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Off the charts: How the rouble's downfall dispelled fantasies about a “brilliant financial policy”

The rouble has experienced a decline of over 30% against the dollar since the start of the year. The euro has firmly maintained a position above 100 roubles, and the dollar is edging closer to this threshold. Dr. Igor Lipsits, an accomplished economist, firmly believes that due to recent decisions by Putin, the rouble is inevitably headed for further depreciation. The measures that were once praised as crisis-controlling tactics in the foreign exchange market under Nabiullina's leadership have proven to be temporary. The exchange rate has now reverted to the fair values seen at the beginning of the war. While there might be a temporary stabilization at this juncture, the overall trend points toward a gradual devaluation. Additionally, the occurrence of short-term collapses is possible in the event of political upheavals, such as the Prigozhin rebellion.

Rupee vs rouble

The primary drivers behind the rouble's decline can be attributed to two key factors: a reduction in foreign currency influx and elevated rouble demand within the Russian market.

The inflow of foreign currency has diminished due to two underlying causes: subdued oil prices and a decline in the quality of currency earnings. As a result of the disruption of established channels, a significant portion of oil and gas exports now find their way to India and China, nations that make payments in their partially convertible currencies (particularly true for India). Russia is steadfastly supplying oil to India, ramping up shipments, yet the predominant form of compensation is in rupees. The appropriate course of action for handling these rupees remains uncertain – they cannot be effectively introduced to the foreign exchange market or readily converted.

Russia is steadfastly supplying oil to India, yet the predominant form of compensation is in rupees

A rather unsettling pattern emerges in the oil industry: when there's no room left for oil storage, companies must cease production. This entails more than just shutting down wells; it involves a deliberate and specialized process of preservation, often with permanent implications. As a result, a portion of the extracted oil ends up being practically given away (sold) to foreign markets, almost free of charge. The underlying aim is to avoid the expenses associated with well preservation and to hold onto even the slightest hope for better prospects down the line.

Paradoxically, when the priority is to stabilize the rouble and maximize revenue, Putin takes a contrary approach by endorsing a directive that permits companies supplying oil and gas under international agreements to retain a portion of their earnings overseas, rather than fully repatriating them to Russia. Consequently, the influx of foreign currency dwindles even further. Meanwhile, the demand for foreign currency in rouble transactions, both from importers and citizens, remains robust, leading to a continual uptick in the exchange rates of the dollar, euro, and yuan.

Mobilization and holiday season

The scenario is further complicated by mobilization efforts. Various special payments, allowances, and notably, death benefits, translate into significant sums. These financial inflows tend to reach the lower-income segments of the population, who typically don't save these larger-than-usual amounts but rather spend them immediately. This heightened demand for consumer goods subsequently prompts an increase in imports. In essence, the funds distributed through military channels turn out to be “hot money,” instantaneously fueling demand across multiple commodity markets.

Moreover, as the summer holiday season approaches, people's desire to travel abroad contributes to a heightened demand for foreign currency. Russian payment cards fall short for journeys to destinations like Turkey or Dubai, necessitating the need for hard currency.

As the summer holiday season approaches, people's desire to travel abroad contributes to a heightened demand for foreign currency

Foreign companies are also encountering difficulties and departing, likely converting currency from roubles obtained from their remaining assets within Russia, albeit within the limit of one billion dollars per month. As a result, there was a reduction in currency inflow on one hand, while on the other, a substantial demand for it contributed to the subsequent collapse.

Inflated military budget fueled by levies on businesses and individuals

Of course, the constantly growing military budget plays a role, contributing to an overall budget deficit. This deficit is essentially compensated for by devaluation. A weaker rouble, coupled with a more intense and widespread devaluation, improves the state's financial position. Currently, the budget deficit will become more tolerable and will stop growing significantly, despite the increase in military expenditures.

Even if the growth in military spending is as Reuters promises, doubling to $100 billion in 2023, it will be easier to cover, both through devaluation and through a substantial withdrawal of funds from the private sector. Currently, Sberbank has paid out substantial dividends – over 280 billion roubles likely went towards financing growing military expenditures. Furthermore, a law on the windfall profits tax has been signed into effect. All major businesses are subject to additional taxes, and a rule has been introduced: if they pay in the following year when the law comes into effect, the profit tax rate will be 10%, but if paid in advance this year, it will be only 5%. Therefore, many companies will attempt to pay this year.

Hence, a considerable surplus of funds is anticipated toward the end of the year, attributable to this tax, which will offset the excess expenses associated with military allocations. Consequently, a substantial overall budget deficit for the year might not materialize. However, this achievement will come at the expense of a sharp deterioration in growth prospects, and even the survival, of Russian businesses. While the state is diverting expenses toward military purposes, it is simultaneously undermining the prospects for the growth of the Russian economy in the coming years. Furthermore, for similar reasons, the feasibility of import substitution becomes questionable, as it would require substantial investments from the same profits.

While the state is diverting expenses toward military purposes, it is undermining the prospects for the growth of the Russian economy

When it comes to ordinary citizens, a formula was established even within Marxism: inflation is a means of robbing the laboring people. And inflation follows in the wake of devaluation. Business owners suffer from inflation to a lesser extent, as they don't consume the goods that experience a sharp price surge (the prices of the cheapest goods, which are purchased by the masses of the poor, always grow at a faster pace). A financially challenged Russian citizen will see their situation deteriorate rapidly due to the rising costs of the entire consumer basket – reports of price hikes are a daily occurrence. For example, nearly all types of meat, including pork and turkey, are becoming more expensive. Alcoholic beverages and household appliances are also becoming pricier. This will create an unpleasant and protracted sequence of events for the citizens.

