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Russia's Ruble Hits a New Low Amid Warnings of Recession

Sanctions over the Ukraine crisis have scared investors and encouraged capital flight — but it is plummeting oil prices that have really taken their toll.
October 17, 2014, 10:35am
Image via AFP/Getty

Russia's ruble currency has hit yet another record low on the back of plummeting oil prices, casting a far larger shadow on the country's economy than Western sanctions have been able to do.

The ruble, which has lost almost 20 percent of its value against the dollar this year, bottomed out at its weakest-ever level of 41.14 to the dollar before finishing the trading day at 41.06. It had first broken 41 on Wednesday, after which Russia's central bank announced that it would sell $50 billion in foreign currency auctions to help the banking sector pay back its dollar and euro debts and try to ease the ruble's volatility. The central bank has already spent almost $7 billion this month propping up the ruble.


Economists have warned that if the oil price does not improve, Russia could face a recession in 2016 or even earlier. Predicted spending cuts could increase discontent among the population, which has widely supported its government, and even put the organizers of the 2018 World Cup in Russia in a cash bind.

Along with the dearth of foreign currency, the driving factor behind the ruble's roller-coaster rate has been the price of oil, since Russia's government gets half its revenue from oil and gas exports. The benchmark Brent crude price fell for the fourth day in a row on Thursday, reaching $83 per barrel, the lowest it has been in nearly four years.

Russia's stock market has also been dropping, with its Micex index losing 1.4 percent on Thursday.

The slump in the ruble's value comes after the European Union and United States implemented sanctions against Russia's defense, finance and energy industries in August and September over Russia's support for separatist rebels in eastern Ukraine. Three earlier rounds of Western sanctions in March, April and July had already scared investors and likely increased capital outflows, which reached a whopping $75 billion in the first half of 2014, already exceeding the estimated $61 billion in capital flight in 2013. But it wasn't until oil prices began dropping sharply in September that the ruble really took a dive.

Sanctions could still pose a long-term threat as Russian banks, virtually cut off from US financing, pay more for credit, and toil companies seek to replace the Western technology needed for new exploration. In an interview before Vladimir Putin's visit to Italy on Thursday and Friday, where he was to discuss the Ukraine ceasefire with Petro Poroshenko, the Russian leader lashed out at sanctions. He argued the economic health of Europe and the world could be "seriously undermined" by the sanctions regime, along with the Ukraine peace process.


"We are hoping that our partners will understand the imprudence of attempts to blackmail Russia, remember what discord between large nuclear powers can do to strategic stability," Putin warned ominously.

According to Timur Nigmatullin, a macroeconomic expert at the Moscow-based independent analysis agency Investcafe, once the central bank's foreign currency auctions begin, the ruble should stabilize.

"What we're talking about here is that the ruble has weakened a lot due to inertia, plus there was the influence of [banks'] speculation with the ruble to pay off their debts, which exacerbated its devaluation," Nigmatullin said. "But it shouldn't be this weak. If there aren't any new sanctions and oil doesn't keep falling, it will strengthen again."

The Russian government will likely try to soften the blow from falling oil prices by borrowing, reducing expenditures and spending money from its $452 billion reserve fund, which was padded by higher oil prices in the first half of the year, he said. The trade off will be higher debt servicing costs and public anger at cuts in services.

Nonetheless, Nigmatullin said that if oil prices and other economic factors remain at the current level, the economy will enter a recession in 2016. Bank of America this week said a recession will likely even sooner, predicting that Russia's economy will shrink 1.5 percent in 2015.

Among those affected by spending cuts could be organizers of the 2018 World Cup, whose budget has been ballooning as the ruble's fall makes imported construction materials more expensive. The head of the organizing committee warned that while the government has "no big desire" to raise the event's budget from the $16 billion it is at now, "there's nothing left to be cut." Sports Minister Vitaly Mutko warned on Wednesday that rising costs for the World Cup stadium in Kaliningrad "don't satisfy" the government.


But if February's Sochi Olympics are any indication, the Russian government in the end is usually willing to take care of skyrocketing costs in the name of "bread and circuses." Putin's projected budget of $12 billion had risen to $51 billion — helped along by sweet deals for his businessmen friends — by the time the Sochi Games were held.

The first hints at popular unease with the economic situation may be emerging as Russians' confidence in the financial system starts to crumble. According to a survey by market researcher Synovate Comcon, during the first half of 2014, when the first sanctions were adopted and the ruble had begun to lose value, 47 percent of Russians said they don't trust banks, up from 41 percent during the same time last year.

Konstantin Sonin, a professor at the Higher School of Economics, said the falling oil price would lead to spending cuts that could set off alarm bells among business leaders. "The elite is now realizing what these achievements cost," Sonin said, referring to Putin's annexation of Crimea and support for the separatist state in eastern Ukraine.

But Nigmatullin noted that for now, the effects of sanctions and the falling ruble on everyday life have been limited, with inflation remaining at a relatively low 8 percent. If Russian consumers were truly panicking, they would likely be lining up to convert their ruble accounts into dollars, which hasn't happened, he said.

He warned of a potential drop-off in trade with Europe due to sanctions and the increasing cost of imports. European producers provide Russia with oil drilling technology as well as consumer goods like cars and trucks.

"The ruble rate worries many people, but objectively speaking, as long as the exchange rate is free-floating it won't affect the economy drastically," he said. "The fall in oil prices and reduction of trade with Europe have a far greater effect."

Follow Alec Luhn on Twitter: @ASLuhn