Macro Analysis /

Russia: Ruble exchange rate 2022 – Hoping for best, preparing for worst

  • The ruble’s fair values corridor for 2022 is at RUB70-80/$ but we see 2 reasons to focus on the lower end of this range

  • Ruble exchange rate did well this year, but lags behind oil prices

  • Change in investor behavior is a key reason explaining the gap between the ruble and oil price

Natalia Orlova
Natalia Orlova

Chief Economist

2 September 2021
Published byAlfa

The ruble’s fair values corridor for 2022 is at RUB70-80/$ but we see two reasons to focus on the lower end of this range. First, the drivers of depreciation risks are out of Russia’s direct control – the real interest rate differential (guiding for RUB70/$) could be hit by US monetary tightening, while the performance of Russian exports (guiding for RUB80/$) is vulnerable to downside under zero-carbon transition risks. Second, with a possible shift in global monetary policy expected next year, we tend to favor values derived from the real sector performance: this is a range of RUB78-80/$ which we set as a target for 2022 YE.

Ruble exchange rate did well this year, but lags behind oil prices: Eight months of 2021 have passed already and the ruble is still trading at the level of year-end 2020, which is a glass half-empty versus glass half-full situation. Some would say it is a favorable development – the ruble is doing very well versus other EM currencies this year (see Figure 1) and did not react to US sanctions introduced for Russian local primary bond placements from June. A different view is that while the oil price has recovered to pre-pandemic levels, the ruble exchange rate has lost around 10% from its pre-pandemic levels and, thus, remains weak (see Figure 2). While the current ruble exchange rate is fully in line with our expectations – see our report from 6 April, when we set a RUB76/$ target for year-end 2021 – back then, we expected lower oil prices and a much lower CBR key policy rate. Thus, we share the view of those who consider the ruble exchange rate is demonstrating a weak performance this year.

Change in investor behavior is a key reason explaining the gap between the ruble and oil price: The effect of higher oil prices on the ruble exchange rate typically comes through two channels. The first is the direct effect of the larger current account surplus that is neutralized under the budget rule: in 2021, we expect the finance ministry to purchase around $35 bn from the forex market – for January-August it has already bought $17.5 bn. The second channel was, however, the effect of the higher oil prices on the capital account – the improved outlook for the National Wealth Fund dynamic and lower borrowing appetite by the Russian cabinet were the triggers for a stronger capital account. There are two negative developments on this front in 2021. One observation is that given the US sanctions threat, the share of non-residents on the local OFZs market has declined to 20% from 23% in 1Q21 (see Figure 3), and even in August their nominal holdings of OFZs is still below the maximum level seen in 1Q21. Another point is that Russian households started active investments abroad – as of April 2021, their investments in foreign bonds and equities reached $20 bn and, in our estimates, they made net investments of around $5-7 bn in 1H21 to these instruments, including $3 bn in 1Q21. In 1Q21, these operations contributed to 18% of Russia’s total net private capital outflow (see Figure 4). This development is a very new trend and, in our view, is a reason explaining the larger gap that has emerged between oil prices and the ruble exchange rate.

The ruble fair value calculated on the interest rate differential moved to RUB70/$ for 2022: The local market, however, seems to disregard the deterioration in the private capital structure and consider that the large gap between oil prices and the ruble exchange rate may narrow, as the CBR’s high key policy rate should renew the appetite of foreign investors for local bonds and help strengthen the ruble. To check the likelihood of this, we have updated one of our four ruble-fair-value models. This model derives a ruble fair value from the real interest rate differentials between Russia and the US. Figure 5 shows that while prior to 2020 the 4% real interest rate differential was consistent with the RUB65/$ exchange rate, the inclusion of 2020 market performance caused a shift of the ruble exchange rate to RUB67/$ under the unchanged 4% real interest rate differential. This shift suggests an increase in country risk premia and structural pressure coming from capital outflow. Our previous calculation of this metric for the end of 2021 provided an exchange rate of RUB66/$; the updated model shows that the 2022 fair value ruble guidance is now RUB70/$. This means that the increase in the CBR’s key policy rate was the price to pay for the high economic uncertainty, particularly related to the strong pick-up in inflation and inflationary pressure (see our note on inflation from 7 July). Another concern is that the 2022 real interest rate differential in 2022 will be vulnerable to the US monetary tightening and very little in control of the Russian economic authorities. The shift in this model guidance for 2022 is generally consistent with the previous one indicating Russian household’s higher preference for investments abroad.

