Much has been written in the press recently about the collapse of the ruble and inflation soaring to 60% in Russia. Such claims appear exaggerated and, more importantly, neglect associated implications. For policy purposes, we are interested in devaluation and inflation as they affect the Kremlin's ability to finance its war and contain public discontent at home.
Analysts tend to focus on year-ago data, but Russia's pre-war position is the appropriate baseline. Before the war, the ruble was trading at 74 / USD. With the start of hostilities, oil prices soared and Russian consumer goods imports collapsed, leading to a 40% revaluation of the ruble. Over time, oil prices declined and Russia re-oriented its imports, leading the ruble to fall back to its pre-war level. That trend has continued, with the ruble today at 98 / USD, representing a devaluation of 25% since the start of the war. This is certainly significant, but not catastrophic under the circumstances.
Currencies can devalue for a number of reasons, for example, underlying terms of trade, comparative interest rates, or sanctions. Large devaluations, however, are often linked to loose monetary policy, that is, the government printing money to cover expenses. We can analyze this using the Quantity Theory of Money (QTM). Basically, QTM holds that, if a country doubles the currency in circulation, the price of goods will accordingly double (twice the money chasing an unchanged amount of goods), and the currency will devalue by half to hold the real exchange rate constant. (More here.) QTM has not been fashionable with economists recently but, nevertheless, remains a useful tool. For example, a QTM analysis of the Federal Reserve's pandemic monetary policy largely predicts the US inflation of the last three years.
The Russian Central Bank reports that Russian money in circulation rose from 15.2 trillion rubles in September 2022 to 17.9 trn rubles in June 2023, representing a money supply increase of 21% on an annualized basis. This is consistent with the 21% pace of devaluation in the same period. These in turn suggest Russian domestic inflation around 20%, rather than the Bank of Russia’s forecast of 5.0–6.5% for 2023. The Bank's surprise interest rate hike to 8.5% also suggests inflation at least in the high single digits. Thus, QTM analysis suggests fairly stiff, but not catastrophic, inflation in Russia for 2023.
We can also assess an increase in the money supply from the fiscal perspective. Based on the Sept.-June period, money in circulation in Russia has been rising at the pace of 3.6 trn rubles (cc $45 bn) per year. This is the equivalent of 2.4% of Russia's GDP. Put another way, the Russian government appears to be covering a budget deficit of 2.4% not through borrowing or fiscal adjustments, but rather by printing money. This implies Russia's net budget deficit is larger than reported. Again, the magnitude is not disastrous, but it does underscore the Russian government's cash hunger, about which I have written on several occasions.
Russian defense spending is running at twice budget levels, implying an additional 6 trn rubles in military spending anticipated for the second half of 2023. If this is covered by printing money, it would imply inflation moving towards 30% and an exchange rate of 110 rubles / USD by year-end, with devaluation continuing in 2024.
For Putin, money is tight, but the situation is not yet critical. Still, our analysis suggests that the Kremlin has precious little wiggle room, something which can be exploited by Ukraine and its allies.