Explained: Putin’s demand for trade in rubles, and how it could work

Predictably, in the immediate aftermath of this announcement, prices of both natural gas and its substitute crude oil spiked.

Why did Putin do this?

The move to accept payments only in rubles has been done to increase the demand for rubles in the international market.

The ruble had been weakening against the dollar in the weeks before Russia invaded Ukraine. It went from being around 75-to-a-dollar to around 85-to-a-dollar [meaning 10 more rubles were required to buy a single dollar in the international market] between the start of 2022 and Russia’s invasion of Ukraine on February 24.

However, after the invasion, the ruble’s value plummeted to almost 145 within a fortnight. Apart from chasing away every investor for obvious reasons of war and uncertainty, the key factor that punished the Russian currency was the set of sweeping sanctions that Western countries applied on Russia.

People walk past a currency exchange office screen displaying the exchange rates of US Dollar and Euro to Russian Rubles in Moscow’s downtown, Russia, Tuesday, March 29, 2022. (AP Photo)

There were two essential aspects to these sanctions. One, they banned most exports, from luxury goods to military goods, out of Russia. Russian flights were banned over the US, UK, EU and Canadian airspace. Two, Russia was slapped with crushing financial sanctions. Russian banks were banned from the Society for Worldwide Interbank Financial Telecommunication or SWIFT mechanism, which enables banks around the world to move money quickly and securely. SWIFT is dominated by US and European banks.

The Russian central bank — the equivalent of India’s RBI — was not spared either. Its foreign-currency assets, worth $630 billion (or over Rs 48 trillion), were frozen.

The net result of these sanctions was a collapse of trade and trading mechanisms. This, in turn, resulted in a collapse of the ruble’s exchange rate because no one wants to hold the currency of a country one can’t trade with.

With this decision, Putin wanted to reverse the tide and create a demand for rubles.

Exchange rate: value of USD in rubles

Will it help the ruble?

On Tuesday, the ruble had recovered to 85-to-a-dollar. That’s because the EU cannot reduce its dependence on energy imports from Russia overnight. To be sure, as the Wall Street Journal reported, even before this decision “Russia has already asked its companies that take payment in dollars and euros to swap 80% of their revenue into rubles”.

While this, too, was a way to create demand for the ruble, the onus was on Russian firms. Under the new diktat, the onus to demand rubles is on the importing countries.

How will European companies get rubles, if they are to comply with Putin’s demand?

Thanks to the sanctions, Russian firms no longer have any use for the dollar or the euro. As such, European firms will now have to find intermediaries — those that accept dollars and euros, convert them to rubles, and give them to the Europeans so that they can pay for the natural gas imports.

The key question is: If direct dollar/euro to ruble exchange is not possible, then which currency would be used as an intermediary? The most likely answer is the Chinese yuan. In such a scenario, dollars/euros will be exchanged for yuan and that, in turn, will be exchanged for rubles.

Could Putin’s decision be counter-productive for Russia? What are the wider ramifications?

As far as the immediate impact is concerned, tracked by the dollar ruble exchange rate, the move could be seen as a masterstroke. But there are severe adverse long-term consequences for Russia as well.

For one, the west sees this move by Russia as a breach of contract. While it, in particular Europe, may not be able to react straightaway owing to the energy dependence on Russia, this move has already triggered the west to find alternatives. These could be both in terms of other forms of energy — say coal or renewable — and other energy producers, for example, Saudi Arabia.

The fact is, Europe’s current dependence on energy imports from Russia works both ways because the earnings from the same energy exports are what fuel the Russian economy. If neighbouring Europe finds alternatives, even if that doesn’t happen in a hurry, it would also hurt Russia eventually.

There is another fallout, which could hurt the US and undermine the dominance of the dollar as the go-to currency across the world. If the Chinese yuan replaces the dollar in trade with Russia — and typically daily trades would be worth billions of dollars — then it would lead to “de-dollarisation” (a term that implies the global financial system’s reduced reliance on the dollar).

How is India affected?

Anindya Banerjee, Vice President, Currency Derivatives & Interest Rate Derivatives at Kotak Securities Ltd says that India’s crude oil imports from Russia have significantly increased over the past month. That’s because the Russian crude oil (Urals) is available at a deep discount to both the Brent and the West Texas Intermediate (WTI).

According to Banerjee, a rupee-ruble trade that is reported to be under consideration will essentially be benchmarked to the Chinese yuan. Benchmarking to yuan, instead of the dollar, would imply that instead of talking about oil prices in dollars per barrel, the price quoted would be in terms of yuan.

India used to have rupee-ruble direct trade since the early 1950s but at that time the exchange rate was not market-determined. Over time, Indian government incentives to exporters were linked to trade that happened in so-called “free” currencies — or the currencies whose value is determined freely by the market.

Since the ruble was not part of such currencies, exporters avoided such trade. Eventually, the direct rupee ruble trade was formally scrapped in 2005.

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