The Russian Financial Crisis and the Ruble Rout

ruble dollar currencies playing chess

As hard as it may be to believe, we are closing in on ten years since the start of the global financial crisis.

The path of recovery since the end of the financial crisis has been slow. Many economies are still struggling with the same structural problems that contributed to their difficulties in the first place.

The financial crisis has had a number of long-lasting consequences:

  1. lower investor confidence
  2. stress on banks and economies
  3. extraordinary stimulus measures by central banks.

In the meantime, we have seen a sequence of more local crises that are in some ways linked to these effects. This article will explore one of these crises in detail – namely, the Russian ruble crisis that began in 2014.

Different negative factors coincided almost at once for the Russian economy, leading to an extended period of devaluation for the Russian ruble (RUB).

Factors that led up to the Russian financial crisis

If we were to sum up the two main factors leading to the collapse of the Russian economy, they would be:

  1. a sharp drop in the price of crude oil
  2. international sanctions imposed on Russia.

Sound quite self-explanatory, but let's take a closer look.

Russian oil crisis

The groundwork for the Russian crisis can be traced back to the global financial crisis. Heading into the financial crisis, oil prices had risen strongly from the early 2000s. These gains had been driven by strong demand from emerging markets and tepid supply growth.

The financial crisis served to curb demand, however.

At the same time, advances in the oil industry, such as fracking and horizontal drilling, eventually led to the shale boom. Previously untapped shale oil reserves were now accessible, resulting in an unexpected surge in US and Canadian oil output.

The supply glut was exacerbated by other factors, including:

  1. the lifting of trade sanctions against Iran
  2. the rebuilding of the Iraqi oil industry following years of military conflict.

Suddenly there was a threat to Saudi Arabia's market share and the oil-rich state seemed unwilling to cut output to defend prices.

How sharply did oil prices fall?

West Texas Intermediate (WTI) is a grade of crude oil that is frequently used as a benchmark for global oil prices. In the summer of 2014, WTI crude oil prices were still holding above $100 per barrel, but moved sharply lower in the autumn. By the new year of 2015, prices had more than halved to under $50 a barrel.

Now, oil is an important commodity and major export of Russia. According to the EIA, oil and natural gas accounted for 68% of Russia's export revenues in 2013.

With the oil price more than halved, the Russian economy experienced a major blow. The collapse in the price of this vital export came at a particularly bad time. Russia was already facing international sanctions by this point.

International sanctions against Russia

Russia annexed the former Ukrainian territory of Crimea in March 2014. The move was condemned by a number of prominent international leaders. This led to the US, the UK, Canada, France, Germany, Italy and Japan agreeing to exclude Russia from G8 meetings.

Hence, the G8 returned to its former status as the G7.

Additionally, a number of countries, including the US, the EU, Canada, Japan and Switzerland, imposed various sanctions against Russia. The sanctions mainly targeted the financial, energy and defence sectors, with stocks of many companies taking a deep dive.

Describing the sanctions, US vice-president Joe Biden said in a speech in October 2014: "The results have been massive capital flight from Russia, a virtual freeze on foreign direct investment, a ruble at an all-time low against the dollar, and the Russian economy teetering on the brink of recession."

So how badly hit was the Russian economy in actual numbers?

According to data compiled by the World Bank and the OECD, Russia's GDP growth was 1.064% in 2013. In 2014, its economy contracted by 1.075%. By 2015, the contraction had deepened to 3.934%.

Effect on the ruble

The combination of international sanctions against Russia and the collapse in oil prices rocked investor confidence in Russia's economy.

Investors consequently began taking their money out of Russia, selling their Russian assets and moving the proceeds elsewhere.

This generated more negative Russian economic news, which may have served to increase speculative selling and further exacerbated the situation.

The daily USD to RUB graph below shows the magnitude of the devaluation in the Russian currency over the second half of 2014.

Russian currency devaluation magnitude over late 2014. 36.90 to 78.12 in 3 months

On 4 September 2014, one US dollar was worth 36.90 Russian rubles in the FX and CFD market. By 16 December 2014, the Forex rate had spiked up to a high of 78.12.

That's an increase of 112% in roughly three months.

