Tuesday, April 29, 2014

Russia and the Upcoming Ruble Crisis

By Market Authority

King Putin has quickly found himself backed into an economic corner, defended only by a small wall of pawns. As the world focuses on the conflict in the Ukraine, an economic battle is raging in Moscow. Central bankers are trying to stop foreigners from dumping the Russian Ruble and control rampant inflation. The most recent central bank offensive occurred today: an unexpected 50 bp hike in one week auction rates from 7% to 7.5%. Unfortunately, a central bank’s solution for defending a falling currency can unknowingly complicate matters and lead to more pain down the road. Let’s take a look back to the start of the Ukraine crisis and see the impact on Russia’s economy.

Since the beginning of 2014 the Ruble has slid 10% against the U.S. greenback. Fearful of diplomatic sanctions against Russia, foreign investors (and Russians) are trading their Rubles for other currencies.

The weakened Ruble benefits Russia’s export sector, since it makes Russian goods suddenly 10% cheaper for foreign buyers. However a weak Ruble means that prices of imports to Russia rise by 10%. Food represents 13% of total imports. Russia is now experiencing food inflation: prices rose 8.4% in March from a year earlier. Overall inflation rose 6.9% recently from a month earlier, much higher than the central bank’s target of 5%.

How will Moscow’s central bank curb capital outflows and cut inflation? To defend the ruble, the central bank has been raising the rate at which banks pay for bank deposits. This rate has risen by 200bp since January, with an unexpected 50bp hike coming today.

Theoretically, a higher interest rate should make the ruble a more attractive investment. However a higher rate also slows economic growth as the price of credit rises. Russia already reported negative growth in the last quarter:

The Russian economy should continue to decline as the central bank raises rates to curb inflation. This will weaken the ruble further, causing more import inflation – exactly what rising rates were intended to fight in the first place.

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