One year ago, the Central Bank of Russia refused to place restrictions on the foreign currency exchange market, releasing the ruble into a free-floating state. What have been the results?

People walk past a board showing currency exchange rates of foreign currencies against the Russian rouble in central Moscow, Russia, November 13, 2015. Photo: Reuters

Almost exactly one year ago, the Bank of Russia abolished the exchange rate corridor for the ruble and stopped carrying out regular interventions, reserving the right to do so in the event of a threat to the financial stability of the country. Thus, the ruble was made fully free-floating.

More than a year has passed since that time, and it is safe to say that this event has significantly changed both the Russian currency and the financial markets.

The path to floating freely

We should recall that a system of freely floating exchange rates involves a system in which state authorities do not try to influence the supply and demand of the currency on the market.

The management of the Russian Central Bank started talking about plans to move to a free-floating currency in the middle of the 2000s. This was necessary to carry out the policy of inflation targeting (controlling inflation via monetary methods), but the process was delayed, and this question was finally settled only in November 2014.

Prior to that, a managed floating exchange rate regime operated in the domestic foreign exchange market, which for some time allowed the Central Bank to smooth out currency fluctuations. However, during the 2014 crisis, the Central Bank could not rescue the ruble.

The first alarm bells rang in March of last year, amid the political crisis in Ukraine. At that time, the volatility in the currency market increased significantly, and to overcome this, the Central Bank had to spend huge amounts from its reserves. In that month, the regulator sold foreign currencies worth $22.3 billion and €2.3 billion – volumes comparable to interventions carried out in late 2008 and early 2009. Moreover, six months later, the Central Bank increased its foreign currency sales, and in October 2014, it sold $27.2 billion and €1.6 billion.

Right after the October 2014 sales of currency, the Bank of Russia started to understand that the country could afford such a “salvation” of the ruble only at an exorbitant cost – the continuation of such a policy would completely “burn up” the reserves, leaving the country’s economy fully exposed to the crisis.

Initially, the Central Bank of Russia was planning to let the ruble float freely by January 2015, but the tense situation on the foreign currency market, the problems in the economy due to falling oil prices, and a tense geopolitical situation, made the regulators’ work extremely confusing. These combined factors forced the Central Bank to carry out the transition to free-floating ruble two months ahead of schedule.

The public as well as the expert community saw these actions of the regulator as controversial moves. In the “free-float” state, the national currency fell sharply – in just three weeks, the exchange rate moved from 44 to the 61 rubles to the dollar. The peak of the drop came in December 2014. This caused much criticism to be levied against the Central Bank for the “dismantling” of the exchange rate corridor.

Most economists then said that the transition to a floating exchange rate should have been carried out earlier, which would have saved a part of foreign exchange reserves. Over the past year, the international reserves of the country were “depleted” by more than $120 billion. At the same time, at the beginning of November 2015, they still form quite an impressive amount – $370 billion. According to this indicator, Russia, in spite of all the losses, is confidently among the top six nations in the world.

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Pros and cons

“The transition to a floating exchange rate was done correctly, but with a certain delay – it should have been done a year earlier. Things would have been quieter on the foreign currency market, and the ruble would have devalued more smoothly,” Sergei Dubinin, former head of the Central Bank and now a member of the Supervisory Council of VTB Bank, told Russia Direct.

According to him, the main result of the changes in monetary policy of the Central Bank was that the price of the ruble began being shaped under the influence of market factors. Thus, on the one hand, the population felt the loss of all the “amenities” that a cheap ruble had brought – imported goods became more expensive and less available. On the other hand, this depreciation of the ruble benefited export-oriented companies, which are the main source of income for the state budget, and thus the country was able to maintain budget stability.

Of course, the free-floating ruble has plenty of opponents and critics. One of the most powerful and consistent is presidential advisor Sergei Glazyev, who a year ago proposed that the ruble should not be allowed to float freely, but rather to fix its exchange rate, and thus, sharply restrict the activities of speculators.

Financial news and data provider Bloomberg, marking the one-year anniversary of Russia’s transition to a floating exchange rate, listed the five main results of this process. Four of them were negative – unprecedented inflation, a sharp rise in the number of poor in Russia, a decline in real wages and incomes of the population, and reduced foreign travel and purchases of imported products by Russians.

The only positive result, according to Bloomberg, was the benefits gained by Russian exporters, mainly the oil companies, which due to the weak ruble and the current tax system, were able to increase their revenues. This, in turn, compensated for the losses they suffered due to the drop in world energy prices.

At the same time, Economic Development Minister Alexei Ulyukayev sees no reason for a new devaluation of the ruble. “Now we see that the situation with the current account balance is quite stable, and the capital account balance has improved. Therefore, I believe that no reasons exist today for us to expect any further devaluations or shocks,” said Ulyukayev.

For his part, Mr. Ulyukayev supports the decision that the Central Bank took one year ago, when it placed the Russian currency into free-float. “I believe that this decision was absolutely correct, and was made under difficult circumstances, I highly praise the actions of the Bank of Russia in this direction,” said the minister.

German Gref, former Minister of Economic Development and now the head of Sberbank, also agrees with this view. According to him, the Bank of Russia let the ruble float freely just at the right time, and thereby managed to prevent serious problems from occurring in the economy.

“If the Central Bank had repeated the mistakes of 2008, when it supported the stability of the ruble, we would have a good situation in the banking sector now, but we would have killed the entire commercial sector.”

According to Mr. Gref, during the current crisis, Russian companies are behaving differently than they did during the last crisis seven years ago, when their profitability fell sharply. “If we exclude the banking sector, the vast majority of other sectors are showing an increase in profitability. Of course, this is due to the intelligent monetary policy followed by the Central Bank of the Russian Federation, which resulted in the beginning of weak growth in industrial production in Russia in September,” said the head of Sberbank.

Thus, what happened during the year that the ruble was allowed to float freely? On the one hand, during this period the national currency weakened by 50 percent against the dollar, and inflation has surpassed 15 percent – all this was a painful hit to the wallets of the population, significantly reducing people’s real incomes by as much as 8 to 9 percent.

On the other hand, Russia was able to avoid a sharp decline and a cataclysm in the currency market, as well as prevent a banking crisis and panicking of depositors. The government has managed to maintain stability of the overall state budget, and monetary authorities were able preserve a considerable amount of foreign currency reserves. Moreover, in the manufacturing sector there was observed, even though small for now, yet nevertheless, a turn towards growth. It seems that the pros outweigh the cons, and so the ruble continues to float freely.