble came under significant pressure and that when the Russian Central Bank at that time intervened heavily and spent $200 billion to defend the ruble and failed that it had very significant costs for the Russian economy in terms of high interest rates and significantly lower growth," Christensen says.

"So, I think the Russian Central Bank is aware of those risks and is therefore likely to allow the ruble to continue to depreciate but will from time to time step in and try to curb that sell-off."

Other than pressure on the ruble, what other ways is the crisis in Ukraine affecting the Russian economy?

On March 3, Russia’s Central Bank raised its key lending rate for the first time since August 2012. The rise from 5.5 percent to 7 percent is intended to guard against inflation and prevent a deeper sell-off of rubles that would put additional burdens on the Russian treasury. 

At the same time, Russian stocks fell sharply on March 3, with the dollar-denominated RTS stock index tumbling 14 percent. Export businesses were particularly affected. The value of Russian gas giant Gazprom's stock reportedly fell over 10 percent on fears its lucrative sales to Ukraine could be interrupted or reduced.

Where do things go from here?

If the crisis is solved quickly, the damage will be limited and Russia can return to the much needed business of solving its own economic problems.

Nikolayev says that without solving those deep structural problems, the ruble will continue to devaluate. "The fundamental reason [for the ruble's weakness] is Russia's macroeconomic weakness. And this weakness will not only persist, it will increase. We have already gone from stagnation to recession," Nikolayev says.

But if the Ukraine crisis is not solved, much greater economic troubles for Russia -- and for the West -- could lie ahead. As Moscow maintains a threatening posture toward Ukraine and the West responds with warnings of possible sanctions, the exchanges sound increasingly like echoes of the Cold War.

And any real slide back toward Cold War risks weakening the infrastructure of trade agreements that today underpins much of the global economy. "If we were to move to a new Cold War-style scenario, then we would see more fundamental negative impacts that would mean higher defense spending, a less open, global economy, and trade barriers coming up between East and West," Christensen says. 

"I think we often forget how beneficial the end of the Cold War has been for the global economy and it would be terrible from a global economic perspective to see us moving in the other direction."

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