That's only part of the story. Things have gotten even worse over the next year. Take a look at our weekly Forex chart for USD/RUB which extends all the way into late 2016:

rub/usd chart mid 2015 - early 2016. 50.00 - 85.91

You can see how volatile the currency pair was in 2015.

The rate dropped back below 50.00 briefly in April 2015 and May 2015, though the overall path of the ruble devaluation continued all the way into early 2016. On 21 January 2016, it reached a high of 85.91 rubles to the dollar.

It was the worst Russian currency devaluation since 1998.

We can see a similar story against the euro and the pound. The weekly EUR to RUB chart below shows basically the same price movement across the same period:

September 2014, EUR/RUB was trading at 48.50. January 2016, the rate is 93.59 – 93% higher

In early September 2014, EUR/RUB was trading at 48.50. By 21 January 2016, the rate had climbed to 93.59 – that's 93% higher than it was in September 2014.

The GBP to RUB rate followed the same general arc. There was a sharp devaluation in the Russian currency to GBP in December 2014 – a trend that continued throughout 2015.

The pound to ruble rate eventually peaked around 117.00 on 21 January 2016, roughly 95% higher than it had been in September 2014. As the charts show, it was an extended decline in the ruble.

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What other factors contributed to the persistence of the move?

Having explored the two main causes behind the Russian economic crisis, we must also consider the lingering effects of the global financial crisis. These effects contributed to the severity of the ruble crisis in at least a couple of ways:

  1. the weakness of the Russian economy left it ill-positioned to weather the economic headwinds
  2. prior to the ruble crisis, the reach for yield sparked by quantitative easing pushed investment flows into emerging market debt.

Russian companies ramped up their issuance of debt in foreign-currency denominated as a response to this second point.

This would eventually be a major negative in the Russian economy news.

Russian debt

Russian companies' revenues are generally in rubles. At the same time, they had to service the debt mentioned above in currencies other than the ruble.

So when the ruble plummeted in value, the cost of servicing that debt effectively rose.

For example, Reuters reported that Gazprombank borrowed $1 billion in global bond markets. However, sanctions shut the company out of global capital markets when the debt came up for repayment.

Of course, a lot of companies were not on the sanctions list. They could secure further funds by issuing debt in the international bond markets.

This demand for dollars served to further undermine the ruble against the dollar, though.

Central bank intervention

The central bank of Russia, which is also the Russian financial regulator, intervened to try and combat the ruble devaluation. The central bank had dropped its soft peg against the euro and dollar in November 2014.

In theory, this would mean spending less defending the ruble, as the intention was to have the currency float freely. The timing was unfortunate, however.

The central bank ended up expending significant chunks of the Russian foreign currency reserves. According to Reuters, it spent more than $8 billion defending the ruble between November 2014 and December 2014.

The central bank also tried to halt the slide in the ruble by hiking interest rates. It raised rates by 100 basis points in early December 2014, followed by a surprise 650-basis-point hike on 16 December 2014.

This move was interpreted as a sign of desperation and proved ineffectual.

Remember those spikes in the charts above on 16 December 2014? When the central bank demonstrated its inability to control the situation, it added to the sense of panic.

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Rouble crisis: are we out of the woods yet?

The worst of the Russian financial crisis seems to have passed. Inflation has eased, allowing the central bank to cut rates. The ruble has progressively gained value throughout 2016 from its lows seen in January of that year.

USD/RUB in early December 2016 has been oscillating near the 68.00 level, roughly 27% below the January 2016 peak. Oil prices, though still weak, have shown signs of stabilisation.

At the time of writing in late 2016, the most liquid WTI oil futures contract was trading just above the $50 per barrel mark. A proposed output cut from OPEC has raised hopes of further recovery.

There are still risks, however – Russia's economy remains overly dependent on oil exports.

If Russia is to maintain economic growth in the long term, it needs to decouple its economy from the vagaries of the energy market. To do this, will require structural change.

Furthermore, the country has been dipping into the Russian reserve fund at an alarming rate to cover its budget deficit.

Should oil recover further or sanctions come to an end, things could quickly change. At the moment, however, it looks like spending cuts may be required to avoid exhausting the fund.

If you liked this article, you might also like our overview of the pound-dollar history.