Tuesday, December 30, 2014

Ruble Trouble

On Russia, the fall of the Ruble.

This is an interesting event on which to test out our various frameworks for thinking about macroeconomics and monetary economics.


There are three basic perspectives on exchange rates.

1. Multiple equilibria. Lots of words are used here, "speculative attacks," "sudden stops," "hot money," "self-confirming equilibria" "self-fulfilling prophecies" "contagion" and so on. Basically, the exchange rate can go up or down on the whims of traders. There is often some news sparking or coordinating the bust.  Some of the mechanism is like bank runs, pointing to "illiquidity" rather than "insolvency" as the basic problem.

This has been a dominant paradigm since the early 1990s. I've been a bit suspicious both on the nebulousness of the economics (lots of buzzwords are always a bad sign), and since the analysis seems a bit reverse engineered to justify capital controls, currency controls, (i.e. expropriation of middle-class savers and poor currency-holders), IMF rescues, and lots of nannying by self-important institutions and their advisers who will monitor "imbalances," "control" who can buy or sell what, and so forth. But models are models and facts are facts.

2. Monetary. Exchange rates come from monetary events, and primarily the actions of central banks. For example, much of the analysis of the dollar strengthening relative to euro and yen attributes it to the idea that the US Fed has stopped QE and will soon raise rates, while the ECB and Japan seem about to start QE and keep rates low.

3. Fiscal theory. Exchange rates come fundamentally from expectations of future fiscal balance of governments; whether the governments will be able and willing to pay off their debts. If people see inflation or default coming, they bail out of the currency, which sends the price of the currency down. Inflation follows; immediately in the price of traded goods, more slowly in others.

Craig Burnside, Marty Eichenbaum and Sergio Rebelo's sequence of papers on currency crises, starting with  JPE "Prospecitve Deficits and the Asian Currency Crisis" (ungated drafts here) was big in my thinking on these issues. They showed how each crisis involved a big claim on future government deficits.  Prices fall, banks get in trouble, governments will bail out banks, so governments will be in trouble.  Inflation lowers real salaries of government workers. And so on.

The "future" part is important. Earlier work on crises noticed that current debts or deficits were seldom large, governments in crises often had surprisingly large foreign currency reserves, and there were no signs of sudden monetary loosening.  This earlier absence of a cause problem had led to much of the multiple-equilibrium literature. But money is like stock, and its value today depends on future "fundamentals."

Monetary and fiscal views are related. The question really is whether the central bank can stop an inflation and currency collapse by force of will, or whether it will have to cave in to fiscal pressures.

Most basically, a currency, like any asset, has a "fundamental" value, like a present value of dividends; it may have a "liquidity" value, like money; and it may have a "sunspot" or "multiple equilibrium value." The question is, which component is really at work in an event like this one -- or, realistically, how much of each? The money and fiscal views also much more clearly bring the currency into the picture.

So, as I read the stories of Russia's troubles, I'm thinking about which broad category of ideas best helps me to digest it. You can guess which one I think fits best. Yes, everyone likes to read the paper and see how it proves they were right all along. But at least being able to do that is the first step.

On a second level, of course, there is the question whether prices and wages are sticky, whether "demand" or "supply" accounts for fluctuations, whether devaluations are great things to "stimulate" economies, and so forth.


1. Oil prices have gone down by half. Russia is a big exporter, and the Russian government gets a lot of revenue from oil exports, 45% by one media account.

2. The Ruble is collapsing. The graph below (from Bloomberg.com) shows the fall's slow slide, the sharp slide in early December, the big collapse two weeks ago, a rebound following various moves (more below) and a new sharp decline as I write.

5. Sanctions are biting. Sanctions cut off Russian businesses and banks from foreign financial markets. The big problem is not so much financing new investment, but that they now cannot roll over debts. (Sanctions seem to mean you can't borrow new money, but you still have to repay the old money.)

