Russian Government Needs Weak Ruble

During the last two weeks, the media say about the central bank of Russia defending the ruble. Though the bank did spend $110 bn. forex reserves over this year, the statement is not entirely correct.


Officially, the central bank is moving to the free-floating ruble. Kinda surprising for a petrocurrency, but the bank’s recent actions should be seen from this perspective.

The other important point concerns political consequences of exchange rate changes. The Russian general government budget infamously depends on oil prices. Falling oil prices have two effects. First, it’s a net loss because fossil fuels get sold for less. Second, the Russian tax system ensures that the central (federal) government remains a relative winner. Oil and gas exporters pay taxes proportionally to their forex revenues and pay them in rubles to the central government. Changes in exchange rates compensate the loss of dollar revenue, so the federal budget escapes a huge deficit. The central government is even a bigger winner under the free float regime, when the ruble rapidly depreciates after sanctions and declining oil prices:


Given the float currency policy and central government interests, the strong ruble has no strong supporters in Russia. The central bank spent $110 bn. trying to avoid sharp moves in exchange rates. People and businesses massively get rid of rubles when they discover vertical hikes in rates, which are familiar after hyperdepreciation of the 1990s. Government tried to avoid the side effects of rapid changes in exchange rates: bank runs, inflation, and underinvestment.

The central bank sold about 20% of its forex reserves in a year. Meanwhile, the ruble did depreciate with all those undesirable effects. Was it a good idea to free the ruble when (a) state-owned corporations were seeking new sources of capital due to sanctions, (b) oil prices fell rapidly to decade-long lows, (c) uncertainty around Ukraine put pressure on the ruble, (d) import required time to respond to current balance hit by new oil prices? The market needed dollars to soften these shocks. Instead, the central bank quitted in the middle of the game with $500 bn. in forex reserves (25% of nominal GDP).

If not in crisis, what’s a better time for a central bank with a free-floating currency to spend reserves? An even worse crisis! It’s better to be wrong on this, of course, and instead, to assume that government just got the ruble down as smoothly as it could.

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.

Debt and Currencies: The Soviet Connections

To have a currency crisis Russia suffered this week, a country needs two things: a local currency tied to a volatile international commodity and some external debt.

In oil exporting countries, the local currency is tied to your-know-what. As for the second condition, oil exporters are not supposed to borrow abroad when oil makes new highs. However, when the central bank let the local currency get stronger as export bucks flow in, borrowing abroad becomes attractive.

This opportunity is exposed when the PPP conversion factor to market exchange rate (PPP/EX) ratio is growing. And the ratio had been growing in oil exporting countries, though most of them escaped the temptation to borrow abroad:

World Bank
World Bank

(Russia and many others are missing in the World Bank’s data on debt. Among the remaining countries, red stands for energy producers. Negative changes in debt are due to countries (sometimes) repaying their external debts in 2001–2011. The worldwide average of external debt to GNI halved during this decade.)

And absolute values:

World Bank
World Bank, 2001–2011

The debt is an important addition to yesterday’s currency overview. A currency may diverge from its “value,” but it’s external debt what creates risk. The Russian debt to GDP ratio stood still around 35% for years, but this level became a problem when the private sector had lost access to western credits. Kazakhstan isn’t under sanctions, but its 80% debt together with dependence on oil put the country in a similar position. Also, some other former Soviet republics, like Tajikistan, depend on dollar-denominated remittances from Russia—it’s their “oil” risks.

After the Ruble, What Currency Falls Next?

Back to the PPP vs exchange rate disparity that occurred in Russia and might explain the recent ruble crisis:


The Russian PPP factor grew faster than the exchange rate, so by 2012 the difference between the indices of the two reached 1.5. A large difference appears in some countries hit by the 1997 Asian crisis:


Indonesia looks very much like Russia. The media report that the rupiah already fell to its post-1998 minimum and that Asian central bankers are concerned about the ruble.

But Asia is not the worst place. Here’s the distribution of the same indicator across countries:


And the countries with the highest accumulated disparity are:


The group consists of former Soviet republics, oil exporters with weak institutions, and poorest African countries. Runner-up Belarus already imposed a 30% tax on currency exchange (that is, added 30% to the dollar’s price) and raised the interest rate to 50%. Russia is in the middle, surrounded by Indonesia and Moldova. Since after this December, Russia’s coefficient is much lower, of course. Ukraine also devalued its currency this summer and drops out of the list.

