The collapse in oil prices is destroying the Russian economy. As oil prices continue to plunge ever lower in the international market, it is bringing economic turmoil to the nations that are dependent on energy exports. Brent the international benchmark for crude, dropped an additional 0.7%. It has now dropped below $60.00 USD (United States Dollar) hitting a low of $59.62 USD. Oil in the United States is priced even lower. WTI (West Texas Intermediate) dropped 1.2% and is now selling for $55.24 USD.
Making matters worse for Russia, the President of the United States is about to sign legislation that will tighten sanctions on the country. The new restrictions will hit the weapons and energy sector of the Russia this time. The idea is to continue to increase the cost for the Russian interference in the Ukraine.
Russia’s currency the ruble, has been falling dramatically against the American dollar. The ruble has dropped from 35 to 1 USD to a low of 80 this week for a brief time. This has all happened in a matter of months and indicates over a 50% decline, for the currency of Russia.
The Central Bank of Russia in response has raised interest rates from 10.5% to 17% overnight, in an attempt to save the currency from collapsing. It was the steepest hike since 1998. In response the ruble plunged in a free fall of some 19%, as panic swept across Russian financial markets. The interest rate hike had failed to stem the hemorrhaging of the ruble.
Conversion rates to the USD hit a low of 80, before a rebound that was the result of Russian officials insisting that there would be no attempt to stop citizens, from converting rubles to dollars and Euros. However, many analysts feel that step is inevitable, as the only way to save the ruble. Currency controls in the long run, may well be the only way to stave off a full financial collapse in Russia. Demand for dollars are already 300% to 400% beyond their normal demand.
The Russian Stock Market also experienced major losses in stocks and bonds. The RTS (Russian Trading System) equity gauge dropped the most since 2008. It is true that it is experiencing some recovery today, moving from a low of 623.88 to over 700 again. Yet it is the lowest for the year to date, with the 52 week high at one time reaching 1,454.02.
Ten year ruble bond yields have spiked over 3 percentage points to new rate of 16.28%. Fears of eventual default are growing. This is evidenced by the climb in insurance rates against a debt default. These have risen to a high of 5.55%, the highest level since the financial panic of 2009.
Events in Russia indicate that the government there, is rapidly losing credibility in economic policy. The collapse in oil prices 49% to date over 6 months, is reducing the options that are available to President Vladimir Putin. His response so far is to signal that he is going to crack down on the massive corruption that exists, as a way of helping the situation. He is also discussing the idea of a further internal liberalization of the economy. While both of these objectives would be extremely helpful, they alone cannot undo the dire straits the Russian economy is now in.
The sell off in Russia is causing widespread concern elsewhere, as fears of a global slowdown mount. Increasingly international investors are looking for safer assets in North America and Europe. Emerging markets are continuing to lose their appeal.
Top currencies in emerging nations have fallen to their lowest rate since 2003. The Indonesian rupiah for example is at a 16 year low, prompting officials there to finally intervene to stem the decline. The diminution in markets has spread to the Persian Gulf as well. The United Arab