25.01.23 Review

The Central Bank and Consumers Want More ‘Toxicity’: the fate of the ruble depends on the effectiveness of Western sanctions on Russian oil

After several months of apparent stability, the ruble finally tumbled to an eight-month low at the end of last year. In its latest review of financial risks, the Russian central bank reveals the set of factors that have contributed to the fluctuations in the value of the nation’s currency. The first reason is a reduction in the foreign exchange earnings of exporters as a result of sanctions against Russian exports. To add to this, dollars and euros are in high demand among those dealing with parallel imports into the country, as well as those purchasing the Russian assets of foreign companies that continue to leave the Russian market. Another factor was the behaviour of  ordinary consumers. In December, Russian citizens continued to worry about the disruptive effect of sanctions on Russian exports, and anticipated a further weakening of the ruble. As the value of the ruble fell, they drove up demand for ‘toxic currencies’ such as dollars and euros. In order to reverse this trend, the Ministry of Finance was forced to sell off some of its yuan reserves from the Russian National Wealth Fund in January. However, if the foreign exchange earnings of exporters fail to recover, they will be unable to maintain the current exchange rate in the long term. This means that the ‘toxic’ dollar will trade at around the 80 ruble mark.

After several months of trading within the narrow range of 60–63 rubles per dollar, the ruble took a nosedive, falling by almost 11% over the course of the week from December 15 to 21. In the latest ‘Financial Market Risk Review’ for November and December 2022, the Bank of Russia identified two main reasons for this noticeable weakening. The first and most important cause was the reduction of ‘toxic currencies’ (the term applied by the central bank to dollars and euros) being supplied to the market from oil and gas companies, as well as other exporters. For the entire month of December, the 29 largest Russian exporters reduced their average daily net foreign currency sales by 6%, as compared to November. In the second half of December, when the ruble fell, sales decreased to 37.7 billion rubles, or by 24% (compared to the first two weeks of the month).

Along with the seasonal factor (in Russia and in the West, market participants traditionally withdraw their ruble assets in preparation for the long holiday season), the central bank identified two more important issues: a fall in hydrocarbon prices and a reduction in the physical volumes of oil and gas exports as a result of the sanctions on Russian oil. Since December 5, there has been an embargo on Russian oil supplies to the EU, as well as a price cap that potential buyers must abide by if they want to use the services of European shipping and insurance companies. According to the Ministry of Finance, from December 15, 2022 to January 14, 2023, the average price of a barrel of Urals oil was just $46.82, this is compared with an average price of $66.47 in November and $78.32 in January–November. For deeper analysis regarding the true discount on Russian oil, which may be even smaller than it first appears, refer to this report by independent analyst Sergey Vakulenko for Re: Russia.

The second reason for the decline in the value of the ruble is the growing demand for ‘toxic currencies’ from some financial market participants. The last two weeks of the year accounted for 68% of its total monthly volume (386 billion rubles), with the majority of these purchases carried out by banks not typically considered to be systemically important. In addition to traditionally robust buyers of foreign currencies (importers and individual citizens), a significant proportion of these currencies was acquired by those who needed to buy assets from foreign companies leaving the Russian market (Re: Russia previously reported on the scale of this phenomena here). To add to this, by the end of the year, the process of converting foreign currency loans into rubles had accelerated, which in turn led to an increase in banks' demand for foreign currency, which the Bank of Russia concludes took place ‘in order to compensate for the impact on the open foreign exchange position.’

Under normal circumstances, the central bank notes, individuals have a countercyclical impact on the foreign exchange market: they sell dollars and euros when the ruble weakens and buy them when it strengthens. At the end of December, citizens began displaying abnormal behaviour, that is they were stocking up on foreign currencies despite the increase in price. In November, the total volume of these purchases amounted to 70.1 billion rubles, and in December that figure rose to 154.2 billion rubles. This suggests that these individuals were worried about the effects of sanctions on Russian exports and expected a further weakening of the ruble.

At the beginning of this year the ruble bounced back somewhat, but it is currently trading cheaper than it was in December. The trend was reversed as a result of the Ministry of Finance selling ‘foreign currency (yuan)’ from the National Wealth Fund (NWF) under a new budgetary rule. According to this rule, which the authorities approved at the end of 2022, the volume of oil and gas revenues for the next three years is set at 8 trillion rubles annually. To achieve this target, a barrel of Urals at the current level of production should cost about $55. Consequently, if it costs more, the excess profits will go to the NWF. If the price is lower (as it is now) the Ministry of Finance must compensate for the shortage by selling the currency it has accumulated.

At the same time, the beginning of the year saw an increase in the prices of raw materials. In addition to this, before the extended January holiday, consumers also bought foreign currencies amid fears that the ruble would continue to tumble. This trend has been partially reversed  as some foreign currency has been sold off. 

Contemplating the future prospects of the ruble, the Bank of Russia indicates that this budget rule will continue to smooth out the effects of fluctuating export earnings. Most analysts predict that, if this is the case, the dollar is likely  to soon be trading at around 70 rubles. At the same time, Russia’s yuan reserves are not going to last long.

If a barrel of Urals costs $45, the Ministry of Finance will be forced to sell more than half of its yuan reserves this year and to curtail operations in the spring of next year, according to the MMI Telegram channel, founded by Kirill Tremasov, director of the central bank’s monetary policy department. He believes that ‘the market will begin to take this into account in the second half of this year, meaning that the ruble is likely to take a nosedive. If oil trades at $45 [per barrel], the ruble will hover at around just under 80 [rubles per dollar].’