The Kremlin’s attempt to make “hostile countries” pay for energy imports in rubles is problematic for a host of reasons. Is there more to this movement than meets the eye?
In a word
- Russia did everything to support the ruble
- Forcing energy customers to pay in rubles could backfire on Moscow
- Retroactively imposing the “rouble clause” would harm the Russian economy
Unlike the 2014 invasion, occupation and annexation of Crimea, the Western response to President Vladimir Putin’s military intervention in Ukraine this time probably took Russian authorities by surprise: trade was severely restricted, Western businesses were pressured to move out of the country, Russian currency reserves held in the West were frozen.
Not only has Russia been virtually shut out of major financial systems, but the ability to use gold stored at the Central Bank of Russia has also been limited. Admittedly, this wave of sanctions is not watertight, and Moscow can still do business with a large part of the world, including China and India. Russian endurance, patriotism and propaganda will likely convince many Russians that showing off and making sacrifices are more important than economic growth. Yet, while the sanctions will not devastate the economy or cause unbearable hardship for Russia’s people and current leaders, they will continue to wreak havoc, especially in the long term.
Several things went wrong from the Kremlin’s perspective, and the strongest reactions came from the financial sector. As many Russians realized something was not going as planned and months of unrest were likely ahead, they grabbed all kinds of consumer goods. The run on supermarkets and durable goods in general, fueled by the sharp increase in the supply of rubles recorded in the last quarter of 2021, has led to a spike in consumer prices.
In mid-March 2022, annual inflation was around 15%, but stood at a weekly rate of just under 2%. At the same time, those who could tried to swap their cash and ruble-denominated assets for dollars and euros. The result was a rapid depreciation of the rouble, from around 85 rubles per euro in early February to around 150 rubles per euro on March 10.
Russia blamed the West for the falling ruble exchange rate.
Naturally, the Russian authorities blamed the West for the falling ruble exchange rate and depreciation for inflation. At the same time, they responded by imposing capital controls, restricting convertibility, offering more rubles to support bank liquidity, and raising interest rates on ruble deposits.
Shortly after, they also announced that in future Moscow would honor its debts denominated in euros and dollars, but would ask “hostile countries” to pay for their energy imports in rubles. Some have dubbed this policy the “Ruble Clause”.
The authorities can now boast that the ruble has stabilized. In early April, one euro was worth 85 rubles, marking a slightly stronger exchange rate than before the start of the war. Western traders may not be too interested in Russian monetary policy. But what about the ruble clause? Is it little more than a flash in the pan without much practical relevance, or should we take it more seriously?
Requiring payments in rubles is hardly a game-changer on the international scene. Perhaps this is an attempt to turn the ruble into an international means of payment. If so, the move is premature, to say the least. Current efforts to polish the ruble’s image are more likely to be driven more by domestic issues than by ambitions to play a bigger role in the international money market.
The presence of a ruble clause for Russian energy exports means that importers have to buy rubles to pay Russian exporters. Since there are currently limited amounts of rubles available in the foreign currency markets, the main way to obtain them is to buy them from the Russian central bank at a price (the exchange rate) set by the central bank.
In the end, therefore, “unfriendly” Western importers will always pay for their imports in dollars or euros, but their counterpart will be the central bank, rather than the exporting companies. Does it make a difference? The answer depends on the pricing mechanism, which leads to the second comment.
Facts and figures
Ruble-euro exchange rate
February-early April 2022
Energy contracts are generally denominated in dollars and euros. There are good reasons for this. In a world characterized by globalized transactions, the relative price of energy, ie the price of energy compared to all other goods and services, depends on supply and demand. The manipulation of exchange rates does not cause much distortion.
For example, French nuclear energy exporters or Saudi oil producers can hardly change the nature of a contract by manipulating the euro or dollar exchange rate after the contract is signed. This explains why the dollar and the euro are successful international currencies.
But things would be different if the Russian central bank restricted the full convertibility of the ruble (for example by controlling capital flows), or if the ruble’s exchange rate was strongly influenced by the price of a limited number of goods or raw materials (such as gas and oil). It can perhaps be said that buyers could eliminate currency risk by buying rubles on the futures market, that is, by agreeing today on the price at which rubles will be bought and sold at the future. In turn, the presence of a thriving exchange rate derivatives market would encourage traders to hoard rubles to meet the demand of speculators.
If this were to happen, the ruble would gradually acquire the role of international currency and the Russian central bank would reap the benefits of seigniorage: selling rubles at no cost (apart from the cost of printing). Is it realistic? Can the Russians take advantage of the free ride of seigniorage by introducing a ruble clause? The answer is no. Seigniorage is not up for grabs. This is the reward for a reputation for convertibility and relative stability. The Russian central bank lacks both.
If Moscow tried to enforce such a clause, it would signal its decision to default on Russian debts denominated in dollars and euros.
The situation would be different if the proposed shift to ruble-only payments applied to previously agreed dollar/euro-denominated contracts that now have to be honored in rubles at an exchange rate dictated by the Russian central bank. This would clearly amount to a breach of contract. Insisting on such a change would be a self-inflicted blow: it would weaken Russian operators as commercial counterparts and likely hurt the Russian economy more than the sanctions currently in place.
In other words, if Moscow tried to enforce such a clause, it would signal its decision to default on Russian debts denominated in dollars and euros, at least on those held by “hostile countries”.
Getting around the sanctions
If the ultimate goal is to avoid default, the reasons for requesting ruble-denominated payments must lie elsewhere. There are two plausible answers.
One is introverted. The Russian authorities need large quantities of accepted means of payment (gold, dollars and euros) to circumvent the Western financial blockade. As mentioned above, bypassing the blockade is possible (perhaps via Asian and Latin American countries), but it won’t come cheap.
The ruble clause would exclude energy companies from the payment system and help those dollars get to Moscow.
Therefore, President Putin must ensure that all foreign currency earnings from energy exports reach the Russian central bank, rather than remain parked in opaque shell companies and Western bank accounts. The ruble clause would exclude energy companies from the payment system and help those dollars get to Moscow.
The second answer concerns the possible creation of a hard ruble, based on commodities, as opposed to its current status as fiat money (paper money). A “hard rouble” might be the best way to boost Russia’s prestige, kill inflation and meet Russian expectations for a stable currency, much like what happened in Soviet Russia, when Lenin introduced gold-backed “chervonets” in October 1922.
Is this a feasible project? Could oil or gas replace gold as a commodity standard? Could this pave the way for other commodity-based currencies, like the Chinese Yuan?
The response is mixed. A hard ruble would probably be a partial national success, but only if it were really hard – gold coins that individuals can hold and possibly hide. Liquid rubles – certificates (paper money) backed by oil and gas – will not suffice because people would not trust a commitment to convert paper into gold, let alone gas or oil. Yet the liquid ruble could be the benchmark for a monetary standard similar to a currency board, a corset that would prevent the central bank from pursuing discretionary monetary policy.
It is doubtful that monetary rigor is Moscow’s objective. Of course, the lack of confidence in convertibility would dissolve if Russia’s gold reserves were parked outside of Russia. However, the Kremlin would never consider this option. The same would be true for Beijing. Indeed, one can conclude that the recent international tensions have probably also killed all large-scale projects for a golden yuan.