Why does this problem appear at all? Apart from the economic literature, there’s a good intuition explained, for example, by Lee Kuan Yew. Very much admired by corrupted autocratic leaders, he recollects that the absence of corruption was the number one reason why Singapore handled the 1997 crisis better than its neighbors. Some countries on the list can’t say the same about themselves. And that makes them the next most likely candidates for big troubles.

A Brief History of Russian Debt

Paul Krugman draws attention to the role of exchange rates in the Russian debt. I’d add a few notes on this in addition to yesterday’s overview.

External Debt Was Cheap

For two reasons:

  1. QEs and zero interest rates made the dollar and the euro very attractive currencies for borrowing.
  2. The ruble appreciated in nominal terms, while its PPP conversion factor (how much rubles you need to buy the stuff worth $1 in the US) grew steadily (Paul Krugman’s point). Here’s the movement between 2000 and 2008:
WDI 2013
WDI 2013

The ruble becomes de-facto weaker (red line), but the exchange rate (green line) moves in the opposite direction. Russian businesses thought that borrowing abroad at low interest rates was a great idea. A corporation borrows a dollar at 1% per year, exchanges it for rubles in 2004, holds rubles for one year while the exchange rate going down, and returns the principal and the interest to the lender in 2005. Okay, corporations did something else to this money and paid a higher interest, but ruble-denominated debt was still more expensive.

The Russian Private Sector Accumulated $650 bn. of External Debts

About 90% of Russia’s external debt is corporate, though the state owns many of these borrowers:

World Bank's Russia Report, 2014
World Bank’s Russian Report, 2014

It Was Time to Pay the Debts

Russian corporations had to pay about $100 bn. of debts by the second half of 2014, when the States and EU lifted the sanctions:

World Bank’s Russian Report, 2014

Meanwhile, the oil prices fell to $60 and the currency inflow halted. This led to the shortage of dollars in Russia, so several big borrowers could break the thin market when they started lurking for dollars inside Russia:


The Central Bank of Russia held about $500 bn. in reserves but it didn’t support the ruble much over the year:

The Economist
The Economist

It didn’t matter than Russia had a current account surplus of about 5% of GDP throughout the 2000s. These $700–900 bn. were export revenues. Exporters converted them into rubles to pay taxes, wages, and other expenses. So, $500 bn. ended in the central bank.

External Debt Became Expensive

The corporate borrowers panicked in December 2014. The Central Bank didn’t offer enough dollars when the market was running out of them. The exchange rate hiked on December 16. This 10% daily hike meant really large annual returns (try to calculate 1.1^365). The dollar became an attractive investment. Not only corporate borrowers, but the entire population wanted dollars for now. Companies and families bought dollars with their savings or newly borrowed rubles.

People also reasonably expected import to become more expensive and started shopping before retailers adjusted their prices for the new exchange rates. It ended with a daily inflation peak because retailers did react to the new demand.

After the government intervention, the ruble stabilized around 60 RUR/USD. But $720 bn. of external debt remained. Corporations now have to pay about 100% of real interest, adjusted for the exchange rate shift. Though many of them are exporters and sell for dollars, Russian banks naturally earn their revenues mostly in rubles, which makes it difficult to pay forex debts. (Banks can buy the dollars back after the hike, but the financial sector has many other problems now.)

Finally, Weather Forecast

Asian countries had a pretty severe recession after the 1997 currency devaluation:


As Paul Krugman noted, broken balance sheets created troubles for these countries. When you borrow the currency that is different from the currency of your operations, well, you must hedge. Did Russian corporations know the Asian lesson and hedge? We’ll see, soon.

Picking the winners is still up to the government. The Central Bank has plenty of options here. It can use the remaining reserves to bring exchange rates down. It can keep the interest rate high (but not for long because businesses need credit). Or it can pick winners one-by-one.

More notes on the consequences are coming.

