Spot 10 differences
The rapid devaluation of the Russian Rouble in December 2014 and August 2015 can be viewed as a the result of the perfect storm, when all negative factors happened at the same time, or as the logical result of the way the country has lived for the last decade.
To explain the reasons, you need to analyse the similarities and differences between the current crisis and the 2008 financial meltdown.
What happened at the end of 2014 that wasn’t happening before? Technically nothing. But of course the plummeting price of oil, the lifeblood of the country, was rapid, unexpected and deep.
In the fourth quarter the drop on the price compared to a year before was 30%. But this also happened in late 2008 and in early 2009. Another factor is the seven and a half percent drop in the physical export of oil compared to Q4 2013. But that’s also very similar to the situation in 2008-2009.
What else? The issues with paying foreign debts were much worse six years ago. People changing their roubles to foreign currencies? In the forth quarter 2014 it was almost half compared to the same period in 2008. Yet, despite the similarities of events in 2008 and 2014, the scope of the devaluation of the rouble and the reaction to that situation has been different. Why? Because there were also major differences that have to do with the starting conditions for both financial crises and the reaction of the major market players.
A different scenario
First and foremost, the role of the Central Bank was different. In 2008 it spent currency reserves to save the banking system that was inflicted with the currency risk. The actions of the Central Bank, when they sold on currency reserves, allowed banks to enter the currency market with their roubles and swing the situation. Only after that the Bank of Russia allowed a rapid devaluation, which in turn allowed commercial banks to buoy the market.
But last fall the Central Bank announced that it was switching to an inflation targeting model (meaning that they set a planned inflation index), which the market saw as them stopping their attempts to control the exchange rate. This decision can be discussed at length, but the Central Bank didn’t have any other good recourse. The situation wasn’t harming banks with devaluation, so no one needed saving.
Large companies were also relatively ready for a storm of the currency market. If before the 2008 crisis they preferred loans in foreign currency, to save on interest and make money off currency fluctuations, then from early 2009 they minimised their risks. By 2011 the activities of the companies was basically reversed. They chose to take rouble credits, while keeping funds on their accounts in foreign currencies.
The population also changed their views on what’s good and what’s not. This is mostly obvious from the dynamics of international transactions. The way people brought money out of the country changed. In 2014 this process was untraditional. Firstly, the volume of funds leaving the country was unusual, in Q1 2014 it was almost double the average of previous years. Obviously, this was a reaction to the Russia-Ukraine conflict that culminated with the annexation of Crimea. It’s also worth noting that the mass exodus of funds of individuals started in the end of 2013, before the conflict became heated. People have learned from previous crises and started moving their funds early.
What else influences the rouble? The attention of big players to this currency. How can this attention grow or shrink? There are two main variables: the ability to make money, and confidence in the country, its politics and economy. So the fluctuation of the exchange rate depends on the ratio of potential profit and actual risks.
Before the 2008 financial crisis banks, companies and the population were fairly optimistic about the rouble. Which makes the change in attitude by fall 2014 even more extraordinary. Corporations and banks preferred to work with more stable currencies, and the people that had large savings were quick to exchange them into dollars and euro, or move them as far away as possible from a Russia that was confronting the rest of the world.
The August fall of the rouble isn’t all that different from the fall of December 2014. All the negative factors from December had only gotten worse towards the end of summer 2015. Not just the situation in the oil market, which completely annihilates the hopes of Russian politicians for a quick recovery to the levels of the ‘good old days’ - when you didn’t have to concern yourself with the country’s well-being and could easily work on the pleasurable task of building your own wealth. Even worse than the plummeting oil prices, the people that have money and can use it, are losing trust in the Russian economical and political system.
Without a radical change in external economic conditions (and only blind optimists are expecting that), the Russian economy is doomed for periodic devaluation of the national currency. In other words, the rouble will likely fall even more.
It’s time to start treating a scenario reminiscent of the Iron Curtain seriously, and initially likely in terms of finance. Aspiration to protect funds from the heavy hand of the Russian government will only increase. As will schemes to move funds out of the country, into foreign safety assets, real estate being a top choice. Although foreign sellers shouldn’t get their hopes up, without a strong Russian economy this demand won’t be stable and won’t last too long.
To stop these macabre forecasts from becoming reality, the Russian government needs to make Herculean efforts to restore confidence, not just in their actions, but their intentions too, which could be an even more difficult task.
Dmitry Miroshnichenko - Moscow's Higher School of Economics National Research University