Over the course of the 20th and 21st century, various economic crises have arisen and have been crucial in our learning and understanding of the applicability of economic theories and policies in the real world. The Russian Financial Crisis is an example of a prominent economic and political issue that has resulted in many debates across the world. In this paper, I will be attempting to interpret the causes and consequences of the crisis. This paper explores some of the policies that were implemented in the wake of the crisis. In addition to analysing effectiveness of these policies, I will also be including some of my own personal policy suggestions which I believe might work to reduce the impact of the crisis in the long run.
Keywords: Crude Oil, Economic Sanctions, Inflation, Rubble Devaluation
Summarised Overview of the Russian Crisis
One of the major events that characterized the happenings of the world from 2014 to 2015 was the Russian Financial Crisis. It was fuelled by economic and political adversities and was a major event that almost lead to the brink of another cold war. One major phenomenon that was a consequence of this crisis was a rapid devaluation of the Russian rubble. This lead to a downward spiral that increased inflation and impacted people’s standards of living and real wages. The policies implemented to tackle these crises has been debated upon by one and all, and it has been commonly established that Russia did not have the right approach to reducing the impact of the crisis. Although 5 years have passed since the crisis, Russia has only recently entered recovery mode. In this paper, I aim to explain the causes and consequences of the Russian financial crisis and analyse the policy solutions for the same.
Causes
Decrease in Price of Crude Oil
One of the main reasons for the devaluation of Russian rubble is the drastic decrease in prices of crude oil. Crude oil is one of the major exports of Russia. It makes up 30% of Russia’s GDP and 60% of Russia’s export revenue depends on crude oil (Tracey, 2018).
Table 1
The Average Price of Crude Oil Per Barrel in US Dollars from March 2014 to March 2015
| Month | Price of Crude Oil Per Barrel in US Dollars |
| March 2014 | 103.21 |
| April 2014 | 99.49 |
| May 2014 | 99.41 |
| June 2014 | 102.38 |
| July 2014 | 104.16 |
| August 2014 | 97.47 |
| September 2014 | 92.99 |
| October 2014 | 91.31 |
| November 2014 | 78.37 |
| December 2014 | 69.35 |
| January 2015 | 52.59 |
| February 2015 | 49.76 |
| March 2015 | 49.83 |
Note. Data fromBusiness Insider
From the above table, it can be seen that from March 2014 to March 2015, the prices of crude oil reduced drastically from 103.21 USD per barrel to 49.83 USD per barrel. This is a significant reduction as the price of crude oil in March 2015 was almost half of that in March 2014. This reduction in prices was caused by a decrease in demand for crude oil. This decrease can be attributed 2 reasons.
Firstly, economies that experienced rapid growth previously, such as China, India and Russia were facing an economic slowdown in 2014. Due to lowered production and output levels, the demand for crude oil, which is a major factor of production in many industries, decreased (E.L, 2014).
Secondly, countries such as the U.S and Canada, which majorly imported crude oil from Russia, pursued new methods to increase the production of oil through processes such as fracking. These production processes resulted in increase in production of oil substitutes such as shale-based oil and natural gas within their countries and they did not demand as much crude oil as before as they were more self- sufficient (Kuepper, 2019).
Imposition of Economic Sanctions
Another reason for Russia’s financial crisis is the economic sanctions imposed on Russia by other nations. Russia’s intervention in Ukraine and annexation of Crimea was condemned by nations across the world. Hence, within a week of the invasion, economic sanctions were imposed on Russia by countries such as the US and Canada. These sanctions have been in the form of travel bans, freezing of US assets and arms embargo, which is a case in which the import and export of military machinery and weaponry into and out of Russia were banned (Kottasova, 2015). The sanctions were drastically strengthened when Russian anti-air artillery shot down Malaysian Airlines flight, MH-17, killing all on-board (Kuchins, 2015). There were 2 main consequences of the sanctions and Russia’s retaliation which will be elaborated in the later section.
Consequences
Plunging of Russian Rubble
One of the key consequences fuelled by the causes stated above is the plunging of the Russian rubble.
Russia’s exchange rate policy was a combination of fixed exchange rate and floating exchange rate where a currency band was fixed in an agreement between The Central Bank of the Russian Federation, World Bank and International Monetary Fund. The currency band is a situation in which the currency can float between a set price floor and price ceiling. As Russia’s economy experienced a boom, in order to fund the rapid growth, Russia acquired many international loans. The currency band was put in place as an assurance and guarantee that Russia was able to pay back these loans. It is important to note that Russia earned in rubbles but paid back in other currencies.
However, even after the loans were repaid, this currency band mechanism was maintained since many businesses had taken out loans from other countries and a stable exchange rate needed to be maintained so as to ensure that these organizations were able to repay their loans.
Yet, over time, the difference between the real value and official value of the Russian rubble increased significantly. However, in order to maintain the currency band, Russia purchased and sold huge amounts of currency, which was funded by wealth accumulated from the sale of crude oil.
However, it was difficult and costly to maintain the currency band as funds decreased. Hence, The Central Bank of the Russian Federation discontinued the currency band mechanism and adopted a floating exchange rate mechanism.
In 2014, with a decrease in demand for crude oil, Russia’s export revenue decreased drastically, and therefore, its trade balance decreased. Investors started losing confidence in the Russian economy and an outflow of capital followed. Since investments decreased, there all lesser demand for the Russian rubble and hence, devaluation of the currency followed.
