Weakening Russian Ruble (RUB) and Rising Inflation
Increase Interest Rates and Capital Restrictions? Impact on the Population.
Dear Subscribers,
“Barbershop Whispers….Russia” begins with “My Takeaways”on the main topic followed by the main topic discussion. The last two sections of “Barbershop Whispers…Russia” will be follow-ups from previous publications and emerging events.
In the previous issue, I discussed the Central Bank of Russia’s (CBR) frozen foreign reserves, the economy, and the weakening RUB. As expected, the RUB breached the psychological barrier of RUB100/USD this past week.
This issue will focus on the CBR’s action to stabilize the RUB, curb inflation, and the impact inflation and RUB weakness is having on the average citizen.
My Takeaways:
The root cause of RUB decline and rising inflation is Putin’s war. The CBR’s ability to effectively manage these two important variables will be a function of the war’s duration and the associated sanctions. The longer the war goes on, the more difficult it will be to control rising inflation and the weakening RUB;
In the next couple of months, the CBR will be forced to formalize capital controls and raise the interest rate again, in order to stabilize RUB and control inflation. The recent 350bps increase in the interest rate will, in and of itself, prove a temporary solution. Again, this will be a function of the duration of the war;
The CBR will not intervene in the currency markets to protect the RUB. This would be a last resort action putting at risk the precious $300B in unencumbered foreign reserves;
Putin is under pressure to maintain the population’s current standard of living against the impact of inflation. To do so, he will need to raise pensions and minimum wage by the end of the 2023 and probably again in Q1 2024. These moves will help improve voter turnout, bolstering election legitimacy in the absence of any real opposition candidate (outside of Alexander Sergeyevich Pushkin).
What Happened to the RUB, Why, and What Action is to be Taken?
The RUB appears to be stabilizing in the mid 90s/USD after CBR Governor Nabiullina called an emergency policy meeting on Tuesday (15 Aug) that ended in a 350bps increase in the CBR’s key rate to 12%. The policy meeting and interest rate hike was driven by Monday’s psychological breach of the RUB100/USD barrier. Since the start of the year, RUB has lost 30% against USD.
(Source: Central Bank of Russia)
Shortly after the second invasion (Feb 2022), the RUB fell precipitously from 74 to 120/USD. In the aftermath of this crash, the CBR immediately raised its key rate to 20% and put strict capital controls in place, forcing exporters to convert 80% of their hard currency receipts into RUB. These controls were removed in May 2022, allowing exporters to retain their hard currency revenue, and the CBR cut its rate down to 7.5%, and the RUB recovered to around 74/USD.
But in the weeks leading up to the RUB100/USD breach that took place on Monday (14 Aug), government officials were putting pressure on the CBR to act against the weakening RUB and curb rising inflation. Maxim Oreshkin, Putin’s economic advisor, wrote in an op-ed for the TASS news agency:
"The main source of ruble weakening and accelerating inflation is soft monetary policy," …
“the CBR has all the necessary tools to normalize the RUB and curb inflation”. “A weak ruble complicates the restructuring of the economy and negatively affects the real incomes of the population…”
Adding to the pressure was the popular pro-Kremlin talk show host Vladimir Solovyev, who launched into an expletive-ridden tirade on air attacking the CBR:
"...every other country is laughing at us, at our ruble being one of the three weakest currencies, thanks to the 'genius' policy of the central bank,"
The CBR blames the country’s shrinking balance of trade, as Russia’s current account surplus fell 85% year-on-year from January to July. This is a direct consequence of western sanctions, particularly the loss of hard currency receipts from reduced natural gas exports to Europe.
In the end, though, the root cause of the weakening RUB and rising inflation is Putin’s war. The war has resulted in labor shortages – young men are being conscripted, thus taken out of the work force to fight, or emigrating to avoid conscription – the loss of export revenues due to tightening western sanctions, the higher cost of imports (due again to western sanctions), and continuing capital flight.
Putin met with his cabinet ministers this week to discuss additional options to rein in inflation and stabilize the RUB. According to Vedomosti, present in these meetings were CBR Governor Elvira Nabiullina, Finance Minister Anton Siluanov, Presidential Assistant for Economic Affairs Maxim Oreshkin and Economic Development Minister Maxim Reshetnikov. More importantly, the executives from Russia’s largest exporters were also included in these discussions, reportedly including senior executives from PhosAgro, Rusal, Evraz, among others. The discussions with the exporters focused on the sale of foreign exchange earnings – the conversion of hard currency into RUB. As a result, the exporters and the government struck an informal agreement to increase the volume of conversion. The informal agreement is a form of jawboning, in central bank speak, and sends a signal to the market ‘all is under control…stay calm’. It also preserves the CBR’s option to formally enact capital controls in the future if the need arises.
The CBR still has the option to intervene in the currency markets using its $300B of unencumbered foreign reserves. This is unlikely to happen now, as this would be an option of last resort. While a respectable sum, $300B can be depleted very fast in an uncontrolled downward sell off, akin to a bank run.
The Impact of Inflation on the Population:
There is growing concern about the rising cost of living and inflation among the general population. This is evidenced by a 70% year-on-year surge for mortgages, as consumers seek safe assets for preserving wealth, instead of holding RUB cash in the banking system. Another worrisome indicator is the costs of imported inputs for medications, which rose 40−100% year-on-year for the January-May period.
