The Land of the Setting Dollar
The year 2003 was a year of unchecked growth of the ruble on the Russian currency market. The year began at a rate of nearly 32 rubles to the dollar, but by November, the rate was considerably less than 30 rubles to the dollar. The result was enormous dollar inflation, which surpassed even the outrageous ruble inflation. The Central Bank was pleased, however, since currency market speculators felt powerless and official gold and foreign exchange reserves increased miraculously.
What Was Planned
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| Photo: Sergei Mikheev |
| Over the past year, Russians have realized the undeniable advantages of the Russian ruble over the American dollar just as quickly as they once came to trust the dollar. (The placard reads “Sell Russian oil for rubles only.”) |
The government set out its plans in the area of ruble rates and inflation in “Main Orientations of a Common State Monetary Policy for 2003,” approved at the end of 2002. The document stated that the ultimate aim of the common state monetary policy carried out by the Bank of Russian in coordination with the government was to reduce inflation and maintain it at a low level. The objective over the next three years was to bring inflation below 8% per year. Low inflation was needed in order to “decrease macroeconomic risks, expand internal credit, concentrate the capital needed to modernize capital assets in the country, and use this as a base for strengthening stable economic growth trends. “
In the opinion of the Central Bank, inflation should have been 10–12% in 2003. As has always happened in past years, the Central Bank pointed out that inflation was not entirely within its power: “Unplanned increases in prices and rates for paid public services, primarily housing and municipal facilities and passenger transport, as a result of administrative regulation had an immediate effect on consumer price trends.” Monetary policy measures will not bring quick relief here. Moreover, these measures are not always effective in Russia, even if the matter does not concern rates. “Central Bank rates do not have sufficient influence on rates on the interbank market, which remains narrow as a result of the persistent mutual mistrust of banks.” In turn, “the interbank market rate has a limited role in formulating deposit and loan rates for bank clients.” All the Central Bank can offer here is an evaluation of its operation, not on general inflation but on base inflation, which is understood as “the part of inflation that is connected with the exchange rate, monetary policy, and inflationary expectations and on which monetary control agencies have a direct influence.” The Central Bank did not emphasize that the ruble rate was not in its power. It merely noted that as usual it planned to employ a floating rate policy. The bank also stressed that in 2002 after the end of a period of high oil prices on world markets, the strengthening of the ruble in real terms with respect to freely convertible currencies had slowed substantially in the current year: “Near-zero growth of the real effective ruble rate allows the conclusion that the balance of payments status will remain stable.” The Central Bank noted in particular that the ruble rate in 2002 did not interfere with exports at all; and in general, “the influence of exchange rate trends on production indices is not unique, but depends on the level of competitiveness of various industrial sectors.” This remark was obviously directed at those who believed that the Central Bank’s artificial support of the ruble rate was a means of subsidizing imports at the expense of export sectors. A document issued in 2003 emphasized that evening out exchange rate swings and maintaining a sufficient level of gold and currency reserves would remain the objectives of exchange rate policy. “Nominal ruble devaluation rates, as expected, will be less than the typical inflation rates of recent years,” because “real strengthening of the national currency has traditionally accompanied successful market transformations in countries with transition economies.” The Central Bank also provided a forecast of the average annual ruble rate for 2003 (with references to the Ministry of Economics, of course). The original forecast was as follows: if world economic growth is poor, the rate will be 34 rubles to the dollar; if it is somewhat better, the rate will be 33.7 rubles to the dollar. The final revision of “Main Orientations of a Common State Monetary Policy for 2003” gave an average annual rate of 33 rubles to the dollar.
We recall that a government economic program for the medium-term outlook (2002–2004) was mainly concerned with questions of exchange rate policy. There were arguments for both increasing and decreasing the ruble rate: “There are two possible, fundamentally different economic policy alternatives that may be arbitrarily characterized as a weak ruble or strong ruble policy.” A weak ruble makes domestic products more competitive on both domestic and foreign markets, thus stimulating higher economic growth rates. However, in protecting industry from outside competition, a weak ruble removes the incentives for economic modernization in Russia by “preserving the existing inefficient economic structure.” The export sector is the main source of revenues for the state, and liberalizing the currency market, at the very least, will not decrease capital outflow. On the other hand, a strong ruble “stimulates imports of machinery and equipment from foreign countries, which is a major factor in modernizing production.” Furthermore, all other factors being equal, a strong ruble will increase real incomes of the population. Although there will be an initial slowdown of economic growth rates, “in the long-term outlook they will be considerably higher” than in the case of a weak ruble.
The government forecast a decrease in the ruble rate for 2003, but it will welcome the increase wholeheartedly.
What Actually Happened
Inflation began to wreck the plan as early as January. On February 5, the Ministry of Economic Development and the State Statistics Committee (Goskomstat) simultaneously announced that prices had increased 2.4% in January. Rates for paid public services increased 4.4%, and food prices rose by 2.5%, with fruit and vegetable prices rising by 13.1%. Goskomstat also calculated base inflation, a figure of interest to the Central Bank (1.2% in January).
