As inflation slows and the ruble recovers, Russia hopes to avoid a crisis


Russian President Vladimir Putin.

Swimming pool | Reuters

Russia believes it has avoided a financial crisis as its currency recovers and economic data improves, but strategists say the numbers hide ugly truths for Moscow.

Although inflation in the country is at an all-time high, there are signs that price rises are slowing and will continue to slow, as the Russian ruble has risen from an all-time low in March to the world’s best-performing currency this year.

Meanwhile, economic activity indicators are improving and Russia has so far managed to avoid defaulting on its foreign currency debt, despite Western sanctions freezing large swaths of its reserves.

Russian inflation hit a two-decade high of 17.8% year-on-year in April, from 16.7% in March, but price inflation is starting to show signs of slowing. Consumer price growth slowed markedly from 7.6% in March to 1.6% in April, and prices of non-food goods rose only 0.5% from 11.3% in March.

Further hikes over the next few months are expected to be modest, and the market is encouraging Russia’s Central Bank to continue unwinding its emergency interest rate hike, possibly with a 200 basis point cut in June.

It comes after the CBR implemented an emergency rate hike that took the country’s key rate from 9.5% to 20% at the end of February, several days after the unprovoked invasion of Ukraine by Russia, in an effort to save the rouble. The central bank has since been able to move the rate to 14% as the outlook for inflation and the currency have improved, and Capital Economics predicts more changes to come.

“Today [inflation] The numbers will further support the central bank’s assessment that the acute phase of the Russian crisis is over,” emerging markets economist Liam Peach wrote in a note last week.

“It is possible that consumer prices will rise by less than 1% m/m in May as a whole and that headline inflation will eventually peak just below 20% later this year.”

Ruble resilience

The slowdown in price growth follows a sharp appreciation of the rouble, which in turn lowers import prices.

On Tuesday morning in Europe, the ruble was trading at just over 62 to the dollar, after plunging to a historic low of 150 to the dollar on March 7, following the announcement of a series of international sanctions in response to the Russian invasion. from Ukraine.

Despite the dollar’s overall strength, due in part to its perceived safe-haven status amid risk aversion in global markets, the greenback is down nearly 17% against the Russian currency since the start. of the year.

The Russian central bank’s strict capital control measures – which include ordering companies to convert 80% of their foreign currency earnings into rubles – have helped revive the struggling currency. The Kremlin also initially banned Russian citizens from transferring money abroad, and transfers are now limited to $10,000 per month for individuals until the end of 2022.

“The Russian economy continues to recover from the initial shock of late February and early March,” the Goldman economist said. Clement Grafe wrote in a note earlier this month. “Financial stability concerns waning, RUB strengthened to return to early 2020 levels.”

For many analysts, however, Moscow’s actions to defend its currency amount to manipulation, in that demand has been created that would not otherwise exist and capital controls have effectively turned the ruble into a “managed” currency. “.

Charles-Henry Monchau, chief investment officer of Swiss bank Syz, suggested that while Russia’s central bank has deployed a range of tools to give the ruble value, very few people outside of Russia “want to buy a single ruble unless they absolutely must” and traders “no longer see the ruble as a free-trade currency”.

“If Russia manages to find a solution to the Ukrainian problem with the lifting of sanctions and the restoration of trade relations with the West as a corollary, the ruble can potentially retain its current value,” he said.

“On the other hand, if the measures are withdrawn without resolution, the ruble could collapse, leading to an explosion of domestic inflation and a deep economic recession in Russia.”

And Russia also took another step to strengthen its currency. The CBR has resumed buying gold in the domestic metals market after a two-year absence, hoping to store value to protect Russian wealth against inflation in the event of another shock to foreign exchange liquidity. .

“Another strong move went relatively unnoticed in Western media: The Bank of Russia resumed gold purchases at a fixed price of 5,000 rubles per gram between March 28 and June 30,” Syz’s Monchau said. Bank.

Since gold is traded in US dollars, Monchau noted that this allows the CBR to peg the ruble to gold and set the floor price for the ruble in dollars. Further rises in the ruble could therefore boost the price of gold, and Russia has been rapidly accumulating the precious metal since its annexation of Crimea in 2014, now having the fifth largest stockpile in the world.

Therefore, this decision provides additional protection for the Russian economy against liquidity constraints resulting from new sanctions and the deterioration of the country’s foreign currency reserves to service dollar-denominated debts.

The highly watched economic indicators of the Purchasing Managers Index also show some improvement.

After plunging from 48.6 in February to 44.1 in March – with a reading below 50 indicating contraction – April’s figures rose to 48.2. According to Goldman Sachs, this is mainly due to improved production and reduced delivery times from suppliers.

“Russian financial conditions have improved primarily due to narrowing CDS (credit default swap) spreads as Russia has paid principal and interest on Eurobonds in USD,” Goldman’s Grafe noted.

Russia has successfully made payments to holders of two dollar-denominated Russian sovereign bonds, maturing in 2022 and 2042 and collectively worth $650 million, before the end of a 30-day grace period May 4. However, analysts are still warning that there is a high probability of a Russian default within two years.

temporary victory

The collective improvement in data has led Russian President Vladimir Putin to claim that the West’s “economic blitzkrieg” – or “blitzkrieg” – has failed.

Yet while Russia appears to have avoided an impending economic collapse, the longer-term outlook is less optimistic as the ripple effects of mitigation measures and the threat of further sanctions remain in play.

A survey of more than 13,000 companies conducted by the Central Bank of Russia recently revealed that many are already having difficulty importing goods into the country.

These included auto parts, packaging and microchips, and shortages of raw materials are forcing some companies to suspend plant operations or seek resources elsewhere, according to the survey.

Meanwhile, Elina Ribakova, deputy chief economist at the Institute of International Finance, told the BBC last week that “shallow” economic indicators would mean little to those on the ground, where job security remains. hazy for many Russians.

“During this year we will see the effect on the Russian economy as businesses start to run out of parts or equipment and have to start laying off workers or putting them on unpaid leave,” she said. to Grid News in a separate interview this week.

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