Since Vladimir Putin started his war against Ukraine in February 2022, the Russian rouble has behaved like a yoyo, jumping up and down. In summer 2022 the Central Bank of Russia managed to restore the value of the rouble, but it is not likely to happen again. Recently its value plummeted from 73 roubles per US dollar to 100 roubles per dollar and it has since stayed in the nineties. Western financial and energy sanctions are biting, as well as Russia’s increased military costs.
This is a significant blow to Putin’s domestic credibility. In 1998 Russia went through a severe financial crisis. It devalued the rouble and defaulted on its public debt. Putin drew the lesson: never again. Since he became president in 2000, he has insisted on fiscal and monetary austerity. Thanks to steady budget surpluses Russia paid down its public debt, which was equal to its GDP in 1999, to 15 per cent of GDP at present. Putin built vast foreign currency reserves of $640bn to protect his “Fortress Russia” in a war.
By contrast, Putin could not care less about economic growth. He arrived at a laid table because of the market reforms by Boris Yeltsin, the president, and Yegor Gaidar, the acting prime minister, in the 1990s. Russia enjoyed an average economic growth of 7 per cent a year from 1999 to 2008, but it has had minimal growth since 2009 and virtually none since 2014.
Before Russia’s occupation of Crimea and eastern parts of Ukraine in 2014, the rouble exchange rate was relatively stable at 32 roubles per US dollar. Then it halved because of Western financial sanctions. Before the invasion of Ukraine in February 2022 it was 74 roubles per dollar, but within a month the exchange rate halved again to 135 roubles per dollar because of more severe Western financial sanctions. Roughly $300bn of Russian Central Bank reserves kept in the West were frozen.
Yet surprisingly the rouble swiftly recovered. By 20 June 2022 it had surged to 50 roubles per dollar. The Central Bank hiked the interest rate to 20 per cent. Even so, inflation rose from 7 per cent before the war to 17 per cent in April 2022 because of the big devaluation and financial panic in February and March. As inflation abated the Central Bank reduced the interest rate rather fast to 7.5 per cent in September. The financial crisis seemed to be over.
The main reason for Russia escaping from a financial crisis had little to do with the Central Bank, however. More likely it was due to the panicking European energy market. Oil prices rose because of the war; gas prices shot up. The beneficiary was Russia, which continued to sell its overpriced oil and gas to Europe. Its export revenues surged from $382bn in 2020 to $628bn in 2022. As a consequence, Russia’s GDP declined officially by only 2.1 per cent in 2022.
[See also: How Putin lost the energy war]
These vast oil and gas export revenues explain why Russia suffered so little from sanctions in 2022, but in 2023 the West imposed quite severe energy sanctions. Most of Europe has stopped importing gas from Russia, and the G7 has imposed a price cap for oil. These two measures are expected to reduce Russia’s export revenues by $100bn to $200bn this year.
Traditionally, Russia exports far more goods than it imports because wealthy Russians prefer to keep their money abroad, where it is both safer from the Russian state and offers them more enjoyment. Thus, Russia has a large current account surplus, but it is matched by a large net capital outflow of about $40bn a year. Last year, both numbers ballooned. In 2022, Russia’s current account surplus reached a record of $236bn, but the net capital outflow was larger than ever at $239bn. During the first half of this year, the Russian Central Bank assessed the current account surplus at only $23bn and the net capital outflow at $27bn.
Russia is used to austerity but Putin has increased his military expenditure sharply. Typically it has been about $60bn a year, according to the Stockholm International Peace Research Institute, but in 2022 it rose to $87bn and it is likely to almost double in 2023. That is hurting the rouble.
Last year Russia had a budget deficit of 2 per cent of GDP and this year it is heading towards 6 per cent of GDP. For Western countries, such numbers are small, but not so for Russia because Western sanctions prevent it from borrowing from abroad. At the end of 2013 Russia had a foreign debt of $729bn, which it had been forced to reduce by more than half to $358bn by March 2023, according to the Russian Central Bank.
Putin’s financial challenge is to double Russia’s military expenditure from about 6 per cent of GDP to 12 per cent of GDP with no external sources of financing. Half of his currency reserves are frozen in the West and almost half of the rest is stuck in not especially useful Chinese renminbi. Putin wants to spend more on his military, but he does not know where to find the money. The Western sanctions hinder his rearmament.
Putin’s obedient Central Bank has responded to the new rouble crisis by repeating its interest rate hike from last year. So far, it has hiked from 7.5 per cent to 12 per cent. In all probability, it has also intervened forcefully in the still relatively free currency market. But will that be enough? I do not think so. The Russian president faces the choice between tanking the rouble or limiting his rearmament. My suspicion is that Putin is so afraid of the political unrest that a financial crisis could cause that he would rather reduce his arms production than risk letting the rouble fall to 200 roubles per dollar.
[See also: Putin’s secret navy]