Russia said last week that it wanted European countries that buy its natural gas make their payments in rubles, rather than dollars or euros. A month ago, this might have looked like a bargain: the ruble was down 40%, to 139 rubles to the dollar, following Russia’s invasion of Ukraine.
Since that March 7 low, however, the Russian ruble has rallied dramatically. As of this writing, it is trading at 84 to the dollar, which is exactly where it was at the time of the invasion. And it’s not dead cat bounce. It was a clear and sustained recovery that made the ruble the best performing currency worldwide in March.
And yet, all the sanctions imposed at the start of the war are still in place, and in some cases even more severe. So how did the Russians manage to revive their currency?
The hole in the wall gang
There are several components to this recovery. The first is due to the huge hole in the sanctions imposed by the coalition of countries allied to the United States: natural gas. The sanctions are aimed at restricting Russia’s ability to acquire foreign currency, and in particular dollars and euros. But several European countries continue to buy Russian gas, because they have become so dependent on it, and there are not enough alternative suppliers to meet the demand.
Add to that rising oil and natural gas prices and the resilience of Russia’s trade relations with other major economies like China and India, and the net result is that there is always a constant flow of foreign currency into Russia. This eased fears that Russia could become insolvent, and it helped put a floor under the rouble.
There is another hole in the sanctions that deserves mention here: the exclusion of sovereign debt. One of the most significant and impactful sanctions against Russia has been the freezing of its foreign accounts. Russia holds about $640 billion of euros, dollars, yen and other foreign currencies in banks around the world. About half of this amount is in the United States and Europe. Sanctions have blocked Russia’s access to that money…except when it comes to paying interest on its sovereign debt. The US Treasury left a window open allow financial intermediaries to process payments for Russia. This window should close this month, but it has been a big help for Russia. Without it, Russia might have needed to raise dollars by selling rubles, putting downward pressure on the currency. And if he hadn’t been able to raise those dollars, he would have defaulted.
These are the tangible external factors fueling the recovery of the ruble. The internal factors are a little less bodily. On February 28, the Central Bank of Russia increased 20 percent interest rate. Any Russian who might have been tempted to sell their rubles and buy dollars or euros now has a strong incentive to save that money instead. The fewer rubles put up for sale, the less downward pressure there is on the currency.
Next comes a government requirement for Russian companies that 80% of the money these companies earn abroad must be exchanged in rubles. This means that a Russian steelmaker who makes a hundred million euros selling steel to a company in France has to turn around and change 80 million of those euros into rubles, regardless of the exchange rate. There are many Russian companies doing a lot of business with foreign companies, earning a lot of euros, dollars and yen. The order to convert 80% of this revenue into rubles creates significant demand for the Russian currency, helping to sustain it.
The Kremlin also issued a decree ban russian brokers sell securities held by foreigners. Many foreign investors hold shares of Russian companies and government bonds, and it is understandable that they want to sell these securities. By banning these sales, the government strengthens both stock and bond markets and keeps money inside the country, which helps keep the ruble from falling.
Russian citizens themselves have been targeted by the government, which has restricted them to transfer money abroad. The original ban stated that all foreign currency loans and transfers were to be suspended. This served to keep foreign currency in the country and discourage Russians from selling rubles for dollars or euros, which would put pressure on the currency. These restrictions have been relaxed somewhat recently to give relief to Russians who regularly send money abroad, but hard currency conversions are limited to just $10,000 for individuals until the end of this year.
Perhaps the most important factor driving the ruble higher is a risky scheme by Vladimir Putin that we mentioned at the top of the newsletter: telling some buyers of Russian natural gas that they must now pay their gas bills in rubles. Natural gas contracts are usually written and require payment in euros or dollars, and the countries that buy natural gas – the European Union, the United States, Canada, Australia, New Zealand, Japan, South Korea and Taiwan – generally do not have large natural gas reserves. rubles at hand. So if Putin succeeds in forcing these countries to pay in rubles, they are going to have to go out and buy them. Many of them. The demand for money will increase and the price of the ruble will naturally increase. It was the anticipation of this rise that helped push up the market value of the ruble.
A Potemkin coin
One could say that these measures taken by the Russian government are business as usual. After all, the Federal Reserve constantly changes interest rates. The US Treasury has restrictions on remittances to some countries. And why couldn’t a country stipulate in which currency it is paid? And don’t governments have a responsibility to defend their currency anyway? All good points. What the Russian government is up to here, however, is more than defending a currency: it is manipulating the ruble market and a manufacturing demand that otherwise would not exist.
Some observers say that Russia has essentially created a Currency Potemkin. This is a reference to Grigory Potemkin, who was appointed governor of Crimea after it was annexed by Catherine the Great in 1784. Eager to show Catherine how successful he had been in resettling Crimea with Russian villagers, Potemkin supposedly built and populated a mobile village which he assembled, dismantled and then reassembled along his route as she surveyed the area. Russia’s Central Bank Governor Elvira Nabiullina essentially plays Potemkin a la Catherine Putin, using a range of tools to make the ruble look like a currency that has value, when in fact very little people outside Russia want to buy a single ruble unless they absolutely have to, and many people inside Russia I don’t really want rubles either.
There are big risks to all this government intervention. The protectionist measures enacted by the CBR are effectively a kind of bridge for the rouble. If Russia manages to reach some sort of resolution on Ukraine that involves lifting sanctions and restoring trade relations with the West, the ruble could retain its current value once the measures are withdrawn. If the measures are withdrawn without some kind of resolution, however, the ruble could collapse, hammering the economy, increasing inflation and causing enormous suffering for the Russian people. And the measures – some of them, at least – will have to be withdrawn eventually. Russian borrowers cannot continue to pay interest rates above 20% for long, if they can even conceive of borrowing at that price. Growth will be stifled — the Russian economy is already expected to contract by now more than eight percent this year – and the industry will collapse.
Perhaps the greatest risks are those associated with Putin’s natural gas scheme. As we have already said, the natural gas contracts that the buyers have signed with Russia all stipulate that payment will be made in euros, dollars or other foreign currencies. Putin can’t just cross out “dollars” or “euros” and write “roubles” where those contracts say how to pay. He must renegotiate the terms of these contracts. And if it does, these countries are likely to drastically reduce the amount of natural gas they buy from Russia.
Russia is the world’s largest natural gas producer and biggest exporter, but it’s not the only source there, and buyers of Russian gas could turn to new suppliers. The United States is already sending shipments in Europe. There are talks on sourcing from the UK, Norway, Qatar and Azerbaijan. israel is think about the idea of a pipeline. Countries that buy large amounts of Russian gas probably couldn’t all wean themselves off overnight, but if Russia insists on taking that step, it risks turning one of its biggest sources of revenue into a trickle. In short, the problem with creating a facade – like Russia has done with its currency – is not only that it could collapse, it could also collapse on you.
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