Within seven weeks, Russia has implemented 12 mini-devaluations (of a little more than 1 percent each) of the ruble. These moves are awakening fears within Russia that the ruble could crash, much as it did in 1998.
Russia allowed its currency to weaken 2.4 percent on Dec. 29 to 29.28 rubles per dollar. It is the 12th time in seven weeks that Moscow has carried out a mini-devaluation of the currency, each time by just 1 percent or a bit more. The moves have led to fears within Russia that the ruble could see a crash reminiscent of the 1998 crisis. Moscow is in a very different place, both geopolitically and financially, than it was in 1998, but it is once again facing the choice of letting the ruble crash or spending exorbitant amounts of money to prop it up. This time, however, the pressure is compounded by the fallout from the recent Russian-Georgian war and a tumble in global oil prices. And this time, Russia has more to lose.
Background: The 1998 Ruble Crisis
In July 1997, the Asian financial crisis began to ripple throughout the world. The effects were felt particularly keenly in Russia, which was still reeling politically, socially, economically and financially from the fall of the Soviet Union just six years before. The country's industrial and service sectors had collapsed, and capital was fleeing faster than it could be counted. To add to the already-bleak situation, the one thing Russia was still making money with — energy — was taking a price nosedive. Then interest rates skyrocketed by 150 percent in June 1998. Because of this intersection of events, the Kremlin tried to counter the destabilization of the Russian ruble by keeping its value somewhat close to that of the U.S. dollar. Russia used a "floating peg" system for the ruble, in which Russia's central bank would keep the ruble-to-dollar exchange rate within a certain range. (At that time, it was approximately 5.3-7.1 rubles to the dollar.) The government never publicly acknowledged that range, as doing so would have allowed speculators to jump ahead of any government attempts to keep the ruble within that band. But whenever the ruble climbed or fell to either end of that range, the Russian Central Bank took action — such as by selling foreign reserves to create demand for the ruble — to pull it back within the band. But the Russian government was quickly running out of cash to keep the currency stable. Defending a peg — floating or otherwise — requires hard currency, and with energy prices plummeting to generational lows, that hard currency was hard to come by. It was estimated that between October 1997 and August 1998, the Russian Central Bank spent $27 billion of its U.S. dollar currency reserves to keep the ruble within the floating peg range, in addition to some $5 billion it received in loans from the World Bank and the International Monetary Fund (even though the loan terms specified that the money not be used to prop up the ruble). Finally, on Aug. 13, 1998, the Russian stock, bond and currency markets all collapsed as the Kremlin ended its attempts to keep the country financially afloat. The mass uncontrolled devaluation annulled ruble-denominated bonds, and the stock market tumbled 75 percent. Within a month, the ruble plummeted from 6.29 to 21 per dollar. The Russian people saw all their ruble savings (whether in banks or stuffed in mattresses) suddenly become worthless. Furthermore, inflation soared to 84 percent, while the cost of imports rose more than 400 percent and food prices increased more than 100 percent — all of which led to a massive food and goods crisis. Many businesses and institutions simply did not have the cash to pay their workers, so Russians went for months without pay. Russia ended up defaulting on $40 billion of domestic business-to-business debt. The default also severed most international credit access, so the black market stepped in to play the role of financial dealer and to provide goods for Russian society. Since then, Russia has slowly rebuilt its economy. Russia is still highly dependent on exports, though energy and commodity prices have been high for most of the past decade, allowing massive amounts of cash to flow into Russia and into the Kremlin's coffers. Over the past few years of high energy prices, Russia has paid off all its international debt, reset a floating peg for the ruble-to-dollar value and even saved up more than $650 billion in foreign currency reserves — the world's third-largest reserves as of early 2008.
The Current Devaluation
Another global financial crisis surfaced in late 2008, causing the global economy to slow. Many developed countries appear to be in recession, and many currencies are in decline — especially next door to Russia in Eastern Europe. In the past six months, the Polish zloty has fallen 22 percent versus the dollar, the Hungarian forint has declined 16 percent and the Czech koruna has dropped 12 percent — mostly due to the overall global credit crunch. Since August 2008, the Russian ruble overall has fallen 19 percent against the dollar — and not just because of the global credit crisis. The crisis coincided with two other major events: the Russo-Georgian war and plunging oil prices. Russia has seen massive amounts of investment flee because of the Russo-Georgian war. Russia also is looking at the possibility that in 2009 it could run its first budget deficit in a decade because of lower-than-expected oil prices — down 78 percent, to as low as $32 per barrel, from the July 2008 high of $147 per barrel. All three events have shaken Russia's economic outlook, and Moscow once again has been using massive amounts of cash from its vast currency reserves to keep the crisis from spreading throughout the country. But Russia is reaching the point where it will have to make a very tough choice between keeping its currency stable — which could mean eventually losing its wealth and its ability to reassert its influence abroad — and allowing the currency to collapse and send Russian society back into the kind of volatility it saw in 1998. Russia has been fortunate thus far in the overall global economic downturn in that it has large currency reserves. These stood at approximately $650 billion before August 2008, but have shrunk to just less than $500 billion. This financial cushion has allowed the Kremlin to fund many of its banks and Kremlin-endeared companies and keep them from financial failure. This cash also has allowed Russia to keep its currency relatively stable over the past few months.
