Falling ruble forces Russia to abandon its own budget principles

The Russian ruble has continued its steep decline, reaching 95 rubles against the dollar and 105 against the euro this week. For Russians, this is more than the usual psychological blow (many are used to using the exchange rate as a barometer for the economy’s fortunes): it is a tangible problem. The falling ruble accelerates inflation, which was already on the rise due to a mix of high budget spending, rising internal demand and a labor shortage. To ease pressure on the ruble, the government has been pushed into abandoning one of its key budget principles: using windfall oil profits for current spending.

• The ruble has seen a steady decline since December 2022. During that time, it has occasionally hit sudden turbulence, which happened again last week. Over the course of five trading sessions on the Moscow Exchange, the dollar and the euro both increased in value to the tune of five rubles, reaching 95.6 and 105.6 respectively. That’s their highest level since late March 2022, when the Russian market was at the peak of its wartime panic.
• We talked in more detail about the reasons for the ruble’s slump in this newsletter in early July. The currency’s decline since the end of last year is based on foreign trade conditions: a growth in imports, which collapsed in the early months of the war due to the impact of sanctions and a stabilization of global oil prices. Since then, the foreign trade situation has only gotten worse for the ruble. In mid-July, for the first time since the invasion of Ukraine, the Central Bank recorded a current account shortfall in Russia.
• But the underlying reason for the ruble’s decline lies in Russia’s own economic policy. Alexander Isakov, Bloomberg’s chief economist for Russia and the CIS, believes that import growth is a symptom rather than the primary ailment. He feels the true reasons lie in the government’s excessively weak budget policy (expenditure growth of 20% year-on-year) and the Central Bank’s monetary policy: In 2015, when the regulator was forced to hike interest rates to 17% in the aftermath of an oil price crash, the decline to 7.5% took four years. However, faced with a similar situation after the wartime shock of 2022, it took just a few months to push rates up to 20%.
• For Russians, the most unpleasant consequence of the falling ruble is the acceleration of inflation, which was already surging due to rising demand in an overheating economy and a depleted labor market. This week, the official rate of price growth slowed, but only due to seasonal factors in certain categories. The underlying rate of inflation remains high.
• With the dollar approaching the 100-ruble mark and inflation at 10% SAAS, there were rising expectations that the government would take action to try to calm the situation. On Wednesday, the Vedomosti business daily (usually reliable on these matters) reported that the government would not allow and the conversion of oil-and-gas windfalls into currency for the National Wealth Fund for the rest of the year. This would mean rejecting a budget rule that has been in place throughout the year. The next day, the Finance Ministry explained that there would still be currency purchase. However, multiple indicators suggest that this budgetary rule will effectively cease to apply in 2023.
• Since the mid-2010s, the budget rule has been the linchpin of Russia's fiscal planning, dictating the formation of reserves from oil windfalls to safeguard the economy from the so-called “Dutch disease.” Prior to the war, oil revenues exceeding $4.20 per barrel of Urals were allocated for currency reserves, as exemplified by the 2022 budget. A novel mechanism was introduced in 2023, capping oil revenue at 8 trillion rubles ($83.9 billion) annually, with excess funds earmarked for foreign currency investments.
• The overall situation with the Russian budget has not changed: the deficit (projected at 2-2.5% of GDP in 2023) will in any event be partially offset by the National Welfare Fund. The fund currently holds 6.8 trillion rubles ($71 billion) in gold and yuan. By the end of 2024, based on Finance Ministry data, there will be 2.3 trillion rubles ($24 billion) left.

Why the world should care

In itself, the government’s deviation from budget rules is not such a big deal. Indeed, it could be a sign that the government anticipates good revenues in 2023, economists say. However, the fact that Russia’s economic authorities are having to rapidly move the goalposts as the game progresses is a sign that things are spinning out of control.