Furthermore, we're still unsure about the fate of gasoline. The gasoline and diesel fuel markets are heading toward a severe disruption due to the substantial increase in wholesale prices. Retail fuel prices are currently being held back from rising, but the situation is such that this restraint won't last long. Consequently, following the surge in wholesale prices, fueling station prices will begin to rise. This invariably triggers an increase in prices for all goods in Russia. However, the state has brushed this aside and even reduced previous disbursements intended to stabilize gasoline prices (oil damper).

Following the surge in wholesale prices, fueling station prices will begin to rise

Currently, the state will subsist on the grounds of devaluing the rouble, even though this will lead to inflation. Price hikes will occur even for products that are considered “Russian-made,” since they often incorporate numerous imported components in their production. Consequently, domestically-produced goods that aim to replace imports will also become pricier, dealing a blow to the average citizen's wallet.

The rouble's grim fate

When we examine the “broader historical picture,” we observe that the rouble has been in a near-continuous decline since 1992. While there have been some setbacks and troughs along this trend line, the rouble has generally been diminishing in value against convertible currencies. A jest has even arisen that the rouble doesn't have an exchange rate, only a trajectory. This quip holds true—there's only a path toward depreciation, with no other conceivable direction.

What can be counterposed to this situation? Usually, in such circumstances, the government implements a requirement for 100% currency revenue sales to increase inflow. However, as previously mentioned, the president has just endorsed the opposite decision, allowing export companies under intergovernmental agreements to retain all foreign currency revenue abroad.

So, what options are left for the rouble? Only devaluation. Whether it will occur gradually or suddenly depends on the country's political situation. If crises like the Prigozhin rebellion emerge, short-term collapses could also transpire. Without such force majeure events, gradual devaluation is more likely.

Eighteen months of “brilliant financial policy” and oil production manipulation

Zooming in on the scope of the past year and a half, everyone recalls the panic-induced crash of the previous spring. The euro then reached 120 roubles. Subsequently, Russians reassured themselves, believing that “nothing terrible had occurred,” that everything would stabilize and “calm down.” Exchange rates dropped, and by summer, the situation wasn't particularly alarming—hovering around 70 roubles per dollar. It seemed like all was well. However, we've now reverted to crisis-level rates from March of the previous year (back then, there was a hysterical spike, while the current situation is less abrupt, but nonetheless, the rouble has returned to the same crisis values that some ironically dubbed “panic and hysteria in the foreign exchange market”). When compared to the previous summer, the dollar and euro have become more expensive by 60-70%. Furthermore, if we consider the beginning of this year, the rouble has devalued by over 30%—a significant depreciation with noteworthy consequences.

Russians reassured themselves, believing that “nothing terrible had occurred,” that everything would stabilize and “calm down”

So, what happened last summer was merely a temporary suppression of the crisis in the foreign exchange market. Everyone was saying, “Look, the great minds at the Central Bank are working, and they've stabilized the foreign exchange market.” However, the same “great minds” are still at the Central Bank, and the dollar is once again at 95-96 roubles, while the euro is at 107. These exchange rates simply reflect the reality of the Russian economy's state. And, therefore, a significantly better situation cannot be expected.

The Russian government seemed to have manipulated oil production for a while—pledging to OPEC but not actually adhering to the promises. However, during the summer, OPEC “raised its eyebrows” in disapproval, and the Russian government eventually ordered compliance with the OPEC agreement, sending recommendations to oil companies to reduce production. From what can be deduced, production is indeed being curtailed. This is understandable, given that in July, India and China started buying less. Finding other high-demand buyers with significant capacities is simply beyond Russia's reach; they don't exist in the world market.

As a result, the current scenario is such that over 70% of oil exports are directed to India, China, and a small amount to Turkey. This is all that Russia has left in the international market—other markets have shunned it. There are some oil product deliveries to North Africa, where attempts are being made to redirect them to Europe, as well as from Turkey, but this won't salvage the situation. There's no significant increase in currency inflow, and expecting a substantial strengthening of the rouble is not realistic.

Inevitable stabilization

Nonetheless, I am inclined to believe that a certain degree of stabilization, even if temporary, within the range of 90-105 roubles per dollar, is still possible. The rouble being so “cheap” might lead to a decrease in demand for currency, despite the current plethora of panic forecasts suggesting that it will continue to plummet and go significantly below one hundred roubles per dollar. But at the current rate that has already emerged, counteractive processes are now in motion. Firstly, the capital outflow from Russia is waning – those with the means and intent have primarily withdrawn their assets from the country. Resources for such currency export are not limitless, implying that this factor will gradually lose its impact on the foreign exchange market.

Secondly – at this exchange rate of the rouble, imported goods will become products of luxury consumption, meaning that the need to purchase them for the Russian market will decrease significantly. Consequently, the demand for currency to finance imports will also decline.

Hence, a plausible scenario could unfold wherein the rouble stabilizes within the range of 90-105 against the dollar/euro, maintaining fluctuation within this spectrum for a certain duration – possibly extending until the New Year. In this context, the rouble appears to have “dropped to a new foundational level,” or rather, it seems to have transitioned into a fresh stability corridor that takes into account the prevailing economic situation in Russia.

Within this range, it is expected to undergo oscillations for a period of time.

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