Is the Ruble Undervalued?

The Russian government officials keep saying that the ruble is undervalued. Relative to what? To itself and other currencies. For this, we again need the purchasing parity factor.

The ratio of purchasing power parity conversion factor (PPP) to the currency exchange rate (FX) indicates by how much the local currency is “undervalued.” Now, the PPP/FX ratio less than 1 means you can take $1, exchange it to rubles in Russia, and buy more stuff than you could buy on the same $1 in the States. The parity is computed for comparable goods and services. And it can’t be very low, because otherwise cheap import from Russia would raise the ratio by reducing FX.

This is how the fall of the ruble affected Russia’s PPP/FX ratio:


So, the density of the ratio across countries. Before 2014, Russia was near the mean, that is, no special underappreciation. But in December 2014, the ruble fell so deep that it immediately moved the Russian PPP/FX ratio into the zone where you see no countries at all.

The ruble is traded around 60, which still implies the ratio (0.3) way below the inhabited zone. It does mean that the ruble is undervalued by purchasing parity. The market faces a short-term dollar shortage, which pushed the exchange rate up in the absence of the main holder of foreign currency accumulated during the recent 15 years—the central bank. Yet, we don’t know the 2014 Russian GDP deflator to adjust the ratio’s numerator (0.3 is biased downward), but it should be unrealistically huge to change the fundamental value of the ruble and prevents its appreciation.

As for the ruble’s dependence on oil, annual averages of oil prices are still high; while in terms of daily prices, the ruble happened to fall deeper than oil. This deeper fall may be just a matter of volatility, but one fundamental factor here is the cost of extraction:

Morgan Stanley
Morgan Stanley

Compared to the Persian Gulf, oil from Russia has lower quality and more complex extraction processes. Revenues are lower and costs are higher, so the breakeven price of Russian oil is higher. As the market price is getting closer to the breakeven price from above, you can expect negative consequences for the entire Russian economy, starting from lower profit margins (the current margins) and lower investments in extraction. These secondary effects drive the ruble down faster than the oil price alone does.