Events in Ukraine and the associated sanctions have started to bite. And Russian asset prices continue to get hammered. It’s difficult to find worse-performing equity markets anywhere this year, while the rouble now sits alongside the Argentine peso and Ukraine’s hryvnia as one of the world’s top basket-case currencies.  

Last week the rouble plunged new depths through the lower bound of its exchange rate corridor on reports that capital controls were on their way. The Central Bank of Russia (CBR) refuted the suggestions, subsequently launching an investigation amid allegations of “market manipulation”. Moscow–based economists were quick to back the CBR’s assertion, arguing that the story was likely to remain far from the truth for as long as the Bank’s current leadership, in particular Governor Elvira Nabiullina, is in office. And Putin echoed the CBR position, stating that Russia was not planning any capital controls.  

We don’t doubt the desire of the CBR leadership to try to avoid capital controls, which have no place in its plans to modernise Russia’s monetary policy, with interest rates the preferred prime policy tool and exchange-rate management gradually phased out. And, like the general public, the CBR worries more about inflation than the rouble, with depreciation a major concern principally insofar as it increases prices of imported goods. Indeed, Nabiullina recently presented draft monetary policy guidelines for the coming three years, emphasising the central role of the inflation target and proposing that the rouble should float freely from next year. But that proposal now seems at best ironic, if not inflammatory, with the CBR forced into automatic large-scale forex market interventions ($350mn for every 5 kopecks of depreciation) to defend the rouble.

Indeed, despite the CBR’s continued selling of forex reserves, it is difficult to see why the market’s momentum will reverse. Russians know that the rouble is in trouble, and are not so naïve to think that their currency will start to strengthen again soon. Countless factors point in favour of further depreciation, not least the inability of Russian entities to borrow from international markets, recent marked falls in oil prices, and expectations of future US rate hikes. And the CBR’s struggle to defend the rouble simply highlights the incentives for capital flight. Recent government estimates that capital flight is likely to reach between $90-120bn this year look too conservative to us. The experience of the last five months of 2008 – when the initial unease in the wake of the Georgia conflict was exacerbated by the Lehman crisis to prompt a net private capital outflow of about $170bn – might provide a more reliable benchmark for what to expect this year.

To some extent too the experience of 2008 suggests how the authorities might respond to intensified pressure on the rouble this time around. In particular, we doubt that they will be too fearful of further steady rouble depreciation. After all, a weaker rouble would provide support for Russia’s trade and current account surpluses. It would also boost the domestic-currency value of energy revenues, giving a boost to the government’s budgetary position despite the weaker dollar oil price. So, a perhaps sizeable widening of the rouble’s fluctuation corridor – i.e. further significant depreciation – might be in order.

Moreover, while tens of billions of dollars might be required to help banks and corporations cope with foreign debt repayments over coming quarters, the current stock of forex reserves – in excess of $400bn – currently appears adequate to be able to manage the depreciation of the rouble in a relatively orderly way under the CBR’s intervention arrangements. We would not, however, be surprised to see the scale of automatic interventions reduced from the current amounts. And with the weaker exchange rate likely to push inflation several percentage points above this year’s 5% inflation target, we certainly expect further hikes in interest rates too.

But as ever with Russia, there are countless risks. What if capital flight accelerates to rates well beyond expectations to generate genuine unease about the adequacy of the CBR’s reserves? What if the rouble is completely irresponsive to interest rate hikes, and simply depreciates rapidly further beyond the CBR’s comfort zone fuelling a jump in inflation into double digits? And what if companies, already unable to borrow from international markets because of sanctions, struggle to meet debt repayments? And – perhaps most obviously – what if the geopolitical situation, which is well beyond the control of the CBR, further deteriorates?

You get the point. Under certain scenarios, capital controls might well – for some in policymaking circles – look to be an easy answer. Despite the familiar difficulties in designing and implementing them effectively, some economists and politicians are already advocating their use, even if one consequence would be a lasting impact on foreign investor sentiment for a long time after sanctions have been lifted.

For as long as Nabiullina’s team is in charge at the CBR, we see only a limited probability that (large-scale) capital controls will be introduced – a relatively orthodox policy response remains far more likely. But – particularly if events do not pan out as Russia’s leadership might hope – personnel might be replaced along with current policy. And so, despite the statements of recent days, capital controls remain possible.

So, keep an eye on how events unfold. Almost anything is possible. Russia’s never been boring. And it’s never been predictable. Or risk-free. And it probably never will.