Why is Russia deliberately weakening its currency?

On August 5th, Russia's Ministry of Finance announced it would boost its daily purchases of foreign currencies and gold by about 20%, raising the rate from 5.4bn roubles in July to 6.5bn roubles. This move led to the rouble's value dropping against the dollar, falling from around 80 to over 85 by the middle of the month, its lowest level since March.

A robust currency typically entails cheaper imports, lower inflation, and reduced strain on interest rates; conversely, a weaker currency triggers the opposite effect. Russian citizens are acutely aware that a swift plunge can spark financial panic, as evident after Russia's invasion of Ukraine in February 2022, when Western nations imposed sanctions.

In just two weeks, the rouble's value plummeted by two-fifths against the dollar. People rushed to acquire foreign currency and withdrew cash from banks, many of which they spent on consumer goods.

However, a strong rouble has become a burden in recent times, particularly for the federal budget. In the first half of the year, the average exchange rate stood at 77 to the dollar, whereas the budget had anticipated a rate of 92. This discrepancy is significant because Russian oil exporters—mainly state-owned or otherwise associated with the government—receive their income in dollars.

Consequently, their earnings translate into fewer roubles than previously projected. Oil and gas account for 20% of budget revenue. Although the Gulf war has disrupted global oil distribution, resulting in higher oil prices, the government's oil price assumption for tax calculations has remained stable at $68 per barrel, up from the $59 expected in the budget.

Despite this, oil and gas revenue, totaling 3.7trn roubles, was 23% less than a year ago. The first-half deficit alone amounted to 5.7trn roubles, or 2.5% of annual GDP, exceeding the projected 3.8trn (1.6%) for the entire year. To combat a persistently strong rouble, the government is seeking additional revenue sources. The Russian parliament has authorized the finance ministry to increase borrowing beyond the statutory limit without further approval.

Additionally, the government has been requesting voluntary contributions from Russian businessmen, including funds to aid in financing the war against Ukraine. This initiative originated from a private meeting in March with Russian President Vladimir Putin, discussing a windfall tax on past profits. Since the beginning of the year, well-intentioned business leaders have contributed 384bn roubles.

While a weaker rouble may temporarily alleviate Russia's budgetary pressures, it carries the usual drawbacks in the long term, such as higher inflation, more expensive imports, and lower real household incomes. Inflation has already risen to 6% in June, partly due to a petrol shortage caused by Ukrainian strikes on Russian oil infrastructure. Nevertheless, a weaker rouble could exacerbate these issues.