Furthermore, as result of the economic sanctions imposed on Russia, in order to prevent Russian companies to experience a rolling over debt, which is a scenario in which an additional fee is paid due to the extension of a loan’s repayment date, Russian corporations had to exchange their currency for that of other countries (foreign exchange reserve) in order to fund the interest rates of their debt. This lead to a decrease in demand for the Russian rubble hence resulting in its devaluation (Tracey, 2018).
Hence, as 2014 progressed the Russian rubble plunged. The devaluation over the course of the later part of 2014 and beginning of 2015 can be seen in the table below (“USDRUB:CUR”, n.d.).
Table 2
The Average Exchange Rate of Rubbles per US Dollar from July 2014 to January 2015
| Month | Rubbles per US Dollar |
| July 2014 | 35.13 |
| August 2014 | 36.19 |
| September 2014 | 38.43 |
| October 2014 | 40.65 |
| November 2014 | 47.31 |
| December 2014 | 58.61 |
| January 2015 | 65.30 |
Note. Data fromBloomberg
Inflation
As a retaliation to the sanctions imposed on them, Russia banned imports from countries that imposed sanctions on Russia or their allies. This lead to a drastic reduction in imports which resulted in a sudden drop in the standard of living and real wages. This is because a large percentage of Russian imports consist of food products. With a sudden embargo on imports, there was a shortage of food which resulted in rapid increases in the price of food. Coupled with the drastic decrease of crude oil prices and devaluation of Russian rubble which has led to an increase in prices of commodities and imports, inflation shot up in Russia. The annual inflation steeply increased from 6.5% in late 2014 to 11.4% by the end of 2014 (“Russia annual inflation”, 2014).
The increased devaluation of the Russian rubble and inflation has led to a decrease in aggregate demand in the economy.
Policy Consequences
Increase in Interest Rates to Tackle Inflation
Russia’s immediate response was to hike up interest rates to 17.5% from the previous rate of 10.5% (Monaghan, 2014). With a sudden rise in interest rate, investors were discouraged to invest in Russia and hence, investments decreased. With a fall in investments, the planned expenditure, which captures the demand side, decreased. Hence, liquidity is squeezed out from the market and therefore, there was a fall in economic growth and output. This translates to decreased production in the Russian economy and hence, unemployment increased as lesser workers were required. Consequently, income decreased and this led to a fall in purchasing power. Hence, consumption fell and as a result, inflation decreased.
Spending of Foreign Exchange Reserve to Tackle Rubble Devaluation
Furthermore, the Russian government also spent a large amount of its foreign exchange reserves as they increased the limit till which reserves can be used up from 500 million rubbles to 3.5 trillion rubbles (Tracey, 2018). By spending more foreign reserves, the amount of foreign currency in the market appreciated and hence, its value depreciated. Consequently, the value of Russian rubble appreciated. Therefore, this prevented the Russian rubble from devaluating. The revaluation of the rubble that occurred in the beginning of 2015 can be seen from the data below:
Table 3
The Average Exchange Rate of Rubbles per US Dollar from January 2015 to May 2015
| Month | Rubbles per US Dollar |
| January 2015 | 65.30 |
| February 2015 | 62.06 |
| March 2015 | 59.29 |
| April 2015 | 51.96 |
| May 2015 | 49.53 |
Note. Data fromBloomberg
Conversion to Free Float Exchange Mechanism to Achieve Stability in Income
By converting to the free float mechanism, Russia was also able to increase the amount of revenue it received from the sale of crude oil to almost twice as much as it would receive if it has maintained the currency band mechanism (Kuchins, 2015). This ensured that Russia had a stable source of income. In addition, OPEC (Organization of the Petroleum Exporting Countries) engaged in production cuts which meant that the demand for crude oil increased since crude oil is a substitute of petroleum (Kuchins, 2015).
Criticisms and Other Policy Suggestions
Although in the short run, these policies worked to improve the state of Russian’s economic conditions, they were not entirely successful in improving Russia’s situation. Russia was stuck in a loop of trying to maintain its exchange rate, reduce inflation and promote economic growth. The effects of these policies contradicted with each other. It is also an aspect of the impossible trinity. This is a situation in which out of 3 scenarios (exchange-rate maintenance, capital mobility and free monetary policy), only 2 can be maintained.
Furthermore, there is a cost occurred from the increase of interest rates as it is a case in which the sacrifice-ratio comes into play whereby in the course of pursuing decreased inflation, Russia sacrificed its economic growth and output.
Hence, a more ideal solution in the long run would be to tackle the causes of the devaluation of Russian rubble in the first place. Since crude oil is extremely prone to price fluctuations, it would be more suitable if Russia looked for alternative sources of income rather than completely relying on crude oil. In the years to come, with people becoming more environmentally conscious, it is natural to expect an increase in demand for alternate energy sources that are cleaner. In such a case, the demand for crude oil will decrease and hence, a repetition of this crisis is inevitable. Hence, it is healthier for Russia’s economy in the long run if they sought out other methods to earn income.
Conclusion
It has been 5 years since Russia’ downfall into a financial crisis. Its current economy is in recovery mode and as the policies and changes that were implemented from 2014-2015 are slowly taking shape. However, it is important to note that the causes of these financial crisis are not just one-time situations and history has the potential to repeat itself. With ongoing political tensions across the world and an increasing preference for cleaner fuels, Russia should be well prepared to face another crisis of a similar nature. If Russia’s intention is to avoid these types of crises entirely, it should look into more stable sources of income and work on building long term safety nets for its economy.
References
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