On the face of it, the Central Bank of Russia is winning the currency war to defend the ruble against the effects of Western sanctions. Immediately after the Russian invasion of Ukraine and the imposition of the first batch of brutal and unexpected sanctions on Russia – including the freezing of CBR assets – the ruble hit an all-time high of 120 rubles to the dollar.
But since then, in response to the CBR’s deployment of a series of measures to defend the currency, it has risen to Rub62 against the dollar, stronger than its pre-war level, the highest rate in two years and making the ruble one of the best performing emerging market currencies this year.
Figure 1. The ruble at its highest rate for two years
Source: Bloomberg
The CBR’s defense of the ruble has been drastic. It has rolled out a series of measures over the past three months, including:
- Increase in key rates by more than 1,000 basis points to 20% on February 28
- Imposing an 80% refund obligation on exporters
- Prohibition of foreign currency loans and foreign currency transfers from March 1
- Prohibit short selling in Russian markets
- Prohibit non-residents from selling securities;
- Prohibition on paying dividends and interest to non-residents
- Limit the exit of Russians from the country with more than $10,000
- Limit all overseas money transfers by individuals to $5,000
- Prohibit bank transfers to “unfriendly” countries
- Imposing a 30% commission on FX transactions by individuals
- Prohibit the purchase of foreign currency in cash (although those with foreign currency accounts will be able to withdraw up to $10,000 in cash, the rest in rubles)
As the ruble has rallied, some of these restrictions have been eased, with the export disposal time requirement being raised from three to 60 days, the foreign exchange transaction tax reduced to 12%, and key rates reduced to 14%.
But with foreign participants largely on the sidelines, limited liquidity, and media reports suggesting that the ruble’s spot exchange rate is still in the mid-1970s, it’s hard to call the current rate of the ruble at a rate determined by the market.
It appears that the ruble is now being held at artificially overvalued rates to drive home a propaganda narrative that Russia is still well insulated from the war and is in fact benefiting from improved current account performance, which is reflected in the strength of the ruble. .
CBR reports suggest a huge improvement in the current account position, helped by rising oil and commodity prices. The CBR reports that the current account surplus nearly tripled to $95.8 billion from January to April. The CBR data should be taken with a pinch of salt these days, as it has suspended the release of most data.
The CBR data on the tripling of the current account surplus is not entirely consistent with the data on foreign reserve assets. This suggests a drop of almost $50 billion in foreign exchange reserves to around $593 billion (including the nearly $300 billion that would have been frozen by Western sanctions) in early May. One might have assumed that the huge current account surplus would have led to both an appreciation of the exchange rate but also a sharp increase in foreign exchange reserves.
This does not suggest that Russia suffered a huge wave of capital flight (nearly $150 billion in the same four month period). It also suggests that the CBR most likely intervened aggressively in defense of the ruble, which perhaps partly explains the strength of the ruble, and suggests that it could be somewhat contrived.
And, while the CBR might celebrate the ruble’s resilience, the aggressive capital controls and policy rate hikes used in its defense aren’t gratuitous. They will further block/reduce economic activity. This has already been seen in a collapse in import demand. The sanctions also partly lead to fewer foreign products on the shelves and fewer Western products to buy.
This will mean weaker growth, already reflected in forecasts for real gross domestic product growth, or lack thereof, in Russia this year – the range of estimates is now for real GDP to decline by 8-12%. A strong currency, currency convertibility restrictions and sanctions making critical imports difficult to obtain will further cloud growth prospects beyond this year.
The result of all this is that Russia and the Russian people will inevitably be poorer. Growth and standard of living will decline/remain depressed. A vicious circle of brain drain, capital flight and lower potential growth will most likely ensue, which will surely end up playing out on the rouble.
Even from a commodity price perspective, Russia and the ruble should not expect a lasting windfall. Once the war in Ukraine is over, commodity prices will likely moderate, but the West will inevitably accelerate the push to diversify supplies and reduce reliance on Russia as a supplier. Russia will therefore suffer a drop in volumes and prices of the main commodity exports, which also does not correspond to a strong ruble.
Timothy Ash is Senior Sovereign Strategist at Bluebay Asset Management.
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