Paul Gregory, who among other things writes a blog about Russia, had a presicent Forbes article last August:
Russia, with its thin capital markets, obtains half of its capital abroad. If cut off from European, American, and Japanese capital cold turkey, Russia might be able to replace some of its losses from non-sanctioning countries, like China, but only partially and at a high price. [Many stories now in the news about Russia-China financial links.] 
Refinancing is a particularly harsh problem for Russia with its absence of rule of law. Lenders will lend only for short maturities. According to Russia’s central bank (CBR),  24 percent of the foreign debt of Russian banks and companies, or $157 billion, comes due in 2014 alone. Sanctions take the option of refinancing off the table.  Rosneft, the national oil company, has $15.9 billion maturing this year and $16.2 billion the next, for example, and it is only one of many companies in this fix. 
Remarkably, even unsanctioned Russian companies are frozen out of Western credit markets.  
5. There is a very interesting and quite murky debt situation, especially in banks.  Russian banks and businesses have a lot of foreign currency debt they can't repay or roll over.

The government debt/GDP ratio isn't that bad, and past deficits are not the trouble. Russia ran big trade surpluses, meaning there are foreign assets somewhere. But those may have all ended up as Russian owned London apartments and Swiss banks and not available to Russian banks and businesses.

Chain of events

The mid-December collapse happened around the Roseft bank story (below).  As I read it,  if markets sniff that foreign reserves are going to get spent fast to bail out favored cronies, then capital flight is on.  Fiscal theory and multiple equilibria paint similar pictures here. In a fiscal interpretation, news can come about how much of state assets are going to be used to support currency and government debt, and how much is going to line pockets of insiders. 

In addition, it must be on everyone's mind when capital controls are coming. Naturally, you want to get your money out ahead of capital controls. The fact that so much of our policy establishment now approves of capital controls means that controls are more likely, which means that crises are more likely. If capital controls were considered an awful step, like expropriating property or invading other countries, then people would be less likely to try to jump in advance of capital controls. 

The central bank responded by sharply raising interest rates to 18%, and interbank rates rose to 25%. That didn't seem to have much effect.  Long term rates went up sharply, all on their own. Inflation is already rising, with an official forecast of 11.5% for next year. We'll see what actually happens. 

Russian 10 year bond yields. Source: Financial Times

At this point, I was about to hit "send" on this post. Burnside Eichenbaum and Rebelo redux.  But then the Ruble bounced back.

On 12/25 Russia's finance minster declared the crisis "over" (WSJ "Russia Says Ruble Is Stable, but Economic Troubles Remain"). In addition to the interest rate increase, designed to make Rubles more attractive, factors cited included
exporters converted their dollar holdings to rubles to meet local tax payments due by the end of the month. [JC: and soaking up some Rubles] 
The ruble’s recovery this week was steered by the government’s order that major state companies sell foreign currencies, which applies to big exporters including Gazprom and Rosneft. Within the next two months, the companies will need to cut their foreign-currency holdings to levels of early October, which will fulfill the market demand for dollars and euros needed to repay foreign debt.
These are "voluntary" capital controls of the offer-you-can't-refuse sort. But none of these moves address the fundamental problems, so some frictions or multiple equilibrium story does come to mind first. The articles also mention thin markets around holidays. It's easier to move prices in thin markets.

But then as of the end of the year, the Ruble is heading down again, which looks to me like fundamentals taking over.

On 12/26 "Ruble’s Recovery Runs Out of Steam'' says the Wall Street Journal. Interestingly, Russian Finance Minister Siluanov has become a fiscal theorist when it comes to steps to help the Ruble.
 Mr. Siluanov admitted that Russia will need to adapt its budgets to “new economic realities.” 
The minister said that Russia will need to reassess its military spending amid slowing economic growth and reduced access to global capital markets as falling oil prices have hit the domestic economy hard. 
...“The budget structure is extremely ineffective. It needs to be changed in the conditions when we have limited access to new sources of income,” Mr. Siluanov said.
The macroeconomic stories are interesting as well.  WSJ echoed the interest-rate-centric view of macroeconomic effects :
...the sharp interest-rate increase that the central bank imposed last week to stem the ruble’s slide, along with widening problems in the banking sector, has darkened the outlook for Russia’s economy dramatically.
Really? Of all the problems in Russia's economy too high interest rates and lack of "demand" are the most important?  Also, we will see whether 18% turns out to be a low or a high real interest rate.

