Streetwise Professor

December 5, 2008


Filed under: Commodities,Economics,Energy,Politics,Russia — The Professor @ 8:07 am

Russia Weakens Ruble Defense After Record Drop in Crude to $39.

Dec. 5 (Bloomberg) — Russia weakened its defense of the ruble for a fourth time in a month, pushing the currency near a three-year low against the dollar, as the price of the nation’s crude oil fell by a record this week to less than $40 a barrel.

The currency slid as much as 1.2 percent to 28.1344 per dollar and dropped 1 percent to 31.5971 against the central bank’s target basket of euros and dollars. “The corridor has been widened,” a Bank Rossii official who declined to be identified said in a phone interview from Moscow today.

As for those of you (ahem) who took solace in the $5 billion rise in reserves last week, this was largely a technical seasonal development driven by tax payment considerations.   The article continues:

“Given oil is already below $40 a barrel we can’t rule out more depreciation,” said Evgeny Gavrilenkov, chief economist at Troika Dialog in Moscow, Russia’s oldest investment bank. “Any further devaluation depends on oil.”

Russia is facing its worst financial crisis since the government defaulted on $40 billion of debt a decade ago, prompting a 71 percent ruble devaluation against the dollar that eroded bank deposits.

Concern about the currency’s decline spurred Russians in October to withdraw 355 billion rubles ($13 billion) from their deposits, the most in two years, according to central bank data. Foreign-currency deposits rose 11 percent.

Putin’s Pledge

“The gradual approach feeds expectations of further devaluation and prompts the population and companies to convert all extra rubles into foreign exchange,” said Tatiana Orlova, an economist in Moscow for ING Groep NV. “This policy will likely lead to further depletion of foreign exchange and gold reserves.”

Those quoted in the article predict a ruble decline of between 15 and 30 percent.

The ruble has actually declined less against the dollar than other commodity currencies, even though Russia’s main export has declined in price more than, say, Brazilian soybeans.   This suggests that a big decline is coming.   And the consensus is increasingly that Russia is throwing good money after bad by attempting to slow this process:

Russia is wasting its cash reserves by propping up the ruble as lower oil prices drive away investors from commodity-led economies, according to Brown Brothers Harriman & Co.

“The pressure on the ruble will remain and Russia shouldn’t try to resist it by depleting its reserves,” said Win Thin, a currency strategist at Brown Brothers Harriman in New York. “Oil producers are really struggling in terms of trade shock.”

The CHART OF THE DAY shows that the 16 percent slide in the ruble is yet to match the decline in the currencies of commodity exporters including Australia and Mexico, which have fallen 33 percent and 24 percent versus the dollar since July.

Urals crude, Russia’s main export blend of oil, has slumped 68 percent since July to $43 a barrel, below the $70 average needed to balance the country’s budget next year. Russia has spent $148 billion or a quarter of its international reserves since August to defend the ruble.

Of the other “commodity currencies”, the Brazilian real slid 33 percent against the dollar, the New Zealand dollar dropped 30 percent, the Chilean peso 21 percent and the South African rand fell 23 percent.

Deferring the day of reckoning will only make the ultimate consequences all the worse.

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  1. This from Vedomosti:

    А сегодня российская нефть пробила отметку в $40 за баррель: на 13.00 МСК спотовые котировки Urals с поставкой в порты Северного моря снизились до $39,65 за баррель (-4,76% ко вчерашнему закрытию). В последний раз Urals стоила меньше $40 в начале 2005 г. (14 февраля — $39,64 за баррель).

    In a previous thread, I mentioned that the last challenge Putin faced were the pensioners in the streets demonstrating against the “monetization” reforms. When did these demonstration take place? In January of 2005. Vedomosti notes that that the last time that oil was selling for less than $40 a barrel was less than a month later in February 2005. Coincidence? I don’t think so.

    What should be making the Russian government very nervous is the fact that inflation is still very high in Russia and that inflation is highest for basic goods and foods. According to Vedomosti:

    Самый большой вклад в инфляцию вносят самые дешевые товары. Стоимость минимального продуктового набора, входящего в прожиточный минимум, в ноябре выросла на 1,3% до 2094 руб.. За январь-ноябрь 2008 г. продуктовый набор подорожал на 16,2%.

    From January to November of this year, the inflation rate for the basic basket of foods went up by 16.2%. This will hit pensioners and the poor hardest. If that is the existing inflation rate, imagine what it will be like if the Russian government starts printing rubles as Da Russophile suggests.


