Russia paying high cost for propping up the ruble

Russian policymakers are signalling that they are prepared to sacrifice economic growth in order to stabilise the ruble.

The Bank of Russia raised its benchmark interest rate by the most in 16 years last week and created a money-market cash squeeze, helping the ruble strengthen 45% from a record low on December 16. The consequence of this means the oil producer’s economy may shrink 7.9% in 2015, Danske Bank said, revising a view for a 1.8% contraction.

“We’re seeing a serious monetary shock, especially next year,” said Vladimir Miklashevsky, a strategist at Danske. “What they’ve done is more serious for the economy than falling oil, it’s a big negative factor.”

While the ruble’s plunge may have halted for now, challenges are deepening for the economy, which has been weakened by US and European sanctions over Ukraine.

President Vladimir Putin told Russians to brace for a recession as this year’s 45% drop in oil undermines the world’s biggest energy exporter. If crude drops further, the ruble’s hard-won stability may prove short-lived, said Vladimir Vedeneev at Raiffeisen Capital in Moscow. Higher interest rates and a weaker ruble are combining to squeeze Russian companies and individuals as growth stalls.

The economy may shrink 4.5% in 2015 if oil stays at $60 per barrel, the central bank said. The ruble lost as much as a fifth of its value last Tuesday, blowing through that day’s surprise rate increase and sparking concern that Russia would announce capital controls. It was only when the higher rates led to a shortage of rubles that the currency began its rebound. The currency is still down 45% this year.

“The peak of the currency crisis is behind us as authorities have taken decisive and appropriate actions,” said Bernd Berg of Societe Generale, said. “There is still work to be done and the ruble might remain very volatile in the short term. Over time, volatility will calm down and the ruble steadily appreciate assuming stabilizing oil prices.”

The ruble’s drop has been aggravated by traders betting on central bank intervention to slow its decline. The cash squeeze created last week “stopped local banks from shorting the ruble” using funds previously obtained from central bank liquidity injections, Miklashevsky said.

The success of Russia’s support for the ruble depends on oil prices and the longevity of sanctions, according to Oleg Kouzmin, an economist at Renaissance Capital in Moscow. “At the current oil price of $60 a barrel,” if sanctions aren’t tightened, the ruble might average around 50 in the mid- term, he said. If there’s a “massive run on the currency among the population”, the ruble might “move to levels that are difficult to quantify”, he said.

* Bloomberg