Breaking Down Russia’s Ruble Mess

While some delight in seeing Russia continue headlong into the financial abyss, it’s not really the source of grand news many wish it to be. For the past several years, Russia has maintained the world’s eighth-largest economy, and whenever an economy of that size and scope, on an ever-increasingly globalized world stage, is in dire straits, it can have a profound effect in numerous other places around the world, including the U.S.; as a matter of fact, it was the 1998 ruble crisis that led to the eventual dissolution of hedge fund giant Long-Term Capital Management, which was able to land its plane…as opposed to crash straight into the ground…only after the Federal Reserve Bank of New York managed to get the fund’s largest creditors on board with a bailout that prevented LTCM from having to engage in a massive liquidation of its holdings in order to cover its debt obligations. Collapses in countries as large as Russia are, in this day and age of advanced financial interconnectivity, not merely that particular nation’s problem, and so it is worthwhile for each of us to have a better understanding of the precise nature of the difficulties that plague extra-large economies here in the 21st century.   

Right now, the biggest obstacles to the ruble’s health and happiness are the West’s sanctions over Russian behavior towards the Ukraine, as well as the collapse of oil prices. While some see the former as being the chief antagonist to the ruble this time around, the volatility in the price of oil is every bit as much a cause in the ruble’s upheaval, at present. In July 2014, the U.S. Energy Information Administration published data showing that oil and natural gas represented nearly 70 percent of all of Russia’s exports in 2013. Contrast that with the United States, the exports of which represent well over 100 different product types, and wherein oil, natural gas, and other petroleum products represented just 8 percent of America’s exports in 2013. Tellingly, in the case of the U.S., the preponderance of its exports is in the form of capital goods; whenever a nation like Russia derives so much of its revenue from a (fairly singular) commodity export, there is a substantially larger risk to that nation’s economic stability, one that tends to exist in perpetuity.

Then there is the matter of economic sanctions. That term is thrown around rather casually, perhaps with the assumption that most understand what it means in terms of how it affects the target nation…but it’s worth clarifying here for those not sure how sanctions are, precisely, influencing the value of the ruble. “Sanctions” essentially means that the U.S. and the European Union prevent key Russian banks and other large companies from having access to important capital markets. Roughly 80 percent of the debt of Russia’s largest banks, almost all of which are presently on the U.S.’s sanctions list, is in U.S. dollars, and these sanctions are depriving Russian companies of the ability to refinance their dollar- and euro-based debts, which are substantial. The only alternative they have is to sell rubles to come up with the other currencies, and this, in turn, acts to devalue the ruble further.

So, what is Russia to do? Up to this point, the response to the crisis has been to drastically raise interest rates in a “show of support” for the ruble. In recent weeks, Russia’s central bank raised its benchmark rate from under 10% to 17%; the reason for the drastic moves, and the way in which such moves hopefully bolster the floundering currency, is to help make the currency more attractive, thereby encouraging more investors to keep it as a portfolio component. As for helping the ruble to rebound from its recent lows, when it took 70 of them to buy one U.S. dollar, the move may have helped a little, but the chronic issues ill-affecting Russia remain in place, and as long as they do, the ruble won’t look much good to anyone. At present, the exchange rate, ruble to dollar, has been moving in the range of the low- to mid-60’s to 1, which is still frighteningly bad. What’s more, raising rates in crisis mode usually serves, as well, to significantly sharpen the other edge of the rate-increase sword, by making it more difficult for individuals and companies within Russia to buy and borrow.

The “ultimate” answer? The underlying problems of the Russian economy are many and varied, and include a distinct lack of industry diversification, and, indeed, a continued, heavy reliance on all things oil and gas will help to keep that nation’s economy unsettled. However, even more than that, there is the nation’s adherence to the vestiges of the old command economy that characterized the classic Soviet Union. There is no command economy without central planning, and, yet, central planning remains a material part of today’s Russia, complete with the massive corruption that invariably serves as its companion. Until Russia devotes itself to diversifying its economic interests, which will, in part, demand it more fully embraces the capitalistic tendencies with which it seems content to merely toy, at present, the problems it faces today will remain for years to come.

 The information contained here is for general information purposes only. The Financial Writer blog and Bob Yetman disclaim responsibility for any liability or loss incurred as a consequence of the use or application, either directly or indirectly, of any information presented herein. Nothing contained in this article, or any other article featured at this blog, should be construed as a solicitation or recommendation to engage in any financial transaction. You should seek the advice of a qualified professional before making any changes to your personal financial profile.

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