The Ruble, Russia, and the History of Twelve Devaluations

Bloomberg made the ruble’s collapse look like the end of the world yesterday. It’s not the first collapse of this kind, so let’s put some history together.


The last time the ruble collapsed in 1998, when the Russian government defaulted on its ruble-denominated debt. Economic recovery came immediately. That situation is only tangentially reminds what’s happening now. Right now, it’s the the private sector who is heavily indebted, not the Russian government. Secondly, Russia had several years of recession before 1998, and much physical capital dropped out of production to be available later. As for 2014, physical capital is fully employed and investments are now a huge concern.


In its best years, Russia accumulated forex reserves by running a trade surplus:


The reserves remain in the range from $200 bn. (informal estimates adjusted for “availability”) to $360 bn. (official). The Central Bank provides this liquidity to banks that have to pay their foreign credits and avoids dumping dollars directly into the market. Huge reserves leave an opportunity to wipe out speculators playing against the ruble, but it’d eradicate reserves, which may be needed later to save the Russian financial sector from bankruptcies and their consequences for the economy at large.

That is, the Central Bank ensures forex liquidity for the economy and allows the exchange rates to go up and down. Also, contrary to some media stories, Monday’s interest rate hike addresses inflation, not exchange rates. That’s according to the Head of the Bank.

Other Countries

Twelve countries that had episodes of rapid (and not so rapid) devaluation. The interesting part is (a) what’s happening to output after devaluation, (b) under what conditions the local suggency recovers (hint: low inflation).

Exchange Rate vs GDP

South-East Asia, 1997


Latin America


Exchange Rate vs Inflation

South-East Asia, 1997


Latin America


Bitcoin and virtual currencies reports about half a thousand companies dealing with virtual currencies. CruchBase mentions 17 startups related to Bitcoin alone. Bitcoin was around for five years and attracted attention of the IT community, less of brick-and-mortar sellers and no attention of the finance industry. So, why not?

Critics’ key point about the bitcoin is: it’s not a currency. The plots by David Yermak:

The bitcoin’s value increases over time. Great. You become richer while not spending bitcoins. Hence, very few intend to pay for things in bitcoins. Meanwhile, everyone is glad to accept bitcoins over dollars. And that’s why some sellers integrated bitcoin transactions. They welcome payments in the asset whose value grows effortlessly. Especially if buyers make no adjustments for the deflation and overpay in bitcoins.

Volatility reflects risks, and the bitcoin happens to be a volatility champion among assets. Real prices nominated in fixed bitcoins fluctuate much over very short periods of time. When you have large margins or small number of transactions in bitcoins, it may not hurt. But most retailers are sensible to price changes and have to hedge the risks of even not-so-volatile currencies. Can they hedge bitcoins? Apparently, no:

Well, you don’t even know what asset you should buy to protect your bitcoin holding from sudden movements.

The bitcoin may have something like the Federal Open Market Committee to maintain the exchange rate against the basket of traditional currencies. But the supply of bitcoins is restricted by design, so you can’t treat it like normal money and create inflation of about 1-2% a year. At best, such a committee could avoid excessive volatility if it had sufficient volume of bitcoins under control. Then market participants would form correct expectations about the rate of deflation and would discount prices accordingly. This hypothetical central committee goes against the ideology behind the bitcoin, though.

Is it possible to design a decentralized currency that can smooth its own exchange rate movements? That’s an interesting exercise about managing the monetary base in a particular way. Injecting more money doesn’t move the consumer price level (or exchange rates) by itself. For example, the Fed’s quantitative easing after 2008 didn’t create inflation for non-financial assets also because other financial institutions preferred keeping money to spending it. You’ll need helicopter money drops for deflation, at least.

That’s just a hypothetical solution. Being centralized in terms of both capacities and responsibilities, any central bank is a major stakeholder for its own currency. Along with a national government, the bank is responsible for making its currency suitable for transactions and economic stability, insofar as monetary policies work. The bitcoin is an asset without a central bank. You have no stakeholder who cares about deflation and volatility. People outside the bitcoin community care little because, unlike the dollar, the bitcoin has no impact on the rest of the economy. And current holders of bitcoins must like the idea of ever-increasing value of their assets. All this hurts the bitcoin and similar virtual currencies at large.