Why did the Russian rouble drop and where is it headed?

Western sanctions, a cap on the price of Russian oil and a surge in imports have weighed on the currency

The rouble slid past the value of 100 to the US dollar on Monday and hit its cheapest since the immediate aftermath of Russia’s invasion of Ukraine. EPA
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The Russian rouble, which plummeted to a new low against the US dollar earlier this week, has recovered following rapid policy action but remains under pressure as Moscow continues to face macroeconomic challenges.

The rouble slid past the value of 100 to the US dollar on Monday and hit its lowest since the immediate aftermath of the country’s invasion of Ukraine in February 2022.

In an attempt to stem the decline, Russia’s central bank called for an emergency meeting and then raised interest rates by 3.5 percentage points to 12 per cent on Tuesday.

While the move helped the currency gain some ground – it was trading at 95.25 per dollar as of 5.40pm UAE time on Wednesday – analysts expect that recovery will remain slow.

“Western sanctions, a cap on the price of Russian oil, and a surge in imports are to blame,” said Stephanie Kennedy, economist at Julius Baer.

“Often currency collapses are prompted by nervous international investors or fleeing domestic capital. Sanctions and capital controls have left Russia isolated from the international financial system. Therefore, trading in the rouble, especially against the US dollar, remains thin.

“Thus, it is not speculative momentum that caused the devaluation, but headwinds from the relative flow of exports (which earn foreign currency) against imports (which must be paid for with these earnings).”

The rouble has lost a quarter of its value against the US dollar this year, even as inflation in the country has risen.

“The structural backdrop for this depreciation has been increases in the fiscal deficit and last year's big cuts in Russian interest rates,” said Douglas Greenig, chief executive and chief investment officer at asset manager Florin Court Capital.

The Bank of Russia previously announced an emergency rate increase in late February last year, right at the start of the war, raising the rate to 20 per cent. It was gradually lowered to 7.5 per cent as inflation eased.

“Given the global geopolitical situation, Russia certainly wants to maintain a surplus position, and that would entail tighter policy. So, the jumbo policy rate hike to 12 per cent makes sense and is a meaningful step,” Mr Greenig said.

“My view is that the Bank of Russia and the government will be prepared to tighten policy further if stability requires it.”

However, economists had believed the central bank would raise rates only to 9 per cent by the end of this year, according to Ms Kennedy.

“While the [Bank of Russia] may hike another 100 to 200 basis points to address the slump, aggressive hiking as seen during the beginning of the war seems unlikely,” she said.

“Higher interest rates would hurt mostly consumers and local businesses, thereby undermining the backing of the population for the war further.

“Instead, we expect the [Bank of Russia] to double down on capital controls and the rule that exporters must exchange their earnings from US dollars into roubles.”

Russia’s value of exports has slumped since the G7 group of countries imposed a $60 price cap on Russian oil in December, while imports have surged.

A cheap currency raises the rouble value of the government’s oil revenues, but it also increases the cost of imports.

This has led to a sharp fall in the country’s current account surplus.

The current account is projected by the central bank at around $50 billion in 2023, compared to $233 billion in 2022.

"Russia energy exports have generated hard currency inflows since the Ukrainian invasion and despite the seizure of international reserves, Russia kept generating current account surpluses that kept the currency strong," said Carlo Morelli, portfolio manager at investment company Azimut.

"However terms of trade worsened for Russia lately as exporting commodities prices softened in 2023."

Russian energy revenues have been considerably lower so far in 2023 versus the same period last year, added Mr Greenig.

"So, Russia's current account surplus has been under pressure in 2023,” he said.

In June, Andrei Belousov, Russia’s deputy prime minister, said the value of 80-90 roubles a dollar was best for the country’s budget, exporters and importers.

The rouble trading reaction no longer follows the dynamics of a widely traded currency since sanctions on direct investments/capital flows and financial system limitations – Russian banks still don’t access SWIFT – have significantly limited the tradability of the currency, Mr Morelli said.

"International investors therefore no longer take positions on [the rouble] and the reaction function of higher rates is limited to the effect of ... curbing local consumption and imports of consumer goods and ... enticing more Russian individual and corporates to save in [roubles] on higher yielding accounts instead of keeping balances in [US dollars]," he said.

Looking ahead, the rouble remains under pressure, Ms Kennedy said.

“We reiterate our target of [92 roubles to a dollar] in three months and [95 roubles to a dollar] in 12 months. While this means a spot appreciation, which is accompanied by a sizeable carry, the rouble is hardly tradable and uncertainty about the outlook is high,” she said.

Updated: August 17, 2023, 6:32 AM