The Russian ruble has been facing a significant decline recently. On 27 November alone, it lost 8.5% and touched 114.5 rubles to the dollar, a level not seen since March 2022. After a brief bounce back, it has still fallen 11% in a week. This situation is the result of a combination of factors.

Immediate Triggers and Structural Reasons

The immediate trigger for the ruble's decline was a wave of recent US sanctions. On November 21, about 50 Russian banks with connections to the global financial system, including Gazprombank which serviced international payments for key gas exports, were sanctioned. This led to a rush for dollars.However, there are also structural reasons behind the decline. The dollar has been strengthening against major currencies, and oil prices have been sliding since Donald Trump's victory in the US Presidential elections. This is seen by the markets as a promise of better US growth and increased oil production.

Government Spending and Exchange Market Dynamics

Government spending increased in the fourth quarter, which is a normal occurrence. But this year, the numbers were higher than in previous years, creating an overhang of rubles on the exchange markets. This means there was a higher supply of rubles available.In October, the government allowed exporters to repatriate a quarter of their foreign exchange revenue. This led to an anticipated reduction in dollar supply.

Impact of Sanctions on Transborder Operations

There was a constant rise in the cost of transborder operations due to the stiffening of sanctions against intermediaries, both trading and financial. This resulted in a rise in import prices and a decline in export revenue, tilting the exchange balance towards a weaker ruble.And finally, the sanctions themselves led to a rising demand for dollars in anticipation of even more shortages.

Consequences for the Economy

The rate drop caused by these factors will lead to a rise in inflation, which is a concern for the Central Bank. Previously, a drop in the rate would attract foreign investment in cheaper rubles in anticipation of a higher rate and boost domestic production. But now, with the Russian market out of bounds for international capital, this is no longer possible.The overheated economy has no capacity to increase production, so the result will be a higher than pre-2022 rise in inflation relative to the decline of the ruble exchange rate. A 10% drop in the exchange rate can now be expected to cause about a 0.5 percentage point rise in inflation, compared to around 0.2 in better times.

Options for the Bank of Russia

The Bank of Russia can't do much except reduce its purchase of foreign currency from the market as dictated by fiscal policy. It can't hike interest rates very far from the already painful 21%, which is causing the non-military elements of the economy to slow to stagnation and even flirt with bankruptcy.It also can't directly intervene in the forex market as it has a limited amount of dollars to defend the ruble. And it doesn't have the luxury of relying on China's supply of renminbi as China has shown no appetite for providing liquidity and swap lines to its ally.

The Government's Solution

The most reliable option for the government is for President Putin to ask exporters to sell some of their foreign exchange revenue for rubles. This might help stop the decline, but it would transfer problems to the exporters as they are moving sales to rubles from dollars/euros to avoid sanctions risks and need the currency for their own operations.Alexander Kolyandr, a Non-resident Senior Fellow at the Center for European Policy Analysis (CEPA), specializes in the Russian economy and politics. He was born in Kharkiv, Ukraine, and lives in London.Europe's Edge is CEPA's online journal covering critical topics on the foreign policy docket across Europe and North America. All opinions are those of the author and do not necessarily represent the position or views of the institutions they represent or the Center for European Policy Analysis.Date: November 19, 2024Time: 10:00 a.m. – 6:00 p.m. CTRegister Now