The Ruble's Stability
Since the 1998 crash, Russia has kept the ruble within a floating range of approximately 24-31 rubles per dollar. But in the past few months, Russia has been slowly widening the daily trading band and slowly letting the ruble's decline accelerate. However, Moscow has strictly controlled the value, disallowing the type of uncontrolled collapse that happened in 1998's mass devaluation. (Click to enlarge image)(Click to enlarge image) Moscow also has come up with some inventive ways to raise demand for the ruble, such as asking its former Soviet states to pay for energy supplies and to trade in rubles instead of in dollars. (This is not much help, however; because dollars are appreciating, if the payments had been made in dollars, the Kremlin could have used the extra money to intervene in the currency market at its discretion.) But overall, it is the flow of cash from the Kremlin's massive currency reserve that has managed the ruble's value. According to STRATFOR sources in Moscow, in the past month the Kremlin has been exchanging $6 billion a week in hard currency for rubles in order to keep the ruble within the aforementioned range. (By comparison, the United States is currently spending approximately $2 billion a week on the Iraq war.) Those sources have indicated that Russian Prime Minister Vladimir Putin and Finance Minister Alexei Kudrin are growing tired of continually spending money to keep the ruble stable. Thus far, Putin has agreed to allow another 20 percent drop in the ruble over the next year in twice-a-week increments in order to slowly boost the economy and curb the rise in imports — without wiping out consumer spending, like what happened in 1998. But many believe that even such a slow devaluation will ultimately crash the economy and clear out Russia's currency reserves. So the Kremlin is considering a sudden mass devaluation and could allow the currency to crash once again. The chatter within the Kremlin is that if a mass devaluation does take place, it would happen some time after the Russian Orthodox holiday of Christmas on Jan. 7, in early and mid-January when consumer spending is high. The Kremlin's logic is to avoid making people's money completely worthless just before they spend it en masse.
Implications of Another Devaluation
A large devaluation actually would help the manufacturing and export sectors on which Russia depends so heavily. If the ruble crashes and then stabilizes, Russian products abroad will be cheap, boosting demand, and projects within Russia (such as building pipelines across Siberia) will appear more lucrative because they will be relatively inexpensive. All of Russia's oil and natural gas production, supply payments and export duties are also dollar-denominated, so a weak ruble will help the Russian energy producers and exporters — who in turn feed the Kremlin's budget. This comes as Russia is already concerned about losing money over energy projects and exports. However, there are some very serious problems with a mass devaluation, both for the government and for Russian society. First, allowing the ruble to collapse would ruin Russia's financial prestige. The central pillar of Russian power at the moment is that it is a bastion of stability once again, but that claim would be hard to make if the currency crashes. Russia has already allowed its currency to collapse once, but that was when the country was fighting for its very existence, not pushing to return as a world power, as it is today. If Russia looks financially weak (or even worse, incompetent), its ability to project power abroad would be hampered. The second concern comes from the massive social implications a steep devaluation would bring. The Russian people remember all too well the 1998 crisis; there are already fears of a sharp fall, and small bank runs are being seen. If the Kremlin allowed the ruble to crash again, it could ruin the government's credibility with the people. This concept is not too far-fetched, since the Russian government has allowed it to happen before. Many Russians believe that the 1998 crisis was the final nail in the coffin of then-President Boris Yeltsin's power and led to the rise of Putin's regime. However, another mass turnover in Moscow is unlikely; Yeltsin attempted to run Russia as an open country, and Putin has worked in the past decade to consolidate control over society to prevent mass social unrest. Russia is already seeing small demonstrations prompted by fear of a large financial default, but the Kremlin now has social and security controls to quash any larger movement that could destabilize the country. Then again, that control has not been tested with so many other crises weighing upon the Kremlin's shoulders. The Russian government is trying to balance the credit crunch, an economic downturn and now a possible currency collapse, all at a time when Moscow also is looking to re-establish its place as a world leader. Maintaining such a fragile balance could come at the expense of the Russian people, who then could turn against those leading the country. Editor's Note: An earlier version of this analysis, which was mailed to customers, incorrectly stated the amount of the Dec. 29 ruble devaluation.