    Comment by Michel — December 5, 2008 @ 10:58 am

  2. Such big movements might cause a lot of models to get mis specified. On a related note, if we perform a principal component analysis on the crude forward curve, taking into account just the last 3 months, would we get different results than say using the last 3 years?

    Comment by Surya — December 5, 2008 @ 2:11 pm

  3. @SWP,

    OK I’ve got to quibbles with the above…

    “The ruble has actually declined less against the dollar than other commodity currencies, even though Russia’s main export has declined in price more than, say, Brazilian soybeans. This suggests that a big decline is coming.” – SWP

    But during the period of rising oil prices, Russia bought foreign currencies to slow down ruble appreciation…so i.e. at the peak of oil prices the Russian ruble wasn’t as strong as it was “supposed” to be. This would imply that now it’s not as weak as its supposed to be.

    “And the consensus is increasingly that Russia is throwing good money after bad by attempting to slow this process:”

    I think there are two advantages to a gradual correction rather than sudden devaluation.

    1. More predictably for importing businesses – a 30% spike in prices overnight could be an unsustainable shock.

    2. More importantly, many debt repayments are due on Q4 2008. Letting the ruble sharply devalue would make the real cost of those debts soar by 20-30% to these companies which get their revenues in rubles. So perhaps this to give them room to pay off, instead of dropping the floor away from them by implementing the sudden devaluation idea?

    3. Confidence. If there’s a gradual, “creeping”, decline, it’s not as noticeable.

    Just some thoughts that sudden devaluation, even if it’s nominally cheaper, might not be so good after all.


    “Vedomosti notes that that the last time that oil was selling for less than $40 a barrel was less than a month later in February 2005. Coincidence? I don’t think so.”

    And in the very early 2000’s it was selling for about 10$. So what?

    It also ignores the fact that monetization was done not because of fiscal problems but in an effort to improve efficiency (by removing so-called “regressive privileges”, as I believe they’re called), the kinds of measures that are encouraged by institutions like the World Bank and IMF repeatedly.

    “What should be making the Russian government very nervous is the fact that inflation is still very high in Russia and that inflation is highest for basic goods and foods. According to Vedomosti:”

    As I said in my last reply to you, inflation is already dropping off quite rapidly ( due to the credit crisis. So like in the US, fiscal aggressiveness is to be recommended – including paying more the pensioners about whom Michel is so concerned about, as well as unemployed, people with children, and infrastructure building.

    Comment by Da Russophile — December 5, 2008 @ 3:05 pm

  4. Commenter #3 has deep and revolting problems telling the truth.

    His link states that inflation in Russia INCREASED last month, it did not “drop off,” and the rate of was only
    “SLIGHTLY LOWER” than the month before, not “quite rapid.”

    Russia has massive, double-digit overall consumer price inflation and the rate is much higher on the tiny
    basket of goods that Russians who learn less than $5/hour on average can afford to buy. When the ruble falls,
    inflation on foreign goods skyrockets. It is a brazen lie to contend that inflation in Russia is anything
    but dire and life-threatening.

    I really don’t appreciate commenters who lie so repeatedly and so brazenly in the service of
    a dictatorship that is undermining the basic existence of the Russian people. I can’t think what they
    might have done to him to make him hate them so much.

    Comment by La Russophobe — December 5, 2008 @ 5:25 pm

  5. DR–

    Yes, Russia has managed the currency. It tried to slow the ruble’s appreciation in part to protect Russian manufacturers. It should also be noted that the domestic inflation of the past year or so is a direct consequence of the strong ruble policy. Right now, by trying to slow the ruble’s decline, it is doing great damage to the very firms it tried to protect before. It is also giving speculators, and Russians who can read the writing on the wall, the ability and the incentive to make money at the RCB’s expense. Shorting the ruble has a highly skewed payoff potential–it’s like the RCB is giving a free put option. That’s not sustainable. Moreover, even though Russia has raised interest rates, the real rate is still negative.

    The ruble policy is blowing through the reserves, thereby largely dissipating the windfall that resulted from high oil prices. It is also damaging Russian manufacturing and exacerbating the ongoing and likely worsening employment problem.

    The repayment of corporate debt issue that you raise is one reasonable motive to slow the pace of the decline, but I doubt that the additional cost of repaying the dollar/euro loans that would accompany a 20-30 pct weaker ruble justifies the reserve payments. I don’t have the numbers at hand, but even if there are $100 billion in loan payments due (which I think is way on the high side), at a 30 pct weaker ruble that translates into a $30 bln cost–far less than Russia has spent defending the currency. Seems kopec wise, ruble foolish;-)

    I would also note that throwing money at pensioners, etc., is diametrically at odds with trying to keep the ruble high. Run the printing press, give the rubles to the old folks, then sop them up by selling dollars for rubles?

