Russia’s levitating ruble: Why oil price collapse has NOT sent currency into FREEFALL

While low prices for ‘black gold’ keep shaking the world’s economies, and major oil-exporting nations are trying to weather the trend, the Russian national currency has proven it still has an ace up its sleeve.

The collapse of oil prices at the start of March after Russia withdrew from the OPEC+ deal was a disaster for Moscow, which remains heavily reliant on oil exports to fund the budget.

But then an odd thing happened: the price of oil lost 56 percent of its value in the year to date, as of May 7, but the ruble is down by only 19 percent over the same period. Like some Tibetan monetary monk, the ruble’s value has managed to levitate and stay up, even as the oil-price ground fell away from underneath it.

The ruble’s value has long been tied to the price of oil and the two used to move in lockstep. That changed when the Russian Ministry of Finance introduced the so-called budget rule (aka the financial rule), which automatically siphons off any excess oil-export revenue to the National Welfare Fund (NWF) for all revenues earned from oil prices over US$42.

That rule led to the buildup of the reserve fund, which held 12 trillion rubles, or 11 percent of GDP as of April 1, and helped bring down inflation to post-Soviet lows, but, most importantly, largely broke the tie between the ruble’s value and the price of oil.

That has changed now. Since oil prices have fallen below the key US$42 for a cost of a barrel of oil threshold, the budget rule doesn’t make any difference anymore, so oil prices and the value of the ruble should re-engage.

The average value of the ruble in 2018 was 62.7 rubles to the dollar, while the average price of oil was US$70.8. In 2019, the price of oil fell 11.4 percent to US$62.7, while the value of the ruble fell by less, down only 3.2 percent to 64.7, mainly thanks to the steadying effect of the budget rule.

But the changes in the first four months of 2020 have been a lot more dramatic. The average price of oil has shrunk by a third (31.2 percent) to US$43.1 over the first four months – including January and February, when oil prices were US$63.7 and US$55.7 respectively— whereas the average value of the ruble over this period was 68.7 to the dollar, down by only 6 percent.

Even in March and April, the peak of the crisis, the average cost of oil dropped to US$32 and then US$21.2, respectively, or by another quarter (25.8 percent), followed by another collapse by a third (33.6 percent) the following month, but the value of the ruble in those two months was 73.7 and 75.2, down by 7.3 percent in March and a mere 1.9 percent in April.

That’s not to say the ruble has not been battered by the current crisis, which is considered the worst since 1998’s total meltdown of Russia’s financial system, as the chart of the weekly exchange rates of ruble vs dollar shows. But how can the value of the ruble in Russia’s petro-dependent economy defy gravity so easily? 

CBR to the rescue

One of the reasons why Russia is expected to weather this crisis a lot better than many of its emerging-markets peers is that Central Bank of Russia (CBR) governor Elvira Nabiullina allowed the ruble to float freely as part of her response to the 2014 oil shock, when oil prices collapsed the last time.

As bne IntelliNews has argued elsewhere, the Kremlin is fixated on preserving Russia’s foreign exchange reserves, which totaled US$569.7 billion as of April 1, because it regards them as a strategic asset. The size of Russia’s reserves means it is impervious to sanctions as it can simply buy its way out of trouble if the US imposes harsh sanctions, without the need to borrow on the international capital markets that would make it vulnerable to sanction pressure.

The CBR has shown it’s prepared to allow the exchange rate to take the brunt of the oil shock to preserve those reserves, and has not been defending its currency, unlike many countries, Turkey notable among them, that have also seen their currencies collapse. Moreover, the money in the NWF also won’t be used to defend the ruble as that money is solely tasked with supporting the budget and covering the 3–4 trillion-ruble federal budget deficit expected this year.

During the 2014 oil-price shock, the ruble also tanked, and by a lot more. Before that crisis, it had been trading at about 35 rubles to the dollar for several years, but it suddenly dropped to a nadir of circa 80 to the dollar.

Investors freaked out and called Nabiullina reckless and incompetent, but then, as now, she refused to burn through Russia’s reserves to defend an indefensible exchange rate.

That crisis started in October and peaked in December, when the CBR finally imposed a 17 percent emergence rate hike on December 16, 2014 to put a floor under the collapse of the currency. The ruble has lost a lot less value than it did in those few months in 2014, which has meant both the investors and the population have greeted this crisis with greater calm than in 2014. And it also means the economic damage done by this crisis – as far as currency effects are concerned – is mild by comparison.

Amazingly, unlike 2014, when the CBR made the biggest one-off rate hike in Russian history, the CBR actually cut rates by an aggressive 50bp at its last policy meeting in April to 5.5 percent, in an effort to give the economy a growth-boosting shot in the arm. April’s cut in rates demonstrates an entirely different mindset.

Usually, during a crisis, emerging-market central banks are forced to hike rates to protect their currency, as Russia did in 2014, whereas developed-market economies cut them to boost growth. And, indeed, the first thing the US Federal Reserve did in April was cut US interest rates to zero.