Devaluation and inflation are  supposed to boost economies because prices and wages are sticky. There were great news stories about a crush to buy Ipads at the Apple store in Moscow, and Apple eventually closing it down because they couldn't keep up with currency changes. Ipads seem to be the new Krugerrands. So, there's a little bit of sticky price demand, I guess. Lasting maybe a day.

Some additional readings

Falling oil, rising cucumber prices: how much trouble is Russia in?

Recent calculations show that Russia needs oil to stick to around $105 a barrel for its budget to break-even. .
Russia’s external debt amounted to $731bn in June 2014. 74% of this is denominated in foreign currency, meaning that the depreciation of the rouble makes it more expensive to repay... $35bn of debts are due in December alone.
The largest component of debt is attributable to banks and other non-government sectors, which together owe more than $650bn to foreign lenders, 17% of which is short-term, and much of which (46%) is attributable to state-owned banks and enterprises.
Sanctions too are starting to bite. Companies directly under western sanctions account for about 60% of the total debt due by the end of 2015 (£).
While most of these companies are (for now) relatively cash rich, the fact that many are sanctioned from raising finance means that they cannot simply roll over debt by borrowing externally, and need to instead buy dollars in the market. There also appears to be growing evidence (£) of concerned western banks and financial institutions refusing to finance even those Russian companies that are not on the blacklist.
It is worth keeping in mind at this point that while not being state-run, private companies are often merely quasi-sovereign in Russia, and ownership structures are rather fluid and can change quite rapidly - the potential weight of debt on government finances goes beyond only state-run companies.
... banks alone have $192bn external debt (about 10% of GDP), up from $170bn in 2008, and from $18bn in 1998....The key point here is that Russia’s banks have few dollar assets to set against their dollar debts.
As an example of some of this debt issues, lies the Rosenft loan: Leonid Bershinsky (Dec 15)
Russia's state-owned oil company, Rosneft, raised 625 billion rubles ($10.8 billion at that day's exchange rate) with a bond issue that had a lower yield than Russian government bonds of similar maturity. The Central Bank quickly added the bonds to the list of securities it would accept as collateral from banks seeking liquidity. The deal was opaque,...

Central Bank technocrats have been worried that the government would force them to print rubles for the direct funding of industries, primarily the military industrial complex and the state companies run by Putin friends. The Central Bank's obvious complicity in the Rosneft deal means the pressure is on, and the Central Bank is caving.
Andrew Kramer at the New York Times (dec 16)
He [Putin] faces a particularly delicate dance with Russian companies, which are under significant financing strains. Russian corporations and banks are scheduled to repay $30 billion in foreign loans this month.

And next year, about $130 billion will be due. There is no obvious source for these hard currency payments other than the central bank, whose credibility is now being called into question.

Rosneft, for example, had been clamoring for months for a government bailout to refinance debt the company ran up while making acquisitions when oil prices were high. Because of sanctions, those loans cannot be rolled over with Western banks. Debt payments are coming due later this month.

... With the oil giant in a bind, the central bank ruled that it would accept Rosneft bonds held by commercial banks as collateral for loans.

Rosneft issued 625 billion rubles about $10.9 billion at the exchange rate at the time, in new bonds on Friday. The identities of the buyers were not publicly disclosed, but analysts say that large state banks bought the issue.

When these banks deposit the bonds with the central bank in exchange for loans, Rosneft will have been financed, in effect, with an emission of rubles from the central bank. The deal roiled the ruble on Monday, according to analysts.

