The Russian Rouble: When politics create mess

(Photo: Courtesy)

When analysing the currency of a country such as Russia, the main challenge any analyst or investor would face is to identify the elements that impact the currency. Indeed, there could be so much noise, so much wrong information, so many events that one would think of taking into account.

Logical questions one could wonder about would be: does the Ukraine / Crimea conflict impact the Russian Rouble, does the Syria war have an impact on currency rates, do low oil prices put a downward pressure on the World biggest country’s currency? Does the trade account pushes the currency down or is it the other way around?

Various political analysts are also speculating on the impact of a Syria Conflict’s Resolution on the Russian Rouble. Could it stop the bleeding of Russia’s economy and support its currency ?

In order to answer all these questions, lets’ first put things into context, and then assess expectations.

Troubled Water

While it is true that Russia has a massive territory, great resources and amazing human talent, its economy is experiencing difficulties due to a series of events that took place within the last 3 years. These event, most of which are of a geo-political nature, have somewhat isolated the country and disconnected a part of its economy from the western world.

Looking at Russia’s Gross Domestic Product, one can clearly detect a recession that started by early 2014. As we mentioned events taking place, it happens that this date coincides exactly with the annexation of Crimea, the beginning of the Ukraine Conflict and the International sanctions.

 

Indeed as various countries including Eurozone countries and the US did not approve the annexation of Crimea nor the way it was done - sanctions and restrictions were imposed on Russian companies and individuals. Furthermore and as time went by, more and more sanctions came to impact Russia’s financial, energy and arms industry.

At the same time, the Syrian conflict which has been ongoing since 2011, kept impacting the Western / Russian relationships. As the situation worsened and as views diverged, Russia officially decided to intervene by September 2015 and provide support to Bashar Al Assad’s government.

Within this already tense environment, oil prices added downward pressure. Between mid-2014 and early 2016, Crude Oil prices per barrel lost went south by almost two thirds – limiting the contribution of a key exports driver and economy booster.

 

 

 

Troubled Currency

We all know that when it comes to currencies, the rule is rather straightforward. The higher the demand for a country’s currency, the greater the currency’ value – and vice versa.

In other words, a country that exports less receives less inflows which negatively impacts its currency. A country that loses many of its commercial partners and gets stuck in never ending conflicts receives less foreign capital and less foreign investments. As a matter of fact, capital gets to flee from that country into safer harbours.

All this logically leads to a suffering of that country’s economy and a depreciation of its currency and you guessed well – the currency we are talking about is the Russian Rouble.

 

 

Looking at the graph, we clearly notice a strong downward pattern. The currency lost around 22% of its value versus the US Dollar since January 2016.

The Missing Piece

Now that we are getting a better understanding of the situation, we might still have a question: Why did the Rouble only start depreciating starting 2016, when the Russian economy got to suffer way earlier (as early as 2014).

The answer to this question lies in the graph below and is called: Foreign Reserves

 

 

Foreign reserves can enable a country’s central bank to support its currency for some time. As demand decreased for the Rouble, the central bank would sell foreign currency and buy Rouble. In doing so, the central bank would generate demand for the local currecy therefore offsetting downward pressures and keeping the currency stable.

However and in doing so, a central bank makes strong use of its foreign reserves which are limited. In the case of Russia and as shown in the graph above Russia lost almost a third of its foreign reserves between 2014 and 2016 (From $500bn to $350Bn). This enabled to keep the currency stable in spite of all pressures.

However, by 2015 and given the economic recession, the central bank could not support the Rouble at the same pace as it used to. The Bank needed to decrease interest rates in order to counter the recession and provide liquidity while preserving the foreign currency reserves. Deprived of such support, the Russian Rouble started to depreciate while the central bank successfully mitigated the depletion of its foreign currency reserves.

Putting Things in Order

So making a long story short, we can summarize the situation as follows:

As early as 2011, The Syrian conflict and divergent views generated tensions between Russia and the US along to Euro Countries.

By 2014 and the annexation of Ukraine, tensions peaked and translated into economic sanctions against Russia

These economic sanctions combined with a low oil prices environment impacted the Russian economy and put downward pressure on its currency

For some time, the Central Bank tried to support the Rouble

By end 2015, the Central Bank could no longer provide the needed support and the Rouble started to strongly depreciate versus both the US Dollar and the Euro

Now that things are clear – can a resolution of the Syrian conflict solve the problem?

 

The Syrian Conflict

Without getting into the causes of this conflict which are obviously geo-political we can only say that the Syrian conflict has severely damaged the Russia – US Relationship. Some actually believe that the Crimea annexation is just the straw that broke the camel’s back. They would argue that the real reason behind the economic sanctions is Russia’s rigid backing of Bachar Al Assad’s regime.

A resolution of the Syrian conflict and a convergence of the political views would definitely foster both understanding and cooperation. It would very likely enable to find common grounds regarding Crimea and contribute to lift some if not all the sanctions. It would obviously not all come at once, yet things would move in the right direction not only for Russia but also for the Eurozone (especially for Germany which is an important trade partner of Russia).

An improvement of the relationship between Russia and the US could also send oil prices higher which would benefit the Russian economy. Indeed, as the OPEC countries heavily needed higher oil prices to support their economies, Saudi Arabia has been very resistant to decrease its oil production output. Does such resistance make sense from an economic point of view? Not really. Is it linked to political factors? Very likely.

 

Translating things into FX Trading

The beauty of FX Markets relates to how they link and react to political and economic factors. If you were to notice the signs of a resolution in Syria, it would make a lot of sense to Buy Russian Rouble ahead of its future appreciation. Looking at things objectively, one can say that all sides need a resolution of this conflict as it has created too much opportunity cost.

So why is the conflict still ongoing, what are the causes, how could it be solved, is the Qatar’s recent “Quarantine” anyway related? Is this war ending as we speak or is it just another phrase? Time to say that.