Nabiullina had a difficult choice in April, as she could have gone both ways: cut rates to boost growth, or hike rates to head off inflation caused by the devaluation of the ruble. But it is a testimony to the effective management of Russia’s central bank since she took over in 2013 that she had a choice, and ended up choosing the developed market’s response to a nasty external shock. 

Defending the ruble

The CBR abandoned the “ruble exchange rate corridor” at the end of 2014 – a mechanism that had been in place for almost two decades and obliged it to manage the value of the ruble’s value and stop rapid devaluations.

Russia’s reserves fell this year from a peak of just over US$580 billion to just under US$570 billion as of the start of April, but most of that fall is due to foreign-exchange revaluation effects of the assets the CBR uses to hold Russia’s reserves. The CBR has spent a mere circa US$2 billion of actual cash in the past month in money-market interventions to smooth out the fall in the ruble’s value, which is very little.

Indeed, astonishingly, Russia’s reserves have actually increased this year, by just over US$7 billion from US$562.3 billion, as of January 1. The reserves fell slightly from US$570.3 billion in February to US$563.4 billion in March, but, amazingly, then grew again in April to the current US$569.7 billion.

The CBR will not touch Russia’s foreign-exchange reserves to defend the value of the ruble, and it can’t use the money in the NWF either, which technically belong to the Ministry of Finance. However, the government has come up with a dodge to make more dollars available to the CBR to defend the ruble, which explains its gravity-defying performance over the past two months.

On April 11, the CBR rushed through a deal to sell its 50 percent+1 stake in the state-owned retail banking giant Sberbank to the Ministry of Finance for 2.14 trillion rubles (US$29.1 billion). The change of ownership solves several problems in one go. First, the central bank was in the uncomfortable position of both being the banking-sector regulator and the owner of by far the largest bank in the sector. Now that bank is owned by the Ministry of Finance, which is how it should be.

Second, the deal will put more money into the budget. Sberbank is the most profitable bank in the sector, and recently promised to increase its dividend payments to 50 percent of its income, because the government increasingly uses dividends to tap the profits of its best companies, rather than taxes. However, the CBR regularly held back part of those payments to keep on its own balance sheet.

Now, all of Sberbank’s dividends will be paid directly into the budget. Third, the deal, in effect, provides a back-door route for the CBR to tap the NWF, giving it cash to spend in the money markets to defend the ruble. The Ministry of Finance paid for the deal using NWF money, which has now dropped to about 9 trillion rubles.

This last point is key, as the CBR’s alternative to holding up the ruble’s value was to hike rates again, which would have killed off whatever growth the Russian economy is due to put in during its recovery from April’s crash.

Just how the CBR will use this money remains unclear, but the US$29 billion it now has is thought to be enough to defend the ruble until September, by which time the government hopes the situation will have stabilized and oil prices will have recovered enough to take the pressure off the government’s finances, especially after the OPEC++ production-cut deal that will reduce production of oil by 9.7mbpd and was signed on April 13.

“The CBR will be gradually selling [the US$29bn] until the end of September, [as long] as the price of Urals stays below US$25 a barrel,” Ivan Tkachev, the economics editor of RBC, said in a recent article.

“Since the onset of these interventions, the [Russian benchmark blend] Urals price has never exceeded the threshold, and the CBR sold more than US$2 billion in April. The more Russian oil deviates from US$25, the higher the amount of currency sold by the CBR. Thus, the central bank is effectively compensating for the shortfall of export earnings, supplying the domestic market with that amount of currency as if the Urals price was US$25.”

The CBR’s currency sales will automatically protect the ruble from depreciating too much while oil prices stay low, and buys the government five months of time for the worst effects of the crisis to fade. At US$25 per barrel, the estimated fair value of the ruble is 75–76 rubles to the dollar, estimates Tkachev.

The price of Brent was US$30.97 as of May 9 and the value of the ruble was 73.4 rubles – slightly better than Tkachev’s lower band estimate of oil and exchange-rate forecasts. And the Sberbank money is not the only resources that the government has brought to the ruble’s defense. In addition to the CBR’s own operations, the Ministry of Finance also sells currency on the money markets. The CBR’s statistics aggregate data on both mechanisms, since it’s the CBR, which is the currency sales agent in both cases, says Tkachev.

“Unlike the CBR’s variable sales, the Finance Ministry’s operations are fixed one month in advance. In April, its daily foreign-currency sales amount to the equivalent of 3.5 billion rubles (circa US$46 million). But from March 10, when the CBR launched currency interventions on behalf of the Ministry of Finance, until April 22, more than US$5 billion was sold using both channels,” says Tkachev.

The sale of dollars under the fiscal rule is not happening, as oil prices are under the key US$42 per barrel level. However, on May 8, the CBR formalized an informal ‘auxiliary fiscal rule.’ The CBR announced that it will intervene in the foreign-exchange markets when Russia’s Urals blend of oil (which usually costs about US$2 less than Brent) drops below US$25.

That means the CBR will sell an additional US$0.5– 1.5 billion on the open market for every US$5/bbl decline in the Urals oil price below the lower threshold, analysts at VTB Capital estimate.

“That’s the main reason the ruble has not followed oil prices down in their dramatic plunge,” says Tkachev.

This article also appears in bne IntelliNews.

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