Why the Russian economy is melting down

Russia’s currency is collapsing primarily because of the falling price of oil (and, relatedly, natural gas). When fossil fuels are expensive, Russian energy companies are flush with foreigners’ dollars which they turn into rubles to pay local workers and suppliers. With energy cheaper, there’s much less foreign money pouring in. With less foreign money coming in to buy oil, Russia’s official stockpile of foreign currency is rapidly depleting.

Intensifying the ruble’s collapse is western financial sanctions on Russia in the wake of Russia’s incursions into Ukraine. Those sanctions make it much tougher for Russian companies in other sectors to expand to fill the gap, or to get loans to paper over temporary troubles. Foreign companies also fear that growing Russian conflict with the west means they shouldn’t invest there. All this is combining with the tendency of Russian elites to invest a lot of their money abroad to lead to a plunging currency.

A bit unusually for the recent history of Vladimir Putin, his government’s approach to the currency collapse — don’t impose tough new financial regulations, do hike interest rates drastically — is textbook, orthodox, western-approved economics.

You can think of this as working through three main channels.

One, it should give Russians a second thought about the idea of liquidating their ruble-denominated savings and shifting them abroad. The new higher interest rates mean that keeping your savings at home is suddenly much more appealing than it was last week.

Two, it should tempt some foreigners into buying these new high-yielding Russian bonds.

Three, it should depress the ruble-denominated price of some Russian assets. Mortgage interest rates, for example, are about to get a lot more expensive. That means houses will get cheaper. That means cash-rich investors — perhaps actual foreigners, perhaps wealthy Russians with lots of foreign assets — may bring money to Russian shores in search of bargains.

All three channels would have the same impact — propping up the price of the ruble.

It’s unclear. Sharp rate hike to restore confidence, followed by slow and steady easing once the situation has stabilized is the textbook approach to handling a currency crisis.

But the presumption behind that textbook approach is that confidence is what’s lacking. Russia’s problem is that nothing else Putin has been doing is textbook. Getting embroiled in a war with a neighboring country that leads to sanctions from your main trading partners is not textbook. Having an undiversified economy dependent on natural resource exports is not textbook. The ruble’s plunge might be an overreaction to a short-term decline in oil prices. But it also might simply reflect underlying weaknesses in the Russian economy.

One important thing to understand is that Putin’s policy choices in this matter have important implications for the distribution of wealth in Russia. The collapse in the value of the ruble is a disaster for Russians who have debts denominated in foreign currencies, but it’s not necessarily the worst thing in the world for those who don’t. Indeed, Russians working in tourism (which, admittedly, isn’t that many people since Russia is mostly cold and empty) or in the country’s handful of export industries that aren’t oil and gas actually benefit from a cheap currency.

Conversely, much higher interest rates will be devastating to the fortunes of Russians who need to roll over ruble-denominated loans or who depend on rate-sensitive sectors like construction for their employment.

Many countries facing Russia’s predicament would supplement interest rate hikes with capital controls, financial regulations that make it hard to take large amounts of money out of Russia. Such controls would have little impact on the lives of most Russians, but would be enormously inconvenient to uber-wealthy oligarchs looking to buy property in London and Manhattan or to vacation in Italy. Putin is choosing a policy mix that advantages oligarchs and people who owe money to western banks over other possible alternatives.