Therefore, the sanctions have been tightened and the war now seems far from over. However, the Russian currency has experienced an unexpected development. While many academics thought the ruble would weaken further, it is stronger today than it was at the start of the war. In fact, the US dollar is worth about 57 rubles, an exchange rate not seen for about four years. What is the reason for this development and what can we deduce for the future?
The ruble before the war
To understand this, we must first return to the context. The exchange rate of a country’s currency is determined by the flow of capital and trade: that is, they are the sums of money that enter and leave the country, as well as the difference in value between exports and imports. For the ruble, trade is usually more important because the Russia is a major oil exporter..
The price of oil, as shown in the chart below, is pegged to the ruble: when the price of oil rises, the Russian currency strengthens. The price of oil has continued to rise overall since the first half of 2020, which has benefited the ruble in the run up to the war. However, the price of the Russian currency has not risen as much as usual when oil is strong, which is why the two lines in the chart below have been less in sync since then.
This is undoubtedly due to the evolution of capital inflows, in particular with regard to russian public debt. As of March 2020, the share of foreign (non-resident) investors holding Russian government bonds had reached a historical record by 35%. Since then, this proportion had fallen to 18% in two years due to changes in tax rules.
In fact, interest on Russian government bonds was exempt from taxes for foreign investors until the law of March 31, 2020 required them to pay 30% from March 1.Ahem January 2021. After this announcement, foreign investors began to sell their bonds, and the ruble began to fall.
This explains why the ruble was roughly flat between March 2020 and the invasion, with government bond sales more than offsetting the effect of high oil prices (see blue bond curve in chart below). In short, this bond sell-off was a drag on the ruble, dragging it lower than it would have been in normal times. Today, this effect appears to have faded, putting the ruble in bullish momentum as oil prices remain high.
The ruble after the invasion.
When the ruble fell to 138 to the US dollar in the days after the February 21 invasion, it was an all-time low. On February 24, the Central Bank of the Russian Federation announced several measures to support the currency. For example, it prohibited margin transactions, that is, investment transactions made with borrowed money instead of available funds.
The central bank also used its foreign reserves to buy rubles on the foreign exchange markets to support their value. However, the ruble continued to fall, suggesting that these measures were not enough.
This fall is explained in particular by a series of western sanctions –including the freezing, on February 27, of 60% of the $643 billion Russia’s international reserves. These measures were unexpected and appear to be, without a doubt, the most severe in history to date. In fact, the sanctions have severely hampered the Russian central bank’s access to its assets abroad and its ability to back the ruble.
The central bank reacted on February 28 by taking a new series of measures, including a sharp rise in the Russian global interest rate, from 9.5% to 20%, or limits to 10,000 dollars (9,571 euros) per month for transfers made by residents to bank accounts abroad and for withdrawals in foreign currency.
A month later, Russian President Vladimir Putin signed a special decree requiring “hostile countries” pay russian gas in rubles.
The explanation of the rise of the ruble
One of the reasons why the ruble has strengthened is precisely these restrictions on margin trading and foreign investors, which has drastically reduces trading volumes. However, factors other than the Russian central bank played a role.
The price of oil remained high. After falling from $130 a barrel of Brent in mid-March to around $100 a few weeks later, the price has since recovered to almost $120.
Imports from Russia have been hampered by the exodus of foreign companies and Western sanctions. This brought the current account surplus (the difference between money inflows and outflows) to a all-time highwhich strengthens the currency.
This trade imbalance is likely to continue for some time, which may be one of the reasons why Russia eased some of the restrictions imposed in February-March. The world interest rate is now up to 9.5%, the same level as at the beginning of the invasion. Margin trading is allowed again, residents can now transfer up to $50,000 per month to foreign bank accounts.
In other words, Western sanctions have allowed Russia to return to a more normal financial situation. If this sounds painfully ironic, rest assured: sanctions make it very difficult for Russians to spend these relatively hefty rubles, either on imports or abroad due to restrictions on to travel.
Thus, although the currency has retained its value, its usefulness has been greatly weakened. Therefore, it can be said that Western sanctions fulfill their punitive role against Russia.