Russia’s Ruble Dips to New Lows, But Moscow is Managing

The ruble plunged to new lows today, exceeding 80 to the U.S. dollar for the first time ever. The slump in oil prices – now at $28 per barrel compared with over $100 two years ago – has dragged Russia’s currency down with it. Russia’s government depends on oil earnings for about half of its tax revenue, and commodities constitute the vast majority of the nation’s exports. So the commodity crash has created the most painful recession since the 2008 financial crisis, with Russia’s economy shrinking by about 3.8 percent in 2015. Is Russia now on the brink of financial collapse? And how will the economic crisis affect Russia’s foreign policy?

From the Russian government’s perspective, the depreciation of the ruble over the past week from 75 down toward 80 to the dollar is actually a positive move. The reason is that Moscow earns most of its revenues via taxes that are de-facto dollar denominated – above all, by taxing oil production and exports. But government expenses are in rubles. Because of this, when the ruble falls against the dollar, moving from 75:1, say, to 80:1, the government collects more rubles in taxes.

That is important because government expenses – pensions, salaries, military kit, and the like – are paid in rubles. By decreasing the value of the ruble against the dollar, the government earns more rubles and can thereby more easily meet its spending requirements.

At times when the government is running a large deficit, devaluation can help balance the budget. The Kremlin was going to struggle to hit its 3 percent deficit target this year given its oil price forecast of $50 per barrel – nearly twice the current price. Unless the oil price picks up in the coming months, that target looks highly unlikely. But by letting the value of the ruble fall, the government can counteract some of the negative budgetary effects of the price slump.

Letting the ruble fall against the dollar is by far the best way to adjust to the crisis. If Russia attempted to maintain the value of the ruble, it would have to spend down its over $300 billion in reserves, and it still would have struggled to counteract the powerful forces dragging the ruble downward. By letting the ruble depreciate, the Kremlin spreads the costs of adjustment across the population. Because of this, widespread discussion in Western media about the scale of Russian reserves is irrelevant – Russia isn’t spending reserves to fight the devaluation, it is welcoming it. That is why Russia’s reserves have stayed basically constant over the past year. Given current oil prices, the Central Bank would likely tolerate if not welcome some further depreciation.

The slump in the ruble is of course not a cost-free strategy. It imposes a “tax” on all holders of rubles who would like to purchase goods priced in foreign currency. Because Russia imports many consumer projects, from food to clothes to electronics, this means that almost every Russian is affected – not only the wealthy. The lower value of the ruble makes imported goods more expensive, driving up inflation. Because of the recession and the budget crunch, wages and pensions have increased only slightly over the past year. If you factor in the price increases of imports, the real value of most Russians’ wages and pensions have fallen.

The other main risk of a lower ruble is to the banking system. Many Russian banks have borrowed dollars or euros, but make profits in rubles. Now they need twice as many rubles as two years ago to pay back this debt. Worse still, many of the clients these banks lent to are in a similar position. Russian firms are struggling to pay off or refinance foreign currency debt.

If the ruble continues falling, making repayment of foreign currency debt ever harder, there is a risk that Russia’s banks go bust and the financial system stops functioning. But the government is aware of the risk, and has taken significant steps over the past year and a half to clean up poorly-managed banks and limit risk. The central bank has also offered long-term dollar-denominated loans to Russia’s banks in order to help them service customers who wish to refinance foreign currency debt. It is now easier and cheaper for many Russian firms to borrow dollars in Russia than to seek credit abroad. For now, the government has capably managed financial sector risk.

What does this mean for Russia’s foreign policy? There are two schools of thought. The first is that, given the upcoming Duma elections in September, the Kremlin may decide that the economic mess means that it has to campaign on its foreign policy “successes.” That could mean a more adventurous foreign policy, despite the costs such a decision entails.

The more optimistic view is that the oil price slump and the struggle to balance the budget will empower Russian elites who want to cut military costs and improve relations with the West. The recent flurry of diplomacy between Russian, Ukrainian, and U.S. officials may suggest that Russia’s position in Ukraine has softened. If that turns out to be true, it will not be the first time that Russia’s foreign ambitions were deflated by a plummeting oil price.