Russian policy makers are signaling they're prepared tosacrifice economic growth in order to stabilize the ruble.

Last week the Bank of Russia raised its benchmark interest rateby the most in 16 years and created a money-market cash squeeze,helping the ruble strengthen 45 percent from a record low on Dec.16. The consequence of this means the oil producer's economy mayshrink 7.9 percent in 2015, Danske Bank A/S said on Dec. 19,revising a view for a 1.8 percent contraction.

“We're seeing a serious monetary shock, especially next year,”Vladimir Miklashevsky, a strategist at Danske, said by phone thesame day. “What they've done is more serious for the economy thanfalling oil; it's a big negative factor.”

While the ruble's plunge may have halted for now, challenges aredeepening for the economy, which has been weakened by U.S. andEuropean sanctions over Ukraine. President Vladimir Putin toldRussians last week to brace for a recession as this year's 45percent drop in oil undermines the world's biggest energy exporter.If crude drops further, the ruble's hard-won stability may proveshort-lived, said Vladimir Vedeneev at Raiffeisen Capital inMoscow.

The ruble gained 6.3 percent to 55.08 per dollar at 6:24 p.m. inMoscow, after China offered Russia help with the suggestion ofwider currency swaps. It advanced 5 percent on Dec. 19,strengthening from a low of 80.1 on Dec. 16. One-day interbankdeposit rates dropped to 20 percent from 22.5 percent on Dec. 19.The Bank of Russia raised its rate 6.5 percentage points to 17percent on Dec. 16.

Higher interest rates and a weaker ruble are combining tosqueeze Russian companies and individuals as growth stalls. Theeconomy may shrink 4.5 percent in 2015 if oil stays at $60 perbarrel, the central bank said on Dec. 15.

The ruble lost as much as a fifth of its value on Dec. 16,blowing through that day's surprise rate increase and sparkingconcern that Russia would announce capital controls. It was onlywhen the higher rates led to a shortage of rubles that the currencybegan its rebound. The currency is still down 45 percent thisyear.

“The peak of the currency crisis is behind us as authoritieshave taken decisive and appropriate actions,” Bernd Berg, aLondon-based emerging-market strategist at Societe Generale SA,said in e-mailed comments Dec. 19. “There is still work to be doneand the ruble might remain very volatile in the short term. Overtime, volatility will calm down and the ruble steadily appreciateassuming stabilizing oil prices.”

Ruble Shorts

The ruble's drop this year has been aggravated by tradersbetting on central bank intervention to slow its decline. The cashsqueeze created last week “stopped local banks from shorting theruble” using funds previously obtained from central bank liquidityinjections, Danske's Miklashevsky said.

The success of Russia's support for the ruble depends on oilprices and the longevity of sanctions, according to Oleg Kouzmin,an economist at Renaissance Capital in Moscow.

“At the current oil price of $60 a barrel,” if sanctions aren'ttightened, the ruble might average around 50 in the mid-term,Kouzmin said by e-mail Dec. 19. If there's a “massive run on thecurrency among the population,” the ruble might “move to levelsthat are difficult to quantify,” he said.

Brent crude has rebounded 3.6 percent from a low of $58.50 abarrel on Dec. 16, trading at $60.63 today. This year's slumpaccelerated after the Organization of Petroleum Exporting Countriesheld its output target. Russia gets about half of its budgetrevenue from oil and gas.

Crude may fall to $50 in the medium term, which would imply theruble dropping to between 70 and 75 to the dollar, Vedeneev, chiefinvestment officer of Raiffeisen, said Dec. 19.

Policy makers made it “more expensive to play against theruble,” Aleksei Belkin, who helps manage about $4 billion atKapital Asset Management LLC, said by e-mail from Moscow on Dec.19. “It's a bit too soon to judge the effectiveness, as it isnatural for buyers and sellers to back off on the days followingsuch massive moves.”

–With assistance from Vladimir Kuznetsov in Moscow.

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