The reason for Monday’s currency crash is “well known,” Boris Y. Nemtsov, a former deputy prime minister who is now in the political opposition, wrote on his Facebook page. “The central bank started the printing press to help the Sechin-Putin business, and gave Rosneft 625 billion newly printed rubles. The money immediately appeared on the currency market, and the rate collapsed.” Rosneft, in a statement, denied it had exchanged funds raised from the bonds for hard currency.
Holman Jenkins at Wall Street Journal
Which brings us to Rosneft . This week’s sharp plunge in the ruble was less linked to oil than to a mysterious “bond offering” by the state-controlled Russian oil giant, indirectly financed by Russia’s central bank. 
On Monday, Rosneft felt obliged to issue a one-paragraph statement denying that the ruble proceeds would be used to buy foreign currencies to meet Rosneft’s hefty foreign-debt repayments.
On Why the Ruble is Collapsing,
The value of the ruble dropped as much as 19 percent in the last 24 hours, the worst single-day drop for the ruble in 16 years. Now Russians are reportedly bum-rushing malls to swap cash for washing machines, TVs, or laptops—anything that seems as if it might hold value better than paper money, whose worth is evaporating in real time....
Russia's Central Bank has been trying to fight this trend, first by using its stockpile of foreign currencies to go out into the market and buy rubles, hoping to prop up the price. Then, early in the morning on Tuesday in Moscow, the Central Bank announced a gigantic interest rate increase. The idea is that if you offer people higher interest rates, they're more likely to keep their money in rubles.
Neither move has worked. 
Neil Irwin at New York Times
But interest rate increases aren’t free. Higher interest rates are sure to choke off any chance for growth in a Russian economy that is already reeling from falling oil prices.
Financial Times
The main reseller of Apple in Moscow, re:Store, saw sales two to three times higher than normal at one central branch, according to a salesman, reports Jack Farchy in Moscow.
Another store visited by the FT had sold out of iPhone 6's and iPad Airs entirely by Tuesday night (see first picture).

Marginal revolution commentary and links.

A nice graph from Bloomberg's Henry Meyer and Ilya Arkhipov capturing some of the events:


  1. The ruble has been tracking Brent ever since it was floated, apart from a spike on 17 December. On 17 December, the central bank governor was accused of treason for allowing the ruble to fall, understandably panicked and imposed an unnecessary and harmful midnight interest rate hike. That might not be the whole cause: the same day, OPEC indicated that Brent could fall to $40, well below the CBR's worst case scenario. Over the next few days there were media reports that the ruble fall and subsequent support were all a disguised bailout of Rosneft, which didn't help either. It took public support from Putin for the central bank to restore confidence. The ruble then started tracking Brent again. In other words, behaving exactly as a petrocurrency should. But apparently that's not good enough, so the Russian government has now decided to undermine its central bank by supporting the ruble from Treasury reserves and coercing state-owned industries to do likewise. This can only be a short-term measure. The ruble must be allowed to fall with the oil price.

    Paul Gregory is not the only Forbes contributor writing about this. I am, too. And over at Business Insider, Tomas Hirst (formerly of the Moscow Times) has been following the ruble's story in some detail, though I disagree with him about the significance of the fall.

    1. Hahaha @ "Paul Gregory is not the only Forbes contributor writing about this. I am, too". Can anyone be more attention-starved? Do you want a cookie? Your confusion might be because Cochrane said Paul Gregory was "presicent" while obviously meaning "prescient" - maybe this is something you're not. Simply "contributing" isn't enough to garner attention. Despite it being the new vogue for lib pop-econ writers, the reality is Title XI doesn't apply to economics.

      Try going back and revisiting about banks not lending their reserves.

  2. Two quick points. First, a banking crisis is brewing. The government has already announced huge bailout programs for Trust Bank and VTB. Second, your qualification of the Rosneft bond emission as bailing out favored cronies is off the mark. As you say so yourself, oil exports account for 45% of the Russian government budget. It's hardly a riddle why the government's first priority is saving Rosneft.

  3. Its hard to believe an economy as large as Russia's could be so sensitive to a single commodity's price fluctuations; as if it were an island economy sensitive to price movements of passion fruits.

