With rising prices for oil, the Russian ruble is on the rebound. But how much more can the ruble really strengthen given the underlying weakness of the Russian economy?

A screen showing the currency exchange rates of the Russian ruble, U.S. dollar and euro, in Moscow, Russia, Jan. 20, 2016. Photo: AP 

At the end of last week, the ruble significantly strengthened against both the U.S. dollar and the euro. The U.S. dollar exchange rate was 70 rubles, while the euro rate was under 80 rubles. The last time the ruble was so strong was in December 2015.

Experts agree that the current strengthening of the Russian national currency is determined by the price of oil rising over $40 a barrel. Analysts are now discussing the future of the ruble: is it going to keep strengthening or quickly revert back to falling?

Cause for optimism about the ruble

Last week, the Russian ruble gained 3.96 and 4.25 against the U.S. dollar and the European currency, respectively, due to higher oil prices. Brent crude hit $40 a barrel in anticipation of a new meeting of oil producing nations scheduled to discuss the freeze of "black gold" production. Moreover, prices were further driven up by the news that the Chinese government might introduce additional measures to boost national economic growth, which would increase the demand for resources.

These indicators gave many analysts reasons to be optimistic. "It is possible that the ruble will strengthen to 63-65 rubles per U.S. dollar by 2017," according to Andrei Klepach, the chief economist of Vnesheconombank (VEB), who used to be in charge of macroeconomics as the Deputy Minister of Economic Development.

Still, there are plenty of pessimistic forecasts out there. The Finam analytical service stated that oil futures were already extremely overbought and there were no fundamental factors that would warrant such strong growth, hence oil prices might start dropping again. A falling price of oil would naturally drag the ruble down with it. 

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Additional pressure on the ruble could be exerted by information that Moody's rating agency is considering lowering Russia's credit rating due to low oil prices and the deterioration of the country's balance of payments prospects.

In the meantime, the Ministry of Economic Development completed the assessment necessary for forecasting the country's social and economic development in 2016-19. The calculation of economic prospects relies on the average annual oil price of $40 a barrel. The economy will also be influenced by sanctions and counter-sanctions. The assumption is that they will be prolonged till 2020.

With such benchmark data, Russia's GDP will decline by 0.8 percent in 2016, and the average U.S. dollar rate will be 68.2 rubles, which means that the national currency rate will further strengthen compared to its present rate of 70.

The optimists' main hopes rely on rebounding "black gold" prices, which finally exceeded the $40 a barrel mark. Investors are encouraged by the fact that oil production has been going down: in February, OPEC decreased the production by 280,000 barrels a day, and forecasts indicate that come summer, the U.S. might cut its production by almost 1 million barrels a day. These conditions are putting an end to the macabre forecasts of prices bottoming out at $25.20 or even $17 a barrel.

Currently, most experts are pointing to a new trend in the oil market:

"Lately, we have observed high correlation between the rate of the ruble and oil prices, and the fluctuation of these prices is virtually the sole factor that determines the value of the Russian currency. Thus, forecasting the rate of the ruble amounts to predicting oil prices. Now we can provisionally predict that oil prices will keep growing through the year, albeit slowly, and will ultimately reach $45 a barrel for Brent crude. Then the Russian currency will strengthen up to 63-64 rubles per U.S. dollar," says Vadim Iosub, senior analyst at Alpari.

Is the ruble the most undervalued currency?

But in their recent overview, Deutsche Bank analysts pointed out that the rate of the ruble depends on factors other than oil. They concluded that the ruble was the most undervalued European currency, so it had good chances anyway for going up dramatically.

Actually, Russians have been told time and again that the ruble is undervalued, and that assessment did not just come from Western experts, but was reiterated by representatives of the Bank of Russia.

For example, in November 2014, when the rate was around 44 rubles per dollar, Elvira Nabiullina, the head of the Bank of Russia, claimed that the ruble had a lot of potential for strengthening in spite of dropping oil prices. She did, however, concede that such scenario was only possible in the absence of external negative factors.

Also read: "What the Russian economy needs to do next to avoid stagnation"

That happened just a month before the U.S. dollar skyrocketed and the key interest rate was raised to 17 percent. In March 2015, the public was again told that the ruble was undervalued. Nabiullina then stated that the ruble was undervalued by about 10 percent.

To be fair, the ruble then started gaining and kept going up for about a month and a half peaking at 49 rubles per dollar.

But a further drop in energy resource prices, as well as economic problems brought on by sanctions and the U.S. raising its interest rates, threw the rate back to over 70 rubles per dollar.

This time Deutsche Bank specialists applied the BEER (Behavioral Equilibrium Exchange Rate) analysis developed in 1999 to assess the discrepancy between the actual rate of the ruble and the economic situation in Russia.

They concluded that in the near future, the ruble would be gaining due to such favorable factors as steady oil prices, the gradual revival of the Russian economy and the increase in the country's international reserves starting in mid-February.

Andrew Schenk, an analyst of MC Alfa Capital, believes that the ruble is currently undervalued. “Even though the ruble devaluation was more sudden,” he says, “it still fits the general trend of the devaluation of developing countries' currencies due to the drop in the price of raw materials and a stronger dollar. The ruble rate largely depends on the fluctuation of prices for raw materials, especially oil and metals. Oil prices are expected to rebound, for sooner or later the market balance of demand and offer will stabilize, but this will be a slow process. In the next several months, oil prices may reach $45 a barrel, and that will provide the ruble with an opportunity to go up to 65-67 rubles per dollar. The rate is likely to stabilize there because there are no reasons for higher growth."

More ruble volatility ahead

In any case, it is a fact that over the past month, we have been observing an unusual situation: not just the trend for the weakening of the ruble, but also a tendency for its strengthening, granted the latter is still rather volatile.

Igor Nikolaev, the director of the FBK Strategic Analysis Institute, thinks that presently we cannot expect regular fluctuations of the ruble rate, "I think that equally possible that we see the strengthening and weakening of the national currency. However, it should not be drastic. I expect it to be within several dozen kopecks."

Many economists believe that the ruble will strengthen in March and peak at 68 rubles per dollar for the following reasons: the decrease in U.S. oil production to the levels seen in November 2014, active negotiations between OPEC and other oil-producing nations on freezing oil production and the high probability that the Bank of Russia keep the same key interest rate.

"Indeed, there are factors that facilitate the strengthening of the ruble and the oil price increase, but global tendencies indicate that the supply still exceeds the demand on the oil market. Moreover, so far the production freeze is in the works, but the much needed general agreement has not been reached. In my opinion, the ruble has already taken advantage of the news that is out there. It is not likely to stay under 70 rubles per dollar for long," Nikolaev suggests.