Strong and silent.

Photographer: Andrey Rudakov/Bloomberg

The Strong Ruble Doesn't Mean a Russian Recovery

Leonid Bershidsky is a Bloomberg View columnist. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru.
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It's a measure of international investors' desperation that they are long the Russian ruble and other Russian assets. Even though fears of a major Russian onslaught in Ukraine are likely to prove unfounded, there's nothing about the Russian economy that can support an asset boom, and it's only a matter of time before the central bank is compelled to weaken the currency.

Since the beginning of this year, the ruble has delivered the third-highest returns of any currency to carry traders -- those who borrow in U.S. dollars to buy debt denominated in other currencies. 

Carry Traders' Favorites
Carry trade returns in the year to date, percent
 
Source: Bloomberg

It's natural for the ruble to closely track the oil price, since Russia is the world's biggest energy exporter, but it's been going through long periods of buoyancy as oil prices dipped. The latest of these began in early July.

Not Quite an Oil Currency
Ruble exchange rate vs. Brent crude oil price, normalized to Aug. 2015
 
Source: Bloomberg

The carry trade is the main reason why the currency is doing so well. Observers have been looking for signs that Russia's economy, stuck in recession for the second straight year, might be recovering, but what they're finding can hardly justify the ruble's strength. In the second quarter of this year, Russian economic output dropped 0.6 percent, less than the 0.8 percent expected by most analysts. There's been a slight year-on-year increase in electricity consumption and in transportation volumes. Yet these fluctuations hardly signal a recovery. On a seasonally adjusted basis, industrial production dropped a little in the second quarter. Investment and retail sales remained well below last year's already depressed levels. 

The government hasn't done anything to spur economic growth: It hasn't stimulated demand, increased spending, eased regulation or boosted investor protections. The central bank, in turn, has been slow to drive down lending rates. At the end of last month, it kept its main rate at 10.5 percent, enabling the carry trade to remain highly lucrative but making it difficult for business to fund investment. The rate has changed only once this year, in June, when it was lowered from 11 percent.

The central bank targets inflation. It expects it to drop below 5 percent a year from now -- a noble goal, but not necessarily compatible with the government's needs. The budget for 2016 depends on an oil price of 3,165 rubles per barrel, $48.75 at the current exchange rate. Russian oil only sold at the average price of $37.80 per barrel in the first half of the year, so there's a larger-than-expected deficit to cover, in addition to concerns about non-oil exports depressed by the expensive ruble. 

Late last month, Putin's economic aide Andrei Belousov, who strongly believes in monetary stimulus, complained about the ruble's strength, and President Vladimir Putin echoed his concern -- but not forcefully enough that the central bank would feel the need to react. In fact, it put out a statement saying it had no plans to weaken the ruble. 

The central bank could help the government by buying dollars on the open market to boost international reserves. It's been doing a bit of that: The reserves have steadily increased this year. That, however, hasn't been enough to counteract the carry trade's pressure.

A Growing Cash Pile
Russia's international reserves ($ billion)
 
Source: Bloomberg

There are plenty of bank analysts in Russia who will tell you the ruble is fairly valued. Russia's dependence on oil exports has weakened slightly as the price fell. This year, Russia became the world's biggest exporter of wheat. Its agricultural sector has benefited from an embargo on Western food and from the relative weakness of the ruble last year. The economy is certainly more stable than it was during the oil rout and directly after the annexation of Crimea. Investors are used to Russia's current status: It's not quite a pariah state and not an economic powerhouse, just a good enough country for a trade while rates are negative in safer havens.

That is probably a mistake. The Russian economy is stuck in limbo. Putin is unwilling to allow more economic freedom or reverse the nationalization of much of the commodity-based economy during his rule. The privatization of some oil company stakes, planned to cover this year's deficit, isn't running smoothly. Igor Sechin, the head of Rosneft, the biggest state-controlled oil company in which the government wants to sell a stake, wants to bid for Bashneft, the other oil firm readied for sell-off. Rosneft's own privatization terms are written to give the new investors as little say in the company's running as possible. 

Putin is busy playing checkers with his team: Lately, he has been more willing to fire his old friends and associates and appoint the next generation of bureaucrats, many of them former security police officers, to key positions. On Friday, he sacked his chief of staff, Sergei Ivanov -- one of his closest associates through the years -- replacing him with former diplomat Anton Vaino. But where the economy is concerned, Putin appears to be unable to accept any change to the rigid system he has built. He may talk to experts about alternative scenarios, but he's far more interested in his geopolitical games in Syria and Ukraine than in trying to end the shallow recession.

This means the government and the central bank will eventually be forced to drive down the ruble so the budget deficit can be covered. The inflation targets will be moved again: They, and Russians' purchasing power, matter much less to Putin than his ability to retain control over every aspect of life in his country. After the September parliamentary election runs its course, almost certainly returning the pro-Putin United Russia party to power, there will be even fewer reasons to keep prices from rising fast. Then, the central bank may well put more pressure on the ruble.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Leonid Bershidsky at lbershidsky@bloomberg.net

To contact the editor responsible for this story:
Tracy Walsh at twalsh67@bloomberg.net