On August 17, 1998, Russia announced a default and devalued the ruble. Fast-forward nearly two decades, and there are rising concerns that Russia could be facing a similar type of economic scenario.
Another round of ruble depreciation is real, so the only question is how far it will go. Photo: RIA Novosti
The rapid weakening of the Russian ruble, which began in September 2014 before coming to a halt in the period from February-June 2015, resumed again in July 2015 and has continued for more than one and a half months. There is growing concern in Russia’s financial markets and society in general that the country is staring at a second round of devaluation, similar to the one it experienced in August 1998 and then again in September-December 2014.
But how real are the prospects of another default and devaluation? And does the current situation really resemble summer 1998, when the result was a short-term default and the start of a new page in Russia’s economic history?
The second round of major ruble depreciation is real, so the only question is how far it will go. The answer only partly depends on the Russian market and non-state actors; foreign sanctions against Russia are also a factor.
The keys to controlling the exchange rate of the ruble lie with the Russian presidential administration, the government and the Bank of Russia. So far, these structures have not made any obvious mistakes in macroeconomic policy that could trigger a landslide devaluation. But neither have they taken any steps to help the Russian economy adapt to the new realities of the global market, which stands on the brink of economic crisis.
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The country’s financial market is essentially determined by the conflicting strengths and weaknesses of the Russian economic authorities.
There are several reasons to expect the worst:
- Since February 2015, the Bank of Russia has eased its monetary policy after hiking the refinancing rate in December 2014. In August 2015, the refinancing rate of Russia's Central Bank was lower than the current level of inflation in the country, which points the way to a decline in the ruble exchange rate.
- The reform of the Russian economy was halted in 2003, and since that time, the government and parliament have carried out merely cosmetic measures to adapt the national economy to the realities of the era of globalization. The increase in the public sector, the rise in budget spending, slow productivity growth and stubborn corruption inside executive and judicial bodies are also undermining confidence in the stability of the ruble.
- The aggravation of the conflict in Ukraine in August shows that the United States and Russia cannot reach a compromise. The market is factoring in a future build-up in the confrontation between Russia and the West, which is pushing down the exchange rate of the ruble.
- The fall in world oil prices in July crossed some psychologically important frontiers for the Russian economy. The government feels comfortable at a price of $55-60 per barrel. The budget provides for a drop in the oil price down to $50, although that would increase the budget deficit and spending of gold and foreign currency reserves. However, a fall in the price of a barrel of oil below the psychologically important mark of $50 would cause all market players to expect the worst, in which a situation of “abandoning the ruble for the dollar” would be a quite natural response.
The situation in the Russian economy today is fundamentally different from 1998, so parallels are inappropriate. The trouble in both cases stemmed from falling oil prices. But in 1998, the price of oil dropped below $10 per barrel, i.e. below the base cost of production and transportation.
Back then, Russian oil companies mostly operated at a loss. Today the price does not promise fabulous profits, but is relatively comfortable for the oil and gas business.
Over the past 17 years Russia’s economy has grown several-fold: it has become market-based with the appropriate infrastructure (banks; investment and venture companies; large, medium and small industrial enterprises; a high-performance agricultural sector). It is able to contract and expand quickly, yet robust enough not to disappear at the first mention of negative news.
Russia’s economic dependence on the EU market, which is fluctuating between depression and stagnation, is substantially lower, and substitutes for European partners have appeared in the shape of BRICS (Brazil, Russia, India, China, South Africa) companies.
As for foreign relations, the situation no doubt looks very bad for Russia when compared with 1998. Then-Russian President Boris Yeltsin was reelected for a second term with help from the global community, and effectively received carte blanche from the West to carry out any measures in the country.
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Today relations between Russia and the West leave much to be desired. Sanctions have not produced any significant political results, having only exacerbated the situation. The upshot is a rise in anti-Americanism in Russia, closer ties between Russia and China, and a speed-up of the integration processes in the CIS, which represents the core of the Eurasian Economic Union.
A repeat of the 1998 financial meltdown with a tumbling exchange rate and sovereign debt default is out of the question. But we can expect a significant short-term decline in the exchange rate due to the above reasons. They are compounded by the clear onset in August of a period of currency wars and competitive devaluations among the world’s leading currencies.
Many experts regarded the Bank of Russia’s actions in the fall of 2014, namely the competitive devaluation of the ruble, as “Russia’s step” in the global currency wars. Now China has gone down the same path. Through their policy of quantitative easing, the U.S. Federal Reserve and the European Central Bank are suspected of waging a currency war. If the actions of the major players in the global currency market are successful, it will be Russia’s turn to carry through a substantial devaluation of the ruble.
The crux of the matter is that today the exchange rate of the ruble is almost completely controlled by the Russian authorities. Therefore, foreign companies working in Russia whose earnings depend on the ruble exchange rate are advised to keep a close eye on the rhetoric and concrete actions of the head of the Russian Central Bank, Elvira Nabiullina, and her deputies.
As long as they adhere to their present conservative approach to monetary strategy, Russia remains attractive for foreign partners and markets. Now the market is in a zone of turbulence. But the experience of the 1998 and 2008 crises shows that the Russian economy is able to rebound from the depths of crisis and reopen for business in next to no time. However, in a climate of geopolitical instability and uncertainty, the chances of rebounding are lower.