  4. Dammit, Russia has gotten poorer on account of the oil price drop. Something has got to adjust!

    What is supposed to happen? Raise interest rates, have a nice recession, and save the nominal value of the Ruble? Get foreign loans to intervene in the FX market?

    Hell, the best thing that can happen to Russia is happening, a nice, strong devaluation. Then, any nominal wage rigidity, if it exists, just got devalued away! Ah, yes, Ruble asset holders get nailed. Well, guess what? There is no such thing as free safety.

    Please excuse the hellish expletives, when will we ever learn?

    Happy New Year to all!

  5. Multiple equilbria... It does not necessarily need a whole lot of buzzwords on speculative attacks, etc. but it does require that people acknowledge that markets are unstable. So long as there is a feedback loop, that profits in a market will attract new money to that market, markets must be unstable.

    And, instability is not inefficiency. A market can still subject to downdrafts and crashes and be an efficient market.

  6. There's nothing in a 3rd gen multiple equilibria model (where attacks can happen regardless of fundamentals) that says that attacks can't happen if macro fundamentals are bad anyway.

    But my problem with the Prospective Deficits paper is simple: the 97 AFC featured a great deal of dollar-denominated nonstate debt, so the argument-from-monetary-policy-mechanism-de-facto-guaranteed-bailout is a nonstarter; it has to be fiscal. Floating the baht made Thai bank insolvency worse, not better, since they owed dollars, not baht.

    The governments said: we're not going to bail these banks out. In the end: they (mostly) didn't. So it is straightforwardly difficult to sustain an intuition of perfect foresight of crisis-in-fundamentals.

    Whilst I am sympathetic to a model of 1997 where investors rationally perceive bank insolvency, I think any model has to allow for conflicting limited-info beliefs, where nonstate investors/banks assume a bailout and state investors/banks assume the opposite, possibly as a separating equilibrium/other pet framework revealing personal beliefs on the future outcomes of political struggles between crony camps that were already brewing in e.g. Korea, Thailand, Indonesia, etc. between actors who were broadly pro-internationalist, pro-reform in the heady 1990s post-Cold-War atmosphere and actors who were skeptical of the usefulness of local-US private partnerships (that was generating the US-denominated external debt!) prior to the crisis, more for nationalist/traditionalist than economic ideology reasons. Political actors (Anwar Ibrahim, Djiwandono) who were pro-internationalist pro-(political)-liberalization pro-financialisation prior to the crisis unsurprisingly fought for market-oriented fiscal reforms upon the crisis, but generally did not get them, and lost both personal portfolios and political careers in the wake of the crisis. It is hard to believe that an actor who bets his political survival on fiscal reforms wouldn't also sincerely/rationally bet their personal portfolio on fiscal reform.

    Besides, how does perfect-foresight rationally anticipated inflation not translate to present inflation?

  7. Can we have a "print version" button? Thanks.

  8. It seems odd that the ruble would track the oil price so well. In the short term at least that should help the government as its oil-based revenues (in $) will convert into the same ruble value as before. This will make paying state salaries and pensions a lot easier.

    Refusing to roll over loans is a hardball game indeed, but who will get hit? If Russia grants its companies a moratorium on repayments which are being "forced" by evil Western banks, then the pain goes back onto the lending bank's balance sheet.

    Then everyone loses.

  9. Great overview of the Ruble depreciation and economic situation in Russia. In my view, one additional reason of the Ruble depreciation deserves a separate consideration: it is the continuous war with Ukraine. Apart from the number of sanctions to banks and businesses (which you have mentioned), there are additional important aspects: uncertainty over whether the Russia-Ukraine conflict would escalate and increased military expenditures to support the invasion of Eastern Ukraine. According to IHS, Russian defense spending will rise from about USD68 billion or 15% of federal expenditure in 2013 to just over USD98 billion or 21% of federal expenditure in 2016. According to unofficial information, 2000-3000 EUR/month are paid out to Russian separatists. The ruble already started losing its value (hitting 34 RUB/USD and thus breaking historical lows) right after Ukrainian crisis began and the first signs of Russian invasion followed (January-February 2014).
    Some sources:


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