In 2022, the Kremlin increased pension payments and the minimum wage by 18% to help cushion the impact of rising inflation caused by the war. No doubt more hikes will be needed before the end of 2023, and certainly before presidential elections in March 2024. These additional hikes should improve voter turnout in the upcoming presidential election, particularly among pensioners, and send a message that the government is acting to protect their standard of living against inflation.
The middle and upper economic class of Russian society, accustomed to vacations on the Black Sea, if not farther abroad, are having to forego these vacations because of higher travel costs (driven by the weakening RUB) as well as international restrictions on Russian airlines. Just last week, Russia’s Red Wings airline had 400 passengers stranded in Antalya (TR) for two days because the planes broke down. Airlines are resorting to stripping parts from other planes because sanctions prevent them from purchasing spare parts through the regular distribution channels.
This week I spoke with a Russian consumer in Moscow who told me two years ago he traded in his old car for a different, used import model; the car is now worth twice as much in RUB as his original purchase. This illustrates both the severe decline in the RUB — in dollar terms the value of the two cars would be roughly the same — as well as the growing deficit of high-quality import vehicles in Russia. Another Moscow resident told me how the communal and utility payments for their apartment in the suburbs — water, gas, garbage, building maintenance, etc. — had doubled over the last two years. For the pensioner on a fixed income, this latter consequence of rising inflation is challenging.
(Translation: The carrier of power in the Russian Federation is its multinational people)
While rising inflation, deteriorating standard of living, and a weakening RUB is a growing concern with the average Russian, this concern has not yet reached the tipping point for civil unrest or representing a real threat to Putin’s power.
Follow-ups & Quick Bites:
Follow-Ups:
This issue’s main topic - “Weakening Russian Ruble (RUB) and Rising Inflation” is essentially a follow-up from the previous publication.
Quick Bites:
Food for Thought as it applies to Post-Putin Russia
This week saw two interesting independent pieces about Russian democracy. First is “‘I Can’t Stand the Goat, but I Hate Those Who Let it Get the Cabbage’” by Alexei Navalny, Russian politician and dissident now serving hard time in Russian prison. And the second is “Why Russia’s Democracy Never Began”, by Maria Snegovaya, senior fellow at the Center for Strategic and International Studies in Washington, D.C..
Both pieces together offer insight into how Russia became what it is today, and how previous mistakes may be avoided in the event Russians get another opportunity to create a state that works for all Russians, not just a small, powerful elite.
Regardless of your position on Navalny – love him or hate him – if you spent time in Russia in the 90s and 00s, you will recognize the selective application of law in his description of the self-dealing of the reformist business and political class during those critical years when a rule-of-law-based democracy was being formed. As Navalny described the “goat” walking into positions of power at the invitation of the reformers, it reminded me of Lenin’s description of seizing power in the vacuum of power, not from the Soviets, but on behalf of the Soviets. In the 90s and 00s, the goat seized power on behalf of the reformers.
In “I Can’t Stand the Goat, but I Hate Those Who Let it Get the Cabbage”, Navalny blames the reformers — whom he once admired and followed — for the authoritarian and corrupt state of Russia today. Their self-dealing actions, the absence of principles, and the selective application of the rule of law allowed “the goat” to take power and do as it pleased – eat all the cabbage – because that’s the only thing the goat knows to do. However, Navalny is optimistic that Russians will have another chance to create a democratic Russia that serves the people instead of a corrupt elite.
In “Why Russia’s Democracy Never Began”, Maria Snegovaya opines that Russia never had a chance for democratic reform, because those responsible for the reforms were the same unreformed nomenklatura politicians that were responsible for the collapse of the Soviet Union. In the interest of clarity, I have posted the abstract below:
“Scholars often blame Russia’s recent re-autocratization on mistakes of individual leaders: Yeltsin or Putin. This essay casts doubt on such accounts. It argues instead that after the collapse of the Soviet Union, Russia experienced not a democratic transition but a temporary weakening of the state (incumbent capacity). This is evidenced by a lack of elite rotation and the preservation of the same type of formal and informal institutions that characterized Russia’s political system in the past. Accordingly, subsequent re-autocratization of Russian politics was just a matter of time.”
Both are worthy pieces and should be considered as Russia will soon embark on a transition to a post-Putin era.
Black Sea Grain Exports:
Before the second invasion of Putin’s war, 90% of Ukriane’s grain exports went via the Black Sea corridor. Since then, the EU has established ‘solidarity lanes,’ and these alternative routes now account for nearly 60% of Ukrainian grain exports. Since May 2022 over 45 million tons of grains have been exported via the EU solidarity lanes. In comparison, as of July 2023, around 33 million tons of grain was exported under the Black Sea Grain Initiative, the agreement brokered by the UN and Türkiye that includes Russia’s participation.
Cracks of EU solidarity around the ‘solidarity lanes’ are beginning to appear, because of the limited infrastructure export capacity of these routes. Ukrainian grains are piling up and competing with the EU’s own grain exports, thus threatening the export revenues of EU farmers. Many of these EU countries have upcoming elections and their politicians will need to re-negotiate the terms of the ‘solidarity lanes’ for Ukrainian grains to satisfy their constituents.
The EU negotiations with Ukraine on these alternative routes, along with Chinese and Turkish pressure on Russia to rejoin the Black Sea Grain Initiative, are areas to watch over the next couple of months.
Vol 1, No 7 - BWR 19.08.2023
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