While we in India, like all other net oil importing nations, are celebrating the fall in the crude oil prices; the sentiment is quite the reverse for the net oil exporting nations. It is rightly said that for someone to win, someone has to lose. The prime example of this and of yet another country, after US and Europe, finding itself at the brink of an economic meltdown is – Russia.
Vladimir Putin today finds himself fighting two battles. He is not only at war with Ukraine, but also internally fighting hard to keep Russian economy at bay from slipping into a stagflation, which is seeming inevitable. The Russian ruble has plummeted against the US dollar, the reserves are falling, interest rates are rising and the inflation is soaring. The country is facing one of its worst financial crisis since 1998, the time when the government defaulted on its debt.
So, what is causing all these problems for Russia ?
Root cause can be pinned down to two primary factors:
1. The falling global crude oil prices.
2. The sanctions imposed by the western countries on Russia.
Oil is the backbone of the Russian economy. Almost 50% of the state’s revenue is derived from oil and gas exports and about a quarter of the country’s GDP is linked to energy industry. Thus, a free-fall of the oil prices is bound to hurt the economy. The 40% drop in oil prices from over $100 US Dollar/barrel in June, 2014 to under $60 USD/ barrel in December, 2014, is estimated to have resulted in $100 billion loss of revenue to Russia (CNN estimates).
The other prime reason is the economic sanctions imposed by the west, as a result of Russia’s incursions into Ukraine and Crimea. Economic Sanctions are the domestic penalties applied by one country on another country. Economic sanctions may include various forms of trade barriers and restrictions on financial transactions (source: Wikipedia).
The result of this is that the ruble has lost about 45% of its value against the US dollar so far this year. It even hit an unprecedented low of 80 ruble to the US Dollar.
Enter the Government:
The falling ruble saw the Russian Central Bank pressing the panic button and increasing the interest rate by 6.5 percentage points, the single largest interest rate increase since the 1998 crisis. As a result, the interest rate moved from 10.5% to 17%.
The idea behind increasing the interest rate was to discourage the wave of Russians swapping the rubles for dollars and other less volatile assets. In theory, higher interest rate makes the currency an attractive investment and thus encourages people to keep money as deposit in the bank.
In addition to the emergency rate hike, the government is also estimated to have spent around $87 Bn of its foreign exchange reserves in open market. The action was aimed at preventing the collapse in the ruble and to stabilize the exchange rate. The total international currency reserves now stands at $416 billion.
Unfortunately, both the measures have failed to produce the desired result and the confidence of the people in the ruble and the economy is declining by the day.
The problem doesn’t stop here for Mr. Putin. Lets have a look at how deep in trouble the Russian economy really is.
1. Inflation: The inflation target of the central bank was 5% and currently it stands close to 9.5%. Food price inflation touched 12.6% in November, 2014. This is fueled further by Russian ban on food imports in retaliation to western sanctions.
2. Capital Flight: According to the central bank, the net capital outflows is estimated at $130 Bn for this year and another $120 Bn by the next year.
3. Fall in GDP: A year ago, Russian economy was growing by about 1.5%. Its central bank is now forecasting a 4.5% drop in GDP in 2015, if the price of oil stays at $60/barrel.
4. Debt Burden: The Russian government, bank and companies have a combined foreign currency debt of around $678 billion. Out of that, $130 billion will have to be repaid this year. The total corporate debt, which is falling due next year, is about $76 billion. The corporates’ foreign currency debts are quickly becoming unsustainable with falling ruble. Companies have already started approaching the central bank for bail-outs. In times to come, more corporate defaults are likely.
All these factors have crippled the Russian economy and are forcing it into stagflation [contracting economy (due to falling oil prices and rising interest rate) + high inflation].
In the light of all these, the downgrade to junk status by S&P seems like a distinct possibility. This will further add to the woes of Mr. Putin who is facing an uphill climb. Before yet another domino is set into motion, sending shock waves to other economies of world, one can only hope that Kremlin gets its acts together and does it fast. But one thing is for sure, New Year 2015 doesn’t seem very happy for the people of Russia at the moment.
Financial Fudge 