Ruble Devaluation Policy May Take Russia Back to 1998

12:33, 16 December 2008
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Russian Prime Minister Vladimir Putin’s pledge to avoid a “sharp” devaluation of the ruble and let the currency fall gradually has dissuaded citizens from storming banks to withdraw their savings as they did during the crisis of 1998, according to Bloomberg.

It also has prompted Russia’s first credit-rating downgrade in nine years and may prolong the decline of the nation’s manufacturing industry. A one-time, 20 percent devaluation is needed even though the ruble has fallen 15 percent against the dollar since August and the central bank widened its trading band six times since Nov. 11, said Anton Struchenvsky, an economist at Moscow brokerage Troika Dialog. The central bank said it weakened its defense of the ruble again today.

“It’s like using a tourniquet: The blood doesn’t flow, the arm goes numb, but if you keep it tight for long the tissue will die,” Struchenvksy said. A devaluation is “the only way to let the blood, the money, back into the economy.”

After oil-fueled growth averaging more than 7 percent a year, the Russian economy may now go into reverse, according to Deputy Economy Minister Andrei Klepach, the first government official to suggest that the Russian economy is heading for recession. Industrial output shrank in November for the first time since at least 2003, according to the median forecast of 12 economists in a Bloomberg survey. The figures may be released tomorrow.

Reserve Spending

The central bank has burned through a quarter of its reserves, or $161 billion, since August to stem the ruble’s decline. International and domestic investors have pulled about $211 billion from the country, BNP Paribas SA estimates, after the price of Urals crude oil dropped 64 percent, credit markets seized up and Russia fought a five-day war with Georgia.

The budget surplus narrowed by almost 300 billion rubles ($11 billion) last month as tax collection plummeted. Energy accounts for 73 percent of Russian exports outside the Commonwealth of Independent States.

“I hope in the near future the government will weaken the ruble,” Viktor Vekselberg, a billionaire partner in oil company TNK-BP, told reporters on November 28.

Putin, 56, reiterated his pledge that there would be no “sharp” fluctuations in a televised question-and-answer session on Dec. 4, during which he sought to reassure Russians about their jobs and benefits. Alexei Ulyukayev, first deputy chairman of Russia’s central bank, said in an interview yesterday with radio station Ekho Moskvy that Russia won’t let the ruble float freely and may continue to widen the band in which it can trade.

Rubles in Coffins

Putin and Dmitry Medvedev, the 43-year-old president he picked to replace him, are trying to avoid a rerun of the 1998 financial crisis, when the government defaulted on $40 billion of debt and devalued the ruble 70 percent. Russians hammered on the locked doors of the country’s collapsing banks as their savings were wiped out, and demonstrators carrying rubles in miniature coffins marched past the central bank headquarters.

That devaluation, in tandem with a surge in oil prices, paved the way for the economic boom of recent years as Russian manufacturers reaped the rewards of a competitive exchange rate for their exports while nudging imports from store shelves.

The economy grew 6.4 percent in 1999 and 10 percent in 2000, the year Putin came to power as president.

This time around, the global recession means customers for Russian goods inside and outside the country may be hard to find, even if prices of goods do fall.

A sharp devaluation “is not going to be enough to save the economy from a major slowdown,” said Neil Shearing, emerging markets economist at Capital Economics in London.

Unpaid Wages

If the ruble drops more, the accelerating inflation of the early 1990s may reappear and combine with rising unpaid wages and unemployment to choke spending, according to Shearing.

“The ruble-dollar rate is on every corner of Moscow,” displayed on signs outside foreign-exchange kiosks and banks, he said. “It’s seen as a bellwether for the economy. It’s going to have an impact on consumption, not just through the impact of higher prices for imports, but because it hits confidence.”

The global slump also has reduced demand for Russian metals and energy. OAO Magnitogorsk Iron & Steel, Russia’s third-largest steelmaker, said last month it was in talks with OAO Sberbank over a loan to fund operations and investment after demand for the metal slumped and customers delayed payments. The company also cut steel output to 700,000 metric tons in October from a monthly average of about 1 million tons.

“The entire global economy is depressed,” said Maxim Oreshkin, head of research at OAO at Rosbank in Moscow. The World Bank has forecast international trade will contract for the first time in 25 years in 2009.

Chocolate Fears

Russian steelmakers including Magnitogorsk, OAO Severstal and Evraz Group SA are calling for government support through measures such as imposing duties on Chinese imports. The nation’s six largest producers had aimed to invest more than $26 billion through 2012 before the crisis.

And just as inflation has started to decline from a more than six-year high of 15.1 percent in June, a weaker ruble would push up prices for imports, which Russia’s Agriculture Ministry says account for 40 percent of the food consumed in Russia.

Elena Mlotok, marketing director at Moscow-based confectioners Fruzhe, which sources most of its ingredients from Latin America and Turkey, says she dreads a ruble drop, which would force the company to raise prices on its chocolate-covered berries.

“Apart from things like cranberries, none of our ingredients grow in Russia,” said. “Unfortunately, we are very dependent on the rate.” The cost of the company’s ingredients have jumped by 10 percent in the last month, she says, and “the only way we can react is by raising our prices.”

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