Russian (T)Rouble

By Giacomo Saibene

What’s happening in Russia? Well, the exchange rate is skyrocketing, from 35-40 RUB per USD in the summer to about 60 RUB per USD in the last few days. Also, the oil price is plummeting, trading at about a 40% discount compared to last summer.

Let me offer a couple of reasons about why is this bad for the Russian economy:

  1. Falling oil price means falling profits for oil-related businesses. As Russia is an oil-exporting country, this fall in prices must be hurting some Russian businesses. Yes, but why should we care? Who are the owners of Gazprom? That is, we may wish to find other reasons why is this so bad for the Russian economy – and not just for a bunch of oligarchs.
  2. The other candidate is the exchange rate, which is depreciating at record speed. In principle, we should not care much about it as well: indeed, nowadays businesses are very integrated across countries, with business units spread all over the world and sales and costs denominated in very different currencies, which are usually even hedged through futures and forward contracts (at least for periods ranging from few days to several months). Hence, it’s not the level of the exchange rate per se that matters, at least in the very short term, but it’s mainly its sudden drop that, inducing panic and uncertainty, causes temporary disruptions in the real economy:
    1. In the banking sector, Russia is on the edge of a financial crisis, as banks’ collateral (i.e. Russian government debt) suddenly lost a lot of market value. As a consequence, interbank lending may collapse and ­­– let me stop here, we already know how the story could go on.
    2. In the commercial sector, you see people rushing to shops to buy any kind of durable or nondurable goods ­– to get rid of their roubles as soon as possible, worrying that tomorrow’s money will not be worth as much as today. This spike in the expected inflation rate, which is boosting consumption, goes along with a spike in the actual inflation rate, which is not a sign of an overheating economy, however, but is in fact just imported inflation. This is bad for Russians not only because they cannot afford any more iPhones or BMWs [2] or travelling abroad (which is a ‘de facto’ travel ban, without even the need to introduce exit visas or build an iron curtain!), but also because their savings are losing value in real terms. While the former outcome has just a negative impact on Russian imports, i.e. rest of the world’s exports, including ours, the latter outcome implies that Russians are willing to consume less, since their wealth is losing value; this is clearly a negative net contribution to GDP growth.

Yet, these are all temporary problems: if the run on the rouble ends tomorrow and the currency recover its value, everything will be back to normal, as it was few weeks ago ­– more or less. Moreover, there is no “fundamental” problem on the current account side: Russia exports more goods than it imports. So, there is no risk of “starving” because you have not enough home-made goods to exchange for foreign goods.

Therefore, is this just a temporary panic and everything will be all right in a few weeks? Well, maybe. But there are also some other risks, which may have long-lasting effects on the Russian economy. Indeed, currency devaluations may be especially harmful in a very precise way: when you have debts denominated in currencies other than your own. Like in Asia 1997, when a crisis that had all the characteristics of being self-fulfilling (i.e. not caused by any particular or real problem) proved to be particularly damaging for the economies involved. Here’s the story, made short. When you have to pay back debts that are denominated in euro or dollars, but your currency halves in value on the foreign exchange market, then your debts (when you have to pay back them, either interests or principal repayments) are worth twice in real terms, as long as your revenues are priced in your own currency. Therefore, either you cut on new investments and/or sell your assets (potentially, in a fire sale scenario, i.e. when everybody sells and prices plunge), or you go directly out of business, defaulting on your debts and other obligations. This causes GDP to plunge, and may have damaging long-term consequences, as broken business do not easily come back to life. There is a whole economic literature on this topic, on which I even wrote something few years ago [3]. But what about Russia right now? We don’t exactly know the extent of its foreign currency-denominated debts; but there must be some, for sure, as Gillian Tett puts it.

The bottom line is that a sharp currency devaluation may create real damages, even very big ones. Therefore, we can only hope that the fall is just temporary and everything will be back to normal (very) soon, so that the time to create real damages is as short as possible. To understand if this is possible, we need to investigate the reasons of all this.

Why is this happening? First, we may think of global factors, e.g. FED’s tapering that brings dollars back home leaving emerging markets with massive outflows of cash. But this is clearly not the case. Hence, we must conclude that it’s really a Russian-specific issue: first Crimea, then military aircrafts flying over Sweden… what about selling my Russian assets and, say, buy some of those nice Swiss assets?

And we are left with the question: so, what to do? First of all, don’t expect the Russian central bank to solve the problem: do you really think rising rates by 10% or 20% really stop this, without causing any harm? Or selling $200 billions or more of reserves? They can try, of course, and it may even work, but the outcome is not obvious and many things may go wrong. Probably, the best [4] way to cope with this currency crisis is to impose capital controls. Malaysia did it back in the nineties; some Russian neighbors are starting to do this right now. But, again, is not an easy solution.

In my view, the answer to this crisis must come from politics: we need to get back to a friendly relationship between Putin and Western politicians – which is not what’s happening right now. We don’t really need to go back as it was in the ‘good old days’ [5],when our Prime Minister Berlusconi was Putin’s best friend, but we need something at least in that direction.

In the meanwhile, what can we do, in our little own? Best thing to do is not to panic. Then, of course, a risky bet with a potentially very high payoff is to buy Russian assets, especially if the ruoble recovers to pre-crisis levels. However, the longer the ruoble stays depreciated, the higher the real disruptions it causes. And I am worried that Putin will not fix this soon… To conclude, let me get to the easy advice: go to Russia for holidays; it’s really cheap right now.

More on this story: Paul Krugman blog, Tyler Cowen’s Marginal Revolution, the Economist, Menzie Chinn onEconbrowser, or the classic Financial Times.

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