The ruble’s in a slump. For the Kremlin, that’s a two-edged sword

Russia’s ruble is sagging against other currencies, complicating the Kremlin’s efforts to keep consumer inflation under control with one hand even as it overheats the economy with spending on the war against Ukraine with the other.

The official central bank rate for Friday was set at 109 to the U.S. dollar, meaning the ruble is worth less than a penny in dollar terms. At that rate, the ruble was bouncing back from lows around 114 to the dollar touched earlier in the week.

There have been similar declines against the Chinese yuan, which has largely replaced dollars and euros for foreign trade after sanctions imposed by Ukraine’s Western allies cut Russia off from most dealings with Western companies and banks.

Russians interviewed on the street Friday in Moscow – where incautious remarks can lead to jail time – took the decline in stride.

Muscovite Yekaterina, who declined to offer her last name, said she had just made a prepayment for a vacation in Egypt, adding “I’m afraid to know what the rest of payment will be.” But she added: “Maybe it only concerns us individually, people who love travelling. But for Russian economy it’s not that bad. Internal tourism, domestic industry are developing.”

Semyon, again no last name, was even less concerned. “My salary is in rubles, I pay taxes in rubles, I buy a car in rubles and buy groceries in rubles. What do I need the dollar for, explain that to me, please.”

The Kremlin is engaged in a tricky juggle. Government spending on the war has factories running at top speed and the economy growing more strongly than many expected given sanctions. The resulting inflation – an annual 8.5% in October – has led the central bank to crank up its interest rate benchmark to a painful 21% to slow borrowing and spending. That has led to complaints from business leaders hit with high credit costs and fostered predictions from economists that tight credit will eventually slow the economy.

Russian President Vladimir Putin said that the recent decline was “connected not only with inflation processes, it is also connected with payments to the budget, it is connected with oil prices, there are many factors of a seasonal nature.”

“Therefore, in general, in my opinion, the situation is under control and there are certainly no grounds for panic.”

The ruble and inflation nonetheless remain key concerns for the Kremlin, said Janis Kluge, an expert on the Russian economy at the German Institute for Security and International Affairs in Berlin.

“The inflation rate and the exchange rate, those two are very visible and you can feel it in your pocket,” he said. “And there is no propaganda in the world that will convince you prices are not rising when prices are rising. So this is why the Kremlin is so sensitive and really prioritizes fighting inflation so much.”

A lower ruble means Russians will over time pay more for imports, especially for autos, household appliances and electronics made in China, now Russia’s chief trade partner, said Kluge.

There are multiple reasons behind the ruble’s recent decline from levels as high as 85 to the dollar in August. The price of oil – Russia’s most important export – has weakened; foreign investors are no longer available to purchase ruble investments, and Russia’s inflation rate means its currency tends to lose value against those of trade partners.

A key factor recently may have been U.S. Treasury Department sanctions against Russia’s Gazprombank, announced Nov. 21. Since the bank was the conduit for customers for what was left of Russia’s oil and natural gas trade in Europe, the sanctions blocked one source of foreign earnings and increased pressure on the ruble. A big question is when, and whether, Russia might find a workaround for that.

The weaker ruble isn’t all bad for the Kremlin, since it increases oil and gas export earnings in ruble terms. For now the central bank is managing the rate as best it can after the shock of Gazprombank sanctions, said Chris Weafer, CEO of Macro-Advisory Ltd. Since there is no open market trading of the ruble on the Moscow or any other exchange due to sanctions, the rate is set by the central bank based on its estimate of trade requirements.

“The market now is entirely under the control of the central bank, and they set the rates every evening based on what they see, the inflow of money coming from from Russians exporters and the demand for FX from companies who want to buy goods,” said Weafer, using the abbreviation for foreign exchange.

“Nevertheless, there there was this shock element of when Gazprombank was added to sanctions,” he said. “They have decided that the best course of action over the short term is to allow the ruble to weaken. And that is because it significantly helps the finance ministry.”

The central bank will have to juggle inflation and budget concerns and come up with the rate best suited to circumstances, said Weafer. One way of doing that would be to require exporters to change more of their foreign currency earnings to rubles: “They will have to put all of those factors together and come up with what they believe is the optimal rate.”