Why the Ruble Fell as Oil Rose

The ruble dropped sharply today despite an uptick in the oil price.

The separation of church, state and oil.

Photographer: Alexander Zemlianichenko Jr./Bloomberg

Both the Russian government and the broader markets have seized on the decline in oil prices to explain the rapid drop in the ruble's value. Yet it now appears that the actions of the Russian Central Bank and other financial institutions may be playing a more important role than oil.

Consider what happened today: Oil bounced back on news of supply disruptions in Libya, even as the the ruble plummeted, losing 2.8 percent of its value against the dollar:


If, as a top Russian Central Bank official told me last week in Moscow, the relationship between the currency and oil was universally accepted -- built into trading algorithms, for example -- the ruble should have appreciated along with the oil price. 

It would be easy to dismiss the divergence as an anomaly, yet evidence emerged Friday to support the counter-narrative. 

Russia's state-owned oil company, Rosneft, raised 625 billion rubles ($10.8 billion at that day's exchange rate) with a bond issue that had a lower yield than Russian government bonds of similar maturity. The Central Bank quickly added the bonds to the list of securities it would accept as collateral from banks seeking liquidity. The deal was opaque, and it's not clear who bought the bonds or how Rosneft would use the proceeds. There are, however, three distinct possibilities for what could happen now:

First, the banks that bought the Rosneft paper -- probably big state-owned ones -- could use the bonds as collateral to borrow foreign currency from the Central Bank, and then would provide the cash to Rosneft through a currency swap. That would allow the oil company to refinance a $6.88 billion loan from foreign banks. Under this scenario, however, the Central Bank would need to draw on its foreign reserves, which it doesn't want to deplete.

Second, Rosneft could invest the rubles in production. The company announced that it would distribute the money to several subsidiaries. Each, however, would get as much as the others, suggesting the money isn't earmarked for investment.

Third, Rosneft would use the rubles to buy dollars for debt repayment on the market. That, however, would severely erode the ruble's exchange rate.

It would be reasonable to assume that the Central Bank has  a verbal agreement with Rosneft management -- and thus, with the Kremlin, as Rosneft Chief Executive Officer Igor Sechin is a close friend of President Vladimir Putin -- to keep the rubles off the foreign exchange market. The banks that bought the bonds would have to be in on the deal: They can use the obligations to borrow from the Central Bank and also are in a position to flood the market with rubles and drive down the value of the currency.

That's unlikely, however, because such a deal couldn't be enforced. It's impossible to track Rosneft's money with any certainty, and besides, the Central Bank doesn't have enough political weight to take on Sechin. A low ruble exchange rate is good for the oil company, which has ruble expenses and dollar revenue, and it would be tempting for Rosneft to go to the markets.

The state banks, too, could easily find ways to break an informal deal and stock up on hard currency by going through intermediaries.

Central Bank technocrats have been worried that the government would force them to print rubles for the direct funding of industries, primarily the military industrial complex and the state companies run by Putin friends. The Central Bank's obvious complicity in the Rosneft deal means the pressure is on, and the Central Bank is caving. It cannot prevent the funds loaned to corporations in special deals such as Rosneft's from destabilizing the currency and fueling market panic. Besides, the Rosneft deal sends a clear signal to market players that some of them are more equal than the others. That is a sure way to foster distrust and send the ruble into a speculative tailspin regardless of what happens to the oil price.

All who try to understand Russia's stormy markets today should keep in mind that they are dealing with a dictatorship, whose monetary authorities can only conduct reasonable policy until Putin says otherwise. 

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.