The story so far: The Russian rouble has staged an impressive recovery after it lost about half of its value in the wake of Russia’s invasion of Ukraine. The currency has recovered almost all of the losses it incurred following the invasion and has thus, surprised many who had predicted a further fall in its value.
What kind of sanctions were imposed on Russia?
Sanctions were imposed on the Russian economy by Western governments right after Russia invaded Ukraine in late February. These sanctions included cutting off many Russian banks from the SWIFT payments signalling system and also freezing the Russian central bank’s foreign reserves held abroad.
Many western companies including oil majors such as British Petroleum and Shell also pulled out of Russia amid pressure from Western governments.
Sanctions basically made it harder for Russian businesses to sell their goods abroad and also made it harder for ordinary Russians to purchase goods from abroad.
The freezing of the Bank of Russia’s forex reserves held abroad also made it harder for the Russian central bank to use its foreign reserves to prop up the value of the Russian currency.
Naturally, the rouble experienced a sharp hit right after these sanctions, thus leading many to believe that the Russian economy had been brought to its knees.
Surprisingly, however, the Russian currency has staged a remarkable recovery in the last three weeks. It took about 81 roubles to purchase a US dollar one day before Russian forces invaded Ukraine on February 24. A couple of weeks later, it took 151 roubles to purchase a US dollar, marking the rouble’s low since the beginning of the war.
This week, thanks to a significant rally from the lows of early March, it takes about 83 Russian roubles to buy a US dollar.
The rouble has, thus, recovered pretty much all of the losses that it incurred in the aftermath of the war.
What’s driving the rouble’s sharp recovery?
It should first be noted that the price or exchange value of any currency is determined by the supply and demand for the currency. When Western governments imposed sanctions, it made it harder for dollars to flow into Russia, either in the form of investments or by the purchase of Russian goods. Sanctions on the Russian central bank also made sure that the Bank of Russia could not flood the currency market with US dollars to prop up the value of the rouble.
The demand for foreign goods and assets, however, remained stable and when combined with a drop in the inflow of dollars, it caused the value of the rouble to fall precipitously in the initial weeks of the war and the ensuing economic sanctions. The Russian central bank, it seems, was able to counter this negative trend in the forex market that had caused the rouble’s value to plunge against the US dollar. It managed to do this primarily through capital controls that aim to increase demand for roubles and reduce the demand for dollars. For example, the Bank of Russia ordered Russian energy exporters, who still had access to US dollars, thanks to exceptions in Western sanctions to Russian energy exports, to use 80% of their forex holdings to purchase roubles. It has also ordered Russian brokers to not allow foreigners to sell their assets in Russia; this is to prevent the outflow of capital which would further depreciate the rouble as investors sell their roubles to purchase dollars.
The Russian central bank’s decision to raise its benchmark interest rate to 20% could have also helped draw some foreign investment that propped up the exchange value of the rouble.
Lastly, peace talks between Russia and Ukraine have also perhaps helped in the rouble’s recovery to some extent by raising hopes of a return to economic normalcy. Some analysts, however, see the bounce-back of the rouble as a temporary rally in what could be a far deeper correction over the long-run.
What lies ahead?
The remarkable recovery of the rouble should not be taken as a sign that the Russian economy is hale and hearty. Capital controls imposed by the Russian central bank, including the use of dollars earned by selling Russia’s huge energy reserves to prop up the rouble, may help in shoring up the rouble but this respite for the rouble may be temporary. It should be noted that capital controls affect the free flow of capital and could have serious implications for Russia’s future economic growth since investors are generally wary of investing in economies that do not allow the free exit of capital. It should also be remembered that the Russian economy is poorer due to the exit of foreign businesses and the boycott of the Russian economy by the West.
Further, there are limits to how long the Russian state can prop up the value of the rouble against the US dollar, even with the help of various capital controls. A significant drop in crude oil prices or a European boycott of Russian energy, for instance, could significantly reduce the flow of dollars into Russia and thus, the ability of the Russian central bank to prop up the rouble.