13.11.23 Review

Downward Slide: The Russian Central Bank warns that measures to support the ruble will not be enough if lending and budget expenditures are not curbed

The sharp fluctuations in the ruble exchange rate in 2022-2023 were determined by the state of the trade balance and not by any other factors, the Central Bank's experts insist in their latest report on monetary policy. The ruble experienced a significant strengthening in the first half of 2022 due to soaring export revenues and a corresponding decline in imports. However, as export earnings gradually decreased and consumption, including imports, showed significant growth, the trade balance contracted, accelerating the depreciation of the ruble. The authors of the report argue that the measures already implemented by the Central Bank will be enough to stabilise the exchange rate, but only if budgetary spending is curbed and credit market activity cools down; otherwise, the ruble will be at risk of further weakening. However, given the anticipated increase in budgetary expenditures in 2024 and the continuation of preferential credit programmes unaffected by the key interest rate, the likelihood of this scenario remains high.

Following several months of currency turbulence, analysts at the Central Bank suggest in their latest report on monetary policy that the ruble's exchange rate may stabilise at its current level if the measures already taken by the Central Bank prove effective in tempering economic demand. They insist that the sharp fluctuations in the exchange rate throughout 2022-2023 were predominantly influenced by the state of the trade balance – specifically, the amount of currency Russia earned from exports and subsequently spent on imports – rather than by any other factors. Accordingly, the main reason for the acceleration of ruble depreciation this summer was the expansion of domestic demand (including imports) coupled with a reduction in net exports and export revenues. In general, the analysts at the Central Bank identify four stages of adjustment of the exchange rate to the new economic reality in which Russia has found itself following its invasion of Ukraine.

In the initial months following the full-scale invasion of Ukraine, prices for Russian exports predictably surged. Urals crude oil, for instance, cost nearly a third more in January-June 2022 than it did in the first six months of 2021. Gas industry revenues have also increased, despite Gazprom's deliveries to distant markets dropping by a half (in March, a thousand cubic metres of gas on the European spot market almost quadrupled to $3900). In contrast, imports declined due to supply issues and restrictions imposed on the Russian financial sector, which complicated transactions. Some Western companies stopped exporting goods to Russia as a result of sanctions, while others did so voluntarily. Additionally, after the March 2022 rush of purchases, consumers and businesses significantly reduced their activity. As a result, the trade surplus in the second quarter set a historical record ($90 billion), and the dollar fell below 60 rubles, returning to the level seen in 2015.

Exports and imports of goods and services in Russia, 2022-2023, billion USD

In the latter half of 2022, Russian exports gradually diminished under the impact of sanctions. During the first year of the war, the European Union, once Russia's largest trading partner, slashed imports from Russia by 60%. Prior to the full-scale invasion, countries in the EU, along with the United Kingdom, Ukraine, and Moldova, accounted for over 40% of Russia's foreign trade turnover. The most affected sectors in 2022 were the shipments of ferrous metallurgy, precious metals, and timber. The trade balance decreased by 20% in the third quarter compared to the second, and by 14% in the fourth quarter compared to the third. However, as consumption, including imported goods, in Russia has yet to demonstrate meaningful growth, the ruble remained strong. The experts from the Central Bank attribute the overall decline in export revenues to the reduced volume of imports consumed by the economy during that period.

The ruble only began to weaken in the second half of December last year when imports began to recover steadily while exports continued to decline. Analysts from the Central Bank attribute the reduction in exports to the global economic slowdown and sanctions against Russian oil, the effectiveness of which remains a matter of debate. Several factors contributed to the growth in imports. Consumers (both individuals and businesses) adapted to the realities of war, believing that the main shocks were behind them, they began to reduce their savings rate, i.e. to spend more actively. The growth of consumption was fuelled by the increase in monetary incomes caused by the intensified competition of enterprises for personnel and the availability of credit. After the sharp increase in the key interest rate immediately following the start of the war, the Central Bank lowered it fairly quickly below the pre-war level. By this time, parallel imports had been established, consumers had become accustomed to new brands, and affluent Russians had resumed their travel abroad. At the same time, companies dependent on imported equipment and components began actively purchasing them, including in advance. As a result, the trade balance surplus for goods and services during the first nine months of 2023 decreased by 74% compared to the previous year. While exports decreased by almost 30%, imports increased by 15%.

The ongoing depreciation of the ruble is expected to promote import substitution where it is possible, according to the Central Bank experts. However, its effect is likely to be weak in the production of investment and intermediate goods, due to the absence of sufficiently high-quality Russian alternatives, as Re:Russia has previously noted. Moreover, the dynamics of imports should begin to reflect the tight monetary policy that the Central Bank intends to adhere to for several quarters. The process will not be swift, the authors of the report caution: first, orders will start to decline, and this will then be followed by actual deliveries over the next few months. However, the most important factor in the dynamics of the exchange rate, they say, will be the volume of ruble demand in the economy. If it continues to grow due to a weak response of lending to the tightening of monetary policy or high budgetary stimulus, the slowdown in imports will be delayed, and the ruble will continue to weaken.

Thus, the Central Bank reiterates the need for a more balanced budget policy to achieve economic stability. However, budget expenditures in 2024 are set to increase by more than 20%, according to government plans. As for lending activity, during a recent speech in the State Duma, the head of the Central Bank Elvira Nabiullina noted that it has cooled down somewhat, but the volume of lending is still at high levels. As Re:Russia has recently discussed, the challenge of reducing mortgage lending, which constitutes over half of the entire retail portfolio of Russian banks has been hindered by preferential programmes unaffected by the key interest rate. The authorities are unlikely to get rid of these before the presidential elections. Simultaneously, major state-owned companies such as Russian Railways, AvtoVAZ, Roscosmos, Aeroflot, and others are lobbying for new credit subsidy programmes, with the Ministry of Industry and Trade pledging their assistance.