Amidst the instability in Russia's currency market and the ruble’s steep decline, Vladimir Milov, Russia's former Deputy Energy Minister and the president of the Institute of Energy Policy, explains what lies behind this discouraging trend.


Russia’s Central Bank stopped its currency interventions and abolish an official trading corridor for the ruble. This  makes the ruble a freely floating currency. Photo: Reuters

Editor's note: The Russian ruble has plummeted almost 30-40 percent against the U.S. dollar in 2014, and that’s led to increasing uncertainty about the future of the Russian currency. The good news is that the ruble strengthened against the dollar on Monday after Russian President Vladimir Putin said there were no "fundamental economic reasons" for the currency's headlong drop.

The bad news is that Russia's Central Bank officially lifted the currency trading corridor and regular interventions, which makes the ruble a floating currency. This means that the ruble rate will depend more on market factors and makes it more unpredictable in the future.

Against this backdrop of ruble uncertainty, Vladimir Milov, Russia's former Deputy Energy Minister and the president of the Institute of Energy Policy, a Moscow-based independent think tank, explains the reasons behind the ruble's rapid descent as well as the implications for Russia's economy. 

Let me explain what’s happening with the ruble. Its collapse is essentially a direct result of Western sanctions.

The fact is that loans from Western banks are a key source of financing, one that in recent years has helped the Russian economy “get up off its knees.” The scale of lending has been stupefying: Whereas a decade ago, the total external debt of Russian banks and companies amounted to around $100 billion, this year it peaked in July at $660 billion  — one and a half times more than the currency reserves of the Central Bank. By Oct. 1, it had fallen slightly to $615 billion, but the debt is still astonishing.

A significant portion of these loans are relatively short-term and in need of constant refinancing. New loans are needed to pay off old ones. But events in Ukraine and Crimea crept up, and Western creditors, even before sanctions, started closing the credit positions of Russian borrowers, which the Finance Ministry reported back in March. That was followed by direct sanctions on major borrowers, such as Rosneft and state-owned banks.

But as things stand today, funding is limited even for those borrowers not under sanctions. Western banks often impose their own internal rules just to be on the safe side, since they might suddenly end up with a Russian client in the sanctions list. In other words, Western funding is now virtually cut off for the vast majority of Russian borrowers, not just those hit by sanctions.

So we have a situation where lots of currency is required to pay off Western creditors, but no source of lending. We tried to cozy up to our “new geopolitical ally,” China, but they sent us packing. During Chinese Prime Minister Li Keqiang’s long-awaited October visit to Moscow, all hopes of a mass influx of Chinese money to replace Western loans evaporated, and instead we got two laughable agreements to provide VTB and VEB [Russia's leading banks included in the sanction list - Editor's note] with just $2 billion each. And even they were so-called “tied” loans earmarked for the purchase of Chinese goods and services — no money until you present a contract signed with Chinese suppliers.

The fact that the Chinese are not giving us any cash is neither surprising nor unexpected. I don’t understand what the Russian side was hoping for. China’s financial system is not structured for mass lending to foreign borrowers — it doesn’t work like that. It is set up primarily to provide loans for the Chinese economy and Chinese exports. The Chinese are not prepared to extend large credit lines to foreign customers, since unlike Western banks they are not in a position to properly assess the risks — and with Russia right now the risks are many, both as a result of Western sanctions and domestic economic woes. What’s more, give too generously to Russian borrowers, and you’ll get it in the neck from the Chinese financial regulators for overly risky investments.

So it’s a Catch-22. Russia needs money quickly to pay off Western loans, but there’s no available source, while the one remaining hope, China, is keeping a tight grip on its purse strings. As a result, applications for help from the National Welfare Fund (NWF) swelled in October.

But the NWF will probably run dry in the following manner. The requests received so far already exceed the size of the fund, and all applicants are after the same thing — to sell the government 10-to-15 year bonds and immediately send the money to creditors abroad, thereby transferring the entire NWF to America/Europe.

What’s more, our reserves are not that large. All foreign exchange reserves (excluding gold and reserve positions in the IMF) total less than $400 billion, down $70 billion for the year. Half is government money in the form of reserve funds (which are taken into account in foreign exchange reserves, but not added to the reserves of the Central Bank, which many do not realize, including Putin…).

And the payments are sizeable: Sberbank CIB, the corporate and investment banking business of Russia's state-owned bank Sberbank, estimates that Russian debtors have to transfer $29 billion abroad in Quarter 4 this year and $106 billion in 2015, of which $58 billion is presently lacking. Furthermore, “most short-term debt is owed by companies under U.S. and EU sanctions... These companies’ external debt as of end 2015 is expected to stand at $84 billion, which corresponds to almost 60 percent of the gross external debt that must be repaid by end 2015,” write experts at Sberbank CIB.

This group includes companies operating in two sectors of the economy — banking and oil & gas. The liabilities of oil & gas companies make up a large part of the repayments due — $62 billion, or 74 percent of the total liabilities of companies in the group. It’s basically about Rosneft, which amassed debts to acquire TNK-BP and Yukos assets and is still trying to settle them.

The money can be found and the debts paid off, but it must be kept in mind that unlike previous years, when our companies and banks took out loans to refinance past loans and invest in new projects (which is why the external debt was forever rising), this time around all the money will simply go abroad in order to settle debts with no investments whatsoever in the Russian economy. One can only imagine the impact this will have on the economic situation in the country. I personally expect that as early as 2015 the Russian economy will see a marked decline — there is no source to replace Western loans at present.

Hence the feverish demand for hard currency, which is showing no sign of abating. The West certainly knew what pressure points to target with its sanctions.

As for oil, I think the fall in price (which is not critical, incidentally) is the result of objective factors (the end of pumping liquidity into the money markets as the Fed winds down its QE program; the slowing economy and rising demand in China; the U.S. shale boom), and not a “collusion” with Saudi Arabia, which is frankly nonsense.

Nor was there a collusion in the 1980s. It was just that the Saudis foolishly held back production till the last moment, with prices falling all the same, and were then forced to stop what they were doing and lift the curbs on production. Now they are smarter than to sail upwind through curbing production — that’s all there is to it (the fall in price cannot be stopped, and such policy could lose money).

Nor do I believe that the Saudis are engaged in a “price war,” since they have no control over the key factors that influence the market. Only they have spare production capacity, which means that any containment of production will just result in lost revenue, while prices will continue to fall regardless.

As for the economics of shale production in the U.S., there is a lot of guessing and speculation about what price U.S. oil producers can “bear” without their projects stalling — $80, $70, $60? But it’s all guesswork: the market will decide. The economics are dynamic, the technologies are constantly improving, and the wells have a short lifespan. Some projects will stay profitable at $35-40, while some will be mothballed at $80. We’ll see. Any figures on this topic — even ones produced by the most expert of experts — should be taken with a grain of salt. But the fact that the economics of shale oil is a deterrent against an excessive price drop is obvious. If prices dip below the profitability threshold of marginal shale projects, production will be cut, and oil can again nudge upwards. The market will feel about for a new price equilibrium.

So instead of believing conspiracy theories, always look for an objective explanation of events.

The opinion of the author may not necessarily reflect the position of Russia Direct or its staff.

The article was initially published in Russian on the blog “Democratic Choice.” You can read the original version here.

Read another opinion: Now comes the moment of truth for the Russian ruble