OpinionColumnist
A Sickly Ruble Reveals What Putin Will Not
Sanctions have not breached
Russia’s economic fortress, but they have put a time bomb under its
foundations.
Don’t look too closely.
Photographer:
ALEXANDER KAZAKOV/AFP
August 17, 2023 at 5:00 AM GMT+1
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In the 18 months
for which Russia has been waging war against Ukraine, Western countries have
imposed more than 13,000 sanctions on Russia — yet the Russian economy shows no
sign of collapsing. On the contrary, the International Monetary Fund forecast for the
country is for 1.5% growth this year — more than the economies of Germany or
the UK.
The Kremlin likes
to boast that
sanctions don’t work, and similar reservations are increasingly being expressed by
Western observers. Yet the rapidly depreciating ruble, which in August became
the worst-performing
currency among developing countries, suggests otherwise. The Bank of Russia was
even forced to hike the key rate to 12% from 8.5% in one day during an
emergency meeting on Aug. 15. This move is likely aimed at taming inflation
that will be fueled by the ruble’s weakening.
While one
shouldn’t expect this to force Vladimir Putin to stop his disastrous war,
sanctions pressure has proven efficient for at least one goal: reducing the
flow of funds to the Russian economy. The Kremlin has no other option than to
divert money to the war machine, putting the economy on increasingly
unsustainable footing. So the West should continue to go after the Kremlin’s
revenue sources, including by lowering the oil price cap, introducing similar
measures on other Russian exports, and closing sanctions loopholes.
The fluctuating
ruble rate (from 53 to the dollar in June 2022 to 100 a year later) is indeed
an indicator of deeper problems. The immediate trigger for the ruble’s nosedive
in July was almost certainly the brief mutiny staged in late June by Yevgeny
Prigozhin and his mercenary army, Wagner, which added internal instability —
something that hadn’t seriously impacted the ruble exchange rate since the mass
street protests of 2011-2012 — to the risks facing Russia and impacting on the
rate.
But the fundamental
reasons for the fluctuating ruble rate are linked to changes in the structure
of market demand, above all reduced revenues from exporting oil and gas due to
the EU embargo on importing Russian oil and oil products, the price cap imposed
by the G7, and the subsequent rerouting of those commodities to different
destinations.
Although Russia
has managed to redirect significant volumes of its oil from Europe to Asian
markets, the transactional costs have increased, and there is no substitution
for the European gas market. The likelihood of the price cap being lowered even
further and stricter enforcement of sanctions compliance means the prospects
for Russian exports are dismal. Even if the Russian economy looks confident
right now, in the medium-term, the decline in export revenues will lead to an
even greater weakening of the ruble and, as a consequence, inflation.
The ruble is
replacing foreign currencies in export revenues, and now accounts for 39%,
reducing the net inflow of foreign currency into the country. There is also an
imbalance in demand for currencies: exporters need Chinese yuan, while
importers want dollars and euros. In previous years, when the ruble dropped
significantly in value, foreign funds and global investment banks sprang into
action to profit from the situation. Their presence also evened out market fluctuations.
Now they are gone, and that means future swings in the exchange rate are
guaranteed. This increased volatility weakens the currency's payment and saving
functions: People and businesses will cut costs and postpone investments.
Of course, Putin
can always resort to his previous tactic of calling Rosneft Chief Executive
Officer Igor Sechin and other exporters and demanding that they repatriate hard
currency. But manually managing the ruble rate will not fundamentally resolve
the situation.
The ruble’s main
adversary is the Russian state itself, which is actively spending budget funds.
Its high volatility and the fact that it halved in value in less than a year
are consequences of the new economic policy forged by the war and sanctions.
What the Kremlin calls the “structural transformation of the economy” is more
commonly known as military Keynesianism: boosting economic growth through
increased military spending.
The “structural
transformation” of the economy effectively amounts to a huge increase in defense
spending. As in Soviet times, war has engendered entire groups of
beneficiaries: the military-industrial complex and related manufacturing, as
well as military personnel and their families, who are part of the state
sector.
Defense spending
rose 9.2% in 2022 to $86.9 billion, according to estimates by SIPRI. In this
first half of this year, it was already way over budget,
standing at more than $72.2 billion. Combined with social spending (for which
over $75 billion was budgeted this year), that makes up more than one-third of
all state spending — twice as much as before the war.
The defense
industry is pulling other industries along with it, propelling demand for
imports, sustaining GDP and putting money in ordinary Russians’ pockets. Real
incomes increased in regions that are home to military manufacturing, according
to the state statistics service, and where there are reportedly high numbers of
professional soldiers, such as Chechnya. The defense industry is working around
the clock, luring personnel away from the civilian sector with high salaries
and exemptions from being mobilized. To retain personnel, other sectors are
also having to raise salaries. The groundwork for runaway inflation has been
laid.
A significant
part of both state and individual spending is on imports, and the return of
Russian imports to their pre-war
level is stimulating demand for hard currency. Until the
government cuts or slows down spending that stimulates imports, the ruble
exchange rate will remain weak.
Trust in the
Russian financial system is dwindling fast, as evidenced by the constant
outflow of capital. Hard currency deposits into Russian banks fell by $9.1 billion
to $152.4 billion in June, while from the beginning of 2022 to May
2023, the volume of deposits abroad made by Russians (mostly in Armenia,
Georgia, and Kazakhstan) grew by $43.5 billion.
There is no help
forthcoming for the ruble. The central bank’s freeze on buying
hard currency from August through the end of the year is more of a palliative
measure than anything else.
.
Putin’s
disastrous war against Ukraine and the ensuing sanctions have not breached
Russia’s economic fortress, but they have put a time bomb under its
foundations. Any decrease in market demand looks unlikely while the war rages
and the country is gearing up for presidential elections. Thanks to sanctions,
the country is unable to produce certain complex hi-tech goods itself, meaning
that far from becoming more self-sufficient, Russia’s dependence on imports
will only grow.
The volatile and
weakening ruble exchange rate is testament to just how imbalanced the Kremlin
has allowed the economy to become, and that it is already barely coping. When
the war ends, the sudden switch in demand from the inflated defense sector back
to the civilian sector will be a powerful shock that will be impossible to
absorb painlessly. As we know from history, it also proved impossible for
Russia’s predecessor, the Soviet Union.
More From Bloomberg Opinion:
- The Ruble’s Fall Points to Pain but Not Collapse:
Leonid Bershidsky
- Out of Africa, a New World War?:
Andreas Kluth
- Putin and Wagner Are Still Gunning for Africa:
James Stavridis
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— With assistance
by Elaine He
This column does
not necessarily reflect the opinion of the editorial board or Bloomberg LP and
its owners.
--With assistance
from Elaine He.
To contact the
editor responsible for this story:
Nicole Torres at ntorres51@bloomberg.net
Alexandra Prokopenko is a non-resident scholar at
Carnegie Russia Eurasia Center, visiting fellow at the German Council on
Foreign Relations and research fellow at the Centre for East European and
International Studies. She was previously an adviser at the Bank of Russia.
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