The Ruble Exchange Rate: Should we expect new surprises?
After turning a somersault in the first half of the year (see figure 1), the ruble rate stabilized in August 2022 at the level of 60–61 rubles per dollar. Predicting the currency exchange rate now, when uncertainty has grown many times over, is practically impossible. Yet it is possible to describe the key factors which influence the relationship of the ruble to the dollar and euro. For now, the cumulative effect of these factors indicates that it is very unlikely that the ruble will weaken beyond the level of 75 rubles to the dollar by the end of the year.
Against the Ruble
The main factor which could lead to a weakening of the Russian currency would be the introduction of a new, modified version of the budget rule. Keep in mind, the budget rule has functioned in the formation of the Russian federal budget since 2004. While there have been various modifications, its essence has remained the same: fixing a price of oil, beyond which profits from the extraction and export of oil and gas went into a specially-created fund. This is how the National Welfare Fund was created.
Since the profits coming into the NWF were primarily invested in securities of the USA, the countries of the EU, and other countries with so-called “hard” currencies, it meant that a portion of the profits from the sales of oil and gas did not end up on the domestic currency market, and thus did not impact the exchange rate of the ruble. Specifically due to the budget rule, for many years the exchange rate of the Russian currency has not been as volatile as it would have been if it were more directly impacted by the dynamic of oil prices.
However, since the spring of this year the budget rule in its previous incarnation has lost its meaning, since the currency of unfriendly nations has become toxic for all Russian entities: for business, and for the financial sector, and of course for the government. This, and of course the serious contraction of imports, has led the formation of a record current account surplus – and thus to the strengthening of the ruble to a 7-year high.
The government is now actively working on the parameters for a new budget rule; at the beginning of August it was still being discussed, and what it might look like is clear only in general terms. So far the comments of RF Finance Minister Anton Siluanov have revealed only that intervention will take place through the currency of “friendly” countries. However, it is not entirely clear how effective this mechanism would be. Despite the serious growth of trade turnover of the currency pairs yuan-ruble, tenge-ruble, etc., the volume of these currencies still serious trails the familiar dollar and euro.
“At a rate of 60 rub/$, the income side of the budget has a shortfall of about 2–3 trillion rubles, which is one of the main reasons for the modification of the budget rule,” explains Pavel Mitrofanov, asset manager of the Sistema Capital holding company. “At an oil price higher than $60/barrel and fixed production volume of 9.5 million barrels/day, the agency plans to conduct intervention through the currency of ‘friendly’ countries, primarily by purchasing the Chinese yuan. At the current price level, the excess profits from oil can amount to 2.5–3.5 trillion rub/year, which is more or less equivalent to the pre-crisis currency purchases of the Central Bank.”
The expert confirms that one of the main problems of the new rule will be the relatively low liquidity of these “soft” currencies, but this will be partially compensated for by the volumes of the bids of the CB at the first stage. Yet according to Pavel Mitrofanov, there are no other options available to the government to weaken the ruble even a little bit. “As a decline in export income due to sanctions is expected at the end of 2022 and beginning of 2023, the problem of the strong ruble will get worse. And in our opinion, it would be a mistake to depend on any kind of significant recovery of imports which would help to increase demand for foreign currency,” explains the asset manager of the Sistema Capital holding company. “Thus, due to the necessity of financing increased expenditures for the support of the economy, an updated version of the budget rule is probably the key element for some kind of weakening of the ruble.”
“Theoretically the budget rule works against the ruble, even in the case of the purchase of currency of “friendly” countries rather than American dollars,” agrees Yuri Kravchenko, head of the Bank and Currency Market Analysis Division of the Analytical Department of the investment company IC Veles Capital. “Nevertheless, the ruble is likely to receive much more notable support from the expectation of the adoption of a new budget rule than from its actual implementation. The situation is similar with other measures to limit the strengthening of the ruble. Without a stabilization of imports, the real arsenal of the government is limited, and so the ruble loses more in the expectation of new limitations than it would lose from their implementation – more likely, in fact, the ruble would strengthen after the actual adoption of some measure.”
The second quarter is likely to see some kind of recovery of imports, which would mean a weakening of the ruble and a breather for the Finance Ministry. At the start of the August, the CB published a report on monetary policy for July, which raised the projection of the current account surplus for 2022 to 243 billion dollars – as compared to the May predictions of 145 billion dollars for the year (see figure 2).
“The current account surplus significantly increased to 139 billion dollars in the first half of 2022, which led to the marked strengthening of the ruble rate. Thus it will notably decline in the second half of 2022, due to a lowering of raw material prices, as well as the contraction of export volumes due to sanctions, along with the recovery of imports. This will put pressure on the balance of supply and demand of foreign currency and lead to a weakening of the ruble rate,” commented about the CB forecast Natalia Orlova, the head economist of Alfa-bank.
In favor of the Ruble
Nevertheless, the factors working toward the strengthening of the ruble also appear quite weighty. Most important is the prohibition on the expatriation of funds by nonresidents. “In the conditions of the sudden contraction of exports, indeed the current account surplus plays the key role in the support of the position of the ruble. However, significant support for the Russian currency also comes from the continuation of capital controls, specifically the prohibition on the withdrawal of foreign investors from the market,” notes Yuri Kravchenko.
The continuing decoupling from foreign currency of the entire domestic financial system is also quite important. It is more difficult and expensive for citizens and businesses to hold dollars, euro, and currencies of other unfriendly nations. Among the most recent steps in this direction it is worth noting the continuously growing commissions on the holding of foreign currency in brokerage accounts, and the various regulatory documents giving banks a basis for decoupling their obligations from foreign currency.
For example, August 8 was signed Presidential Decree №529, creating a temporary procedure for fulfilling obligations under agreements for bank accounts and deposits denominated in the currencies of “unfriendly” nations. In the event of the imposition of restrictions on Russian banks which make the fulfillment of obligations in foreign currency impossible, in regard to currency which is credited to accounts after August 8, banks may suspend the fulfillment of requirements for these types of obligations.
In its turn, the Bank of Russia is preparing to apply the maximum risk coefficient to assets in the currencies of “unfriendly” countries. Exceptions will be made for exporting legal entities, as well as types of loans secured by state guarantees and under the execution of international agreements of the Russian Federation.
In the opinion of the analysts of Rosbank, all of this means a deterioration of the conditions for the holding and trade of the currencies of “unfriendly” nations. “This can lead to collapses on the domestic currency market in the rates of these specific currencies, in the context of the continuation of the general trend of the progressive weakening of the ruble – and in the future can result in the decline in their liquidity in the market, in favor of the yuan and other ‘regional’ currencies,” concludes Rosbank. There they feel that in connection with the recovery of imports, we can expect a weakening of the ruble to 73 rubles per dollar by the end of 2022, and to 80 rubles/dollar by the end of the first quarter of 2023.
Other analysts have more modest expectations. “We expect a gradual stabilization of the situation with imports, and the long-term decline in exports due to sanction limitations. All of this together will lead to a gradual decline in the ruble. We expect the rate to decrease to the range of 65–70 to the dollar,” explains Yuri Kravchenko.
“Considering the ongoing uncertainty with the export of gas via North Stream-1, which is currently quite important in the formation of the ruble rate, we expect that by the end of 2022, the USD/RUB rate will be in the range of 60–65 rubles per dollar,” says Pavel Mitrofanov.