A Primer from the Professor
In a January 22nd post, Streetwise Professor reviewed the Russian Central Bank’s decision earlier that day to allow a one-day 10% depreciation in the value of the Russian currency. For months, the Bank had followed a policy of no more than 0.5% daily depreciation, on only a handful of occasions allowing depreciation of as much as 1% in a single day.
But in the prior week, that policy cost the Russian treasury the stunning amount of $30 billion in foreign currency reserves. At that rate, Russia’s entire foreign currency account would be exhausted in just 13 weeks! So, as SWP put it, the Bank “cried uncle.” Earlier this week the ruble experienced it’s biggest two-day drop in a decade as it fell to a stunning 35:1 against the U.S. dollar after being at 24:1 just six months ago. Russia’s FOREX account stood at a humbling $386.5 billion, close to half what it was six months ago, and the respite they received as the ruble was allowed to enter freefall may be short-lived indeed. The Central Bank has pledged to begin spending reserves anew if the ruble passes the 36:1 threshold against the dollar.
Moreover, on Friday Russian Finance Minister Alexei Kudrin announced that because of plummeting world oil prices Russia will face a massive budget deficit in 2009 of at least $180 billion and, even incurring massive debt, that will require it to deplete its budget reserves by 25% and would provoke net capital outflow in excess of $100 billion.
It’s important to understand that the consequences of the Putin policy “not to crush the national currency overnight” were disastrous for many reasons, not only because of the horrific deprecision of Russia’s precious cash reserves.
The drawn out process of stepped reductions in the value of the currency, with no end in sight, created a cottage speculation industry. With the stock market virtually useless as an investment vehicle, traders began placing bets on when and by how much the ruble would drop next, and this practice began to consume larger and large amounts of the nation’s liquid capital, which moved away from actual investment projects and starved industry. Industrial production plunged by more than 10% in December alone. The natural result was falling wages and unemployment, about which we wrote on Friday. For the past two months, everyone was just speculating [against the ruble],” said Yevgeny Gavrilenkov, economist at Troika Dialog, a Moscow investment house. “They weren’t paying debts, barter was rising.”
Why would the government engage in such a crazed practice, so clearly placing the nation’s very survival at risk? SWP explains that the Kremlin had two reasons for doing so.
First, the Kremlin cares far more about its own short-term survival than about the nation’s long-term well being. The Kremlin knows that there is nothing it can do to hide from a plummeting ruble, not when every Russian street has a currency exchange office with the current rate prominently displayed outside. It knows that the lay public associates a stable ruble with a successful government. It knows that if unemployment and inflation are rising and the ruble is falling dramatically, its surival could be in danger. So it’s willing to squander the national savings account, regardless of the consequences, to keep the lid on its kettle of power.
And second, there’s the oligarchs. They’ve borrowed massive sums of Western capital to expand their various business enterprises, businesses that earn revenue in rubles. To repay those obligations, the oligarchs must convert rubles into dollars and euros; any loss of value in the ruble makes their loans much more expensive to repay.
To antagonize both the oligarchs and the mass public simultaneously would be a fatal cocktail, more lethal than the one the Kremlin fed to Alexander Litvinenko. So the Kremlin had no problem following a policy that amounted to national financial suicide.
And SWP points out the extremely devious way in which the Kremlin responded when the sand finally ran out of this crooked hour glass. It waited until it could time the 10% announcement with a “periodic increase in the demand for rubles that business use to make VAT payments” and it made one final splurge on rubles out of its own coffers, with the result that on the day of the announcement the ruble actually gained value rather than falling.
But this sleight of hand is futile, neo-Soviet in character. SWP quotes Alexei Moiseyev, economist at Moscow brokerage Renaissance Capital: “It’s inevitable that the ruble will move to the limit of the new band. This had to be done, but it should have been done faster.”
SWP’s running commentary, applying sophisticated knowledge of economics to the Russian financial scene, is unique in the blogosphere and indeed the world, a must-read for anyone concerned about Russia’s future.