Early shift to free-floating policy gives shelter to battered Russian ruble

Scrapping daily currency controls has reduced threat of speculative attacks.Source: TASS

Scrapping daily currency controls has reduced threat of speculative attacks.Source: TASS

Since the beginning of 2014 the value of the ruble has fallen by about 50 percent against the dollar and the euro, a slide most analysts attribute to low oil prices. In the end, Russia's Central Bank decided to bring forward plans to let the ruble float freely on financial markets. The move is advantageous for the Russian government, since it leads to the reduction of a possible budget deficit.

Since the beginning of 2014 the Russian ruble has lost 50 percent of its value in relation to the dollar and the euro. According to analysts, the main reason for the devaluation of the currency is the continuing decline in oil prices.

"Currently, the key factors contributing to the weakening of the Russian currency are the decline in oil prices and other raw assets," says Anton Soroko, an analyst at investment holding Finam.

On Nov. 13 the price of Brent crude fell below $78 per barrel, even though in midsummer quotes were approximately $115. 

The fall of the ruble

According to Soroko, this process is occurring against the backdrop of the dollar's aggressive growth not only in relation to the ruble, but also to the yen, the Swiss franc, the euro and other currencies.

"The dollar's growth first and foremost reflects the shortage of the currency on the market, which is due to the increase in demand," says Mikhail Khromov, scientific collaborator at the Center of Structural Research of the Russian Academy Institute of Applied Economic Research.

"The decline in oil prices is the main indicator, but for now it affects only expectations, since investors are afraid of a decrease in Russia's export revenues."

According to Khromov, the second factor influencing the ruble is that, due to the sanctions on Russia and geopolitical instability, the country has no foreign capital inflow.

In response to the decline in the ruble's value, Russia’s Central Bank carried out a series of currency interventions at the beginning of October. To reduce demand for foreign currency, the regulator began selling dollars in order to support the ruble's value.

In October 2014 the Central Bank spent almost $29.3 billion supporting the ruble and in the course of nine days beginning at the end of October it sold more than $2 billion a day.

"This way the regulator only smoothened out the market fluctuations, but did not try to stop the current descending trend in the Russian currency," asserts UFS IC's chief analyst Alexei Kozlov. However, the large-scale intervention did not produce results and on Nov. 7 the Central Bank decided to let the ruble float freely.

Influence on the budget

It was initially assumed that the Russian ruble would switch to a complete free float, however, in view of the pressure on the national currency the Central Bank decided to accelerate the process.

According to the new strategy, the Bank of Russia will not carry out full-scale currency interventions, that is, selling dollars on the Russian market. The maximum value of a Central Bank sale will be $350 million a day, which, analysts say, will not affect exchange rates. The Central Bank's press office explains that refusing unlimited currency interventions will deter speculators from betting against the ruble.

The decision has led to a dramatic change in the exchange rate: In the course of trading on Nov. 8 the ruble simultaneously fell by about 10 percent to the dollar before rebounding and practically canceling out the decrease.

"The Central Bank's decision falls into the strategy of switching to inflation targeting, a part of which is the free float of the national currency," explains Dmitry Bedenkov, director of the analysis department at Russ-Invest. 

At the same time, Bedenkov says that the Central Bank has reserved the right to intervene with more than the $350 million announced if it senses a threat to the ruble's stability. The establishment of daily intervention limits on the borders of currency corridors is intended to lower the pressure on Russia’s gold reserves, adds Bedenkov.

The weakening of the ruble is also advantageous for the Russian government, since it leads to the reduction of a possible budget deficit. According to Anton Soroko, the fall of the ruble has a positive effect on the budget, since it helps compensate for the fall in revenues of oil and gas sales. The lion’s share of hydrocarbons is sold in dollars and euros, while the Russian budget is drafted in rubles.

The weakened ruble also places the Russian producer in an advantageous position since the value of imports increases, thus helping Russian producers to compete more successfully with foreign producers.

Mikhail Khromov dismisses widespread fears that the low price of Brent will leave a hole in the Russian budget, which currently requires an oil price of just under $100 a barrel to avoid a deficit.

"The average annualized price of oil remains above $96 per barrel (the Russian budget is based on this price) since in August the price of oil was $106, and even if oil will cost $85 until the end of the year, the average annualized price will still be about $100, which does not pose any risks for the budget," he says.

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