While Russia slept last night, its central bankers convened in a Moscow boardroom. Their concern was to halt the freefall in the rouble, which had lost 13.6% of its value in one day. The solution they came up with was as drastic as it was unexpected. At 1am, they increased the interest rate in Russia from 10.5% to 17%, in what could fairly be called a fell swoop.
At first, it seemed to have the desired effects. The rouble did rally for a couple of hours, hitting 59.8 to the dollar from a low of 65.9. But it didn’t last. It's now at an all time low of 78.3.
So why didn’t it work? Interest rate rises typically help a currency appreciate against others, because they incentivise people to hold onto and acquire that currency so they can benefit from those high rates of return. In this case, however, a gloopy mixture of low confidence and cheap oil has spoiled the party.
Russia’s rouble worries began earlier this year with its invasion of eastern Ukraine, since when the currency has lost over half its value. Uncertainty over the crisis and the sanctions that followed began the slide, but the real problem has been the plunge in oil prices.
A barrel of Brent crude now costs just over $60 (£38.40), having been over $100 at the start of the year. As Russia’s economy, budget and exports all depend on oil, it is no surprise that people are losing confidence in the rouble. Colossal interest rate hikes in the middle of the night aren’t especially likely to inspire trust in the state’s handling of the problem either.
Fundamentally, Russia’s efforts to stop the rouble’s slide – it has raised interest rates six times in total this year and only recently gave up on using its own dollar reserves to shore up the currency – are Sisyphean, given that oil and gas represent the majority of the country’s exports. As the oil price has plummeted, and oil is traded in US dollars, demand to trade dollars for roubles will also necessarily tank.
The consequences for Russia are fairly dire, hence the extreme response of the country’s central bank. By raising the cost of imported goods, a weak rouble is bad for inflation, which has already been a huge problem in Russia. Normally, it would help exporters, but sanctions and the low oil price have spoiled that in this case.
The result is that Russia faces both high inflation – the central bank itself expects it to reach 10% by the end of the year despite the high interest rates – and recession – it expects the economy to contract 4.7% in 2015 if oil stays at $60 a barrel. Interest rates at 17% will surely not help the latter.
The whole thing must be giving Vladimir Putin (and the rest of Russia) nightmares about the 1998 crisis, where the currency collapsed and the country defaulted. As the oil price will surely rise again, it may be premature to talk about defaults. It may, however, be time to ditch the ‘R’ from BRIC, the acronym for the world’s rising economic powers (Brazil, Russia, India and China). Russia is no longer rising.