Monetary equilibrium unchanged at RUB70/$: Another metric, sensitive to monetary policy, which we use to calculate the ruble’s fair value is the monetary equilibrium approach. This model is based on the monetary supply components vs. CBR reserves; it defines the ruble fair value as a simple average of the two indicators – the ratio of the monetary mass divided by CBR reserves and the ratio of the monetary base divided by the CBR reserves (see Figure 6). Similar to result of 2021, this approach keeps guiding the ruble fair value at RUB70/$. This guidance emerges under the assumption of a modest 7% y/y increase in monetary supply in 2022, which corresponds to our expectations of deposit market growth; on the reserve side, we have incorporated the $17.5 bn, which the CBR received from the IMF as part of the pandemic-support package. The forecast of reserve dynamics is, however, challenging for 2022 and will consist of a combination of several factors (1) a ~$35 bn transfer to the National Wealth Fund bought by the Finance Ministry from the forex market this year and (2) the spending of National Wealth Fund resources for infrastructural projects. That said, the government savings are projected to increase firmly, compensating the increase in monetary supply effect on the ruble fair value dynamics and keeping the fair-value guidance unchanged.

The industrial production differential points to some improvement in fair value to RUB78/$ on the 2022 horizon: There was a positive surprise for the ruble outlook from our third model, which reflects the industrial production differential. For 2021, this model previously guided for RUB80/$, which reflected expectations of a very strong US economic recovery. However, Russian producers brought a positive surprise in 1H21 – Russian industrial production was up by 4.4% y/y, including a strong recovery in the manufacturing segment where output was reported to increase by 6.4% y/y. The decision of OPEC+ to ease production restrictions from August this year will also likely boost industrial activity in 2H21, generating additional recovery in commodity production and investments. These trends are bringing support to the ruble exchange rate next year, and comparing the industrial production differential with the real effective exchange rate (see Figure 7), this model provides guidance of RUB78/$ for 2022.

Ruble fair value defined by the share of fuel exports moved lower to RUB80/$: The last method of the four that we use to derive the fair value of the ruble exchange rate is the targeted share of fuel exports to GDP. Since 2014 this share has declined to 13% on average while it was 16% in 2000-14; given the growing risk of zero-carbon transition, we use a 13% level of fuel exports to GDP as a benchmark (see Figure 8). Taking this level of fuel exports to GDP as the equilibrium, we have calculated the ruble fair value at RUB76/$ for 2021; however, as inflationary pressure emerged and the non-oil parts of Russia’s GDP moved higher, this metric now guides at RUB80/$ for 2022. We see this development also coming in line with the risks produced by the zero-carbon transition.

We see a RUB78-80/$ 2022 YE target as depreciation risks are out of Russia’s direct control: The take away from the fair value analysis for 2022 is that the range of our four estimates did not shift much from 2021 and the 2022 ruble value corridor is at RUB70-80/$ (see Table 1). This is good news, especially as the ruble exchange rate is traded at the strongest part of this range. At the same time, we see structural risks for both the lower and upper ends of the corridor. The strongest fair value figure comes from the interest rate differential model, which is very sensitive to US monetary policy; this risk is out of the control of the Russian authorities and would require an additional increase in local policy rate. The weakest end of the corridor is subject to risks associated with global commodity regulations, which is very hard to neutralize by internal instruments. Put simply, it looks like depreciation risks are out of Russia’s control and even a prudent macroeconomic policy will not be enough to neutralize them. Another important point is that the RUB70/$ guidance for 2022 comes from two models (monetary equilibrium and interest rate differential), which incorporate monetary components which do not look like being the most reliable during a period of change in US monetary policy. As a result, for 2022 we favor two guiding landmarks that come from the real sector performance, i.e. the industrial production differential model and fuel exports as share of GDP. For this reason, we set a RUB78-80/$ ruble exchange rate range for the end of 2022 as a guiding landmark.