At the beginning of March, President Vladimir Putin, with Prime Minister Mikhail Kasyanov in attendance, held a meeting with cabinet members and noted that inflation in Russia was increasing at “rather high rates.” He ordered the government to keep the situation under control, but to do it properly “to avoid harming the real sector.” All the same, the inflation rate for the first quarter stood at 5.2%; that is, prices increased by about 20% in annual terms. Sergei Ignatev, the Chairman of the Central Bank, came out with an economic theory according to which the sole reason for inflation in Russia was currency purchases by the Central Bank and printing of money for this purpose (from which it follows that if the bank stopped buying currency to prop up a falling dollar rate, inflation might be reduced to 0%).
So without Central Bank’s support, the dollar might fall so much that nominal and real increases in the ruble rate would hamper Russian production and put the brakes on economic growth. Be that as it may, the Central Bank made it clear that it would do everything possible to lower inflation even if the dollar fell.
And it did fall. The official dollar rate on April 22 was 31.1 rubles. The dollar’s endless fall did not show any signs of vigorous speculation on a fall, since there was really nothing to speculate on and there was no particular news to fuel speculation. On the one hand, economic growth in Russia was more than 6% annually; on the other hand, inflation exceeded 20% expressed in annual terms. The ruble either had to rise or fall. Therefore, the currency market contented itself with simple reasoning: there were a lot of dollars in Russia because of high oil prices. Hence, the dollar had no reason to rise and would probably fall.
By May, the dollar was already worth less than 31 rubles. The Central Bank continued to hold to its theory that a falling dollar was a means of fighting inflation, and printing money for buying currency should be avoided in every possible way. The bank did not stop buying dollars altogether: its currency reserves exceeded a record $60 billion in May. However, the bank’s purchase of dollars looked like a forced temporary deviation from theory: they were saying the dollar could not be allowed to collapse, because this would be a sign of currency instability, which the Central Bank always opposed. Seeing this, commercial banks readily parted with dollars. Finally, in October, the dollar fell below 30 rubles; and on October 31, the official rate was only 29.85 rubles to the dollar. Thus, the government’s exchange rate plan for 2003 was never realized, and 33 rubles to the dollar never materialized.
In August, the Central Bank prepared a draft of main monetary policy orientations for the following year, in which it also presented its version of what happened in 2003. As stated in the document, there was a large increase in the money supply: whereas the money supply increased by 148.5 billion rubles (9.3%) in the first half of 2002, it increased by 484.9 billion rubles in the first half of 2003. However, as the Central Bank pointed out, there was nothing wrong with that, because demand for money had increased. “The acceleration of economic growth played a decisive role in accelerating the increase in demand for money. However, the change in consumer and corporate preferences in choosing a currency for accumulating funds in favor of the ruble, caused by the nominal strengthening of the ruble against the dollar that began in February of the current year, was of critical importance,” the document noted. In the first half of 2003, the amount of foreign cash held by the population decreased by $4 billion, whereas an increase of $200 million was observed in the first half of 2002. Foreign currency deposits at commercial banks increased by 84.1 billion rubles in the first half of 2002, but by only 2.9 billion rubles in the first half of 2003. Thus, the Central Bank emphasized, the increase in demand for money solely due to the population’s abandonment of the dollar was estimated at more than 200 billion rubles, or about 10%.
Why were citizens selling currency? Because the dollar was falling. And what was causing the dollar to fall? “The profitability of investing in ruble-denominated assets contributed to a flow of short-term portfolio investments, including investments by nonresidents. In order to restrain inflationary processes, the Bank of Russia adjusted its exchange rate policy. In particular, there was a gradual revaluation of the nominal ruble to dollar rate in the period between January and June 2003.” In other words, short-term investors, including nonresidents, were to blame for the rise in the ruble (which in turn led citizens to sell their dollars).
It should be noted that the bank was not particularly successful in restraining inflationary processes. Before the end of the year, the government was struggling desperately to keep it to 12% (10% was long forgotten). Deflation of 0.4% was observed in August, but this was exclusively due to lower prices for fruit and vegetables. By October, inflation returned to an extremely high rate of 1% per month. As a result, 2003 was a year of accelerated growth of the money supply, rapid ruble inflation, and even greater dollar inflation (owing to the fall of the dollar, commodity prices expressed in American dollars fell even faster than ruble prices). Russian citizens, of course, had not become totally disillusioned with the dollar as the Russian national currency and were probably not very happy with what was going on. The Central Bank did not abandon the dollar either, but was probably very happy, because it had started the year with gold and currency reserves of $47.8 billion, which by August 1 had already reached $64.5 billion. This enormous increase in reserves allowed Moody’s credit rating agency to upgrade Russia’s investment rating, although by the end of the year, instead of an influx of capital into Russia, there was an outflow. But somehow, this outflow did not harm either the ruble rate or gold and currency reserves. According to official Central Bank statistics, Russia’s gold and currency reserves increased by $700 million to $65.4 billion between November 7 and 14, setting a new record. Thus, citizens and banks found it unprofitable to hold either rubles or dollars in 2003, but the Central Bank was pleased with both currencies.
Price of Russian Urals Oil (c.i.f. Mediterranean ports)
Volume of Russia’s Gold and Currency Reserves
Source: Central Bank of the Russian Federation
Inflation on the Russian Consumer Market
Source: State Statistics Committee of the RF
RTS index
Sergei Minaev
All the Article in Russian as of Jan. 12, 2004
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