    Re predictability–once it’s done, it’s done, and the amount of uncertainty after the decline should be lower as people know that the currency reflects fundamentals. Right now, the amount of uncertainty is very high. People know that the ruble will decline. They know it will decline a lot. They don’t know when. That kind of “jump risk” is very difficult to deal with. Better to wait to act until after the inevitable adjustment occurs. This tends to put a drag on economic activity, especially investment.

    Re confidence. Sounds like the old joke about the way to boil a frog is to put it in cool water, then gradually turn up the heat because if you put it in boiling water it jumps out. In this case, the Russian people are the frog in the pot. I think that this in fact is the reason behind the gradual decline–it is a cynical political ploy to obscure reality, and avoid political accountability.

    The ProfessorComment by The Professor — December 5, 2008 @ 5:58 pm

  6. SWP,

    Re-corporate debt: Your 100bn $ is not on the high side. Adding together repayments scheduled for Q3, Q4 2008 and “On Demand” (and I think everybody is would be demanding their money back) actually gets you 120bn $ – and makes up about 45% of Russian long-term debt obligations (data from CBR). Besides, I think companies know correction/devaluation is in the works and are trying their utmost to repay now, including for next year’s.

    Also, I think you overestimate the amount of money that was spent specifically on defending Russia’s exchange rate – some/a lot of it would have gone to support the planned 200bn $ in quasi-fiscal measures to support the banking/financial systems. A 35bn $ chunk of them, for instance, was made out as subordinated debt to Russian banks and companies to help them repay their foreign creditors. Presumably, they will do this now under a still favorable exchange rate; and repay the state over the course of a few years. 60bn $ worth of rubles were deposited for 3 months in banks (to counter iliquidity) – presumably, these came from the selling off of reserves as well, Etc.

    So in practice I doubt it’s such a clear-cut case of “kopecs and rubles”.

    Re-pensioners. Doesn’t this ignore the fact that once winding down of global leverage finishes, there will be a huge inflationary spike in the $ once banks begin to get confident about lending again, given the huge size of the US stimuli? And wouldn’t this relieve the weakening pressure on the ruble, and counteract the deprecationary tendencies from turning up the printing presses?

    Re-manufacturing. I agree. They need a weaker ruble, the faster the better.

    Re-predictability. I think it’s pretty much accepted wisdom that the CBR will pursue a gradual ruble weakening, e.g. by widening it’s trading band by 1% per week – as it has been doing so the past month. Perhaps that figure will be increased to 2% or more once the repayment spree is done with. But I agree with you that “jump risk” is a real negative feature – although assuming the above, it will diminish over the coming months.

    Re-confidence. You say that Putin is going to boil the Russian people – well I don’t think flash-frying them, as you recommend, is any better from a humanitarian perspective. Typically rumors of impending devaluation get out several days before it happens and all the rich well-connected people learn about it, stuff their suitcases full of dollars and depart the country.

    Comment by Da Russophile — December 5, 2008 @ 7:25 pm

  7. Looks like oil has dropped below $35 a barrel. According to Vedomosti:

    Спотовые котировки Urals с поставкой в Роттердаме в пятницу снизились на 14,5% до $35,6 за баррель, в порту Аугуста упали на 16,2% до $34,9. В последний раз Urals стоила меньше $35 в июле 2004 г.


    Comment by Michel — December 7, 2008 @ 10:41 pm

  8. My take on things:

    or pdf here:

    Comment by Da Russophile — December 8, 2008 @ 7:20 pm

  9. You do want us to visit your blog LOL. I see that I am listed as a “suppporter” of the SWP over there 😉

    Comment by Michel — December 9, 2008 @ 4:26 pm

  10. That too, but mainly it’s because I’ve summarized my position on the credit/economic crisis in Russia there; several prominent “Russophiles” have endorsed it; and in general I don’t want to repeat myself. I also think it would be of interest to the lurkers who read SWP’s threads and the debates therein, and as such if anything enriches his blog.

    Yes, I’ve listed you as a supported; would you object to such a characterization? 🙂

    Comment by Da Russophile — December 9, 2008 @ 5:56 pm

  11. LOL. I support no one but myself, but I do agree when I believe someone is right based on logic and analysis. It is called critical thinking 🙂

    Prominent “Russophiles” have endorsed your position? Well, that won’t exactly count as ringing endorsement in my book, but somehow you must have guessed that already 😉

    Comment by Michel — December 9, 2008 @ 8:16 pm

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