Why is Russia's ruble stronger now than before the Ukraine war?

Why is Russia’s ruble stronger now than before the Ukraine war?

Analysis: Russian currency has recovered from its lowest ever after invading Ukraine in February despite economic sanctions

Past Kirill Shakhnov, University of Surrey

The days after Russia invaded Ukraine in February 2022 and the west imposed sanctions, the ruble collapsed. The number of rubles to one US dollar fell sharply from about 78 to 138, a big step in the forex world (foreign currency) and scary for those who have their wealth in the Russian currency.

Since then, sanctions have been tightened and the war shows no signs of coming to an end, but something unexpected has happened to the ruble. Many commentators had thought that it would continue to weaken, but instead it is now stronger than when the war began. The US dollar is now worth 57 rubles, the best exchange rate in about four years. So why has this happened, and what does it mean for the future?

Ruble vs US dollar. Source: Trading View

The pre-war ruble

First the back story. The exchange rate for any country is determined by capital and trade flows: in other words, what money moves in and out of the country, and the value of exports compared to imports. For the ruble, Trade flows are usually more important as Russia is a major oil exporter.

The oil price, as you can see in the chart below, is linked to the ruble, so the ruble becomes stronger as the oil rises. The price of oil has largely risen since the first half of 2020, which favored the ruble in the run-up to the war.

Ruble vs oil. Burned crude oil = blue; ruble vs US $ = turquoise. Source: Trading View

However, the ruble has not risen during that period by as much as it normally would when oil is strong – that is why the two lines on the chart have been less synchronized since then. This is probably due to changes in capital inflows, especially over Russian government debt. Proportion of foreign investors (foreign holders) in federal loan bonds or OFZ reached one historical maximum at 35% in March 2020, but had decreased to 18% before the war.

The reason was changes in the tax rules. Interest payments on Russian government bonds for foreign investors were tax-free until a law was passed on March 31, 2020 that would start paying 30% from January 1, 2021. Note that the ruble began to fall when foreign investors began selling their bonds after March 2020.

This explains why the ruble was largely unchanged between then and the invasion, as a sign that the sale of government bonds more than offset the effect of the strong oil price (you get a sense of this in the chart below, where the bonds are in blue). In short, this bond sale was a temporary millstone around the ruble that kept it lower than it otherwise would have been. Over time, this effect will have diminished, giving the ruble a certain upward pace as oil prices remain high.

Ruble v oil and government bonds. Price of Brent oil (US $) = orange; ruble vs US $ = turquoise; RGBI (Russian government bond index) = blue. Source: Trading View

After the invasion

When the ruble fell to 138 to US dollars in the days after the invasion, this was the lowest level ever. February 24, Central Bank of Russia announced several measures to support the currency. It banned marginal trading, which is when investors borrow money to make much larger investments in the markets than they can otherwise afford: this meant that they could not aggravate the damage to the ruble by investing heavily in it falling further.

The central bank also used its foreign exchange reserves to buy rubles in the foreign exchange markets to support the price. Nevertheless, the ruble continued to fall, indicating that the movements were insufficient. One reason was one package of Western sanctions which were unexpected and undoubtedly the most severe ever imposed, including freezing 60% of Russia’s international reserves of $ 643 billion on February 27. This package severely limited the Russian central bank’s access to its assets abroad and its ability to strengthen the ruble.

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From RTÉ News in February 2020, the ruble will fall to a record low level when Russian sanctions begin

The central bank answered on 28 February with a new set of new measures:

  • introduce capital controls by banning all transactions with foreigners and all trading in shares and shares
  • a sharp rise in the main Russian interest rate from 9.5% to 20%
  • a limit of $ 10,000 per month on transfers from residents to bank accounts abroad
  • a limit of USD 10,000 for foreign currency withdrawals
  • Exporters must exchange 80% of their foreign exchange earnings within three days.

One month later, Russian President Vladimir Putin as well signed a special decree requiring “unfriendly countries” to pay for Russian gas in rubles.

So what is behind the rise?

One reason why the ruble has strengthened is the restrictions on marginal trading and on foreign investors, which has meant that trading volumes have increased much lower than usual. The rule that forces exporters to exchange foreign income and the partial transition to selling gas in rubles has also helped.

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From RTÉ Six One News in March 2022, Putin demands that Russian gas must be paid for in rubles

In the same way, other factors unrelated to the Russian central bank have played a role. The price of oil has remained strong. After falling from a peak just over $ 130 a barrel in mid-March to about $ 100 a few weeks later, Brent is now at about $ 120.

Russia’s imports have also been dampened by the emigration of foreign companies and Western sanctions. This has pushed up the current account surplus (the value of exports minus imports) to one historical maximumwhich strengthens the currency.

This trade imbalance is likely to continue for some time to come, which may be why Russia has eased some of the February-March restrictions. The headline rate is now back to 9.5%, the same as when the invasion began. Margin trading is allowed again, the 80% currency rule is gone, residents can now transfer up to $ 50,000 per month to foreign bank accounts and foreigners in “friendly” countries like China or India are now only restricted to the same extent as Russian residents.

The sanctions make it much harder for Russians to spend these strong rubles either on imports or abroad due to travel restrictions

In other words, Russia has the protection to move to a more normal financial base due to Western sanctions. If this sounds like a painful irony, it should be emphasized that the sanctions make it much more difficult for Russians to spend these relatively strong rubles either on imports or abroad due to travel restrictions.

So even if the currency has retained its value, its usefulness is greatly weakened. Therefore, it can be argued that since the sanctions punish Russia, they actually work.The conversation

Kirill Shakhnov is a senior lecturer in economics at University of Surrey. This article was originally published by The conversation.

The opinions expressed here are those of the author and do not represent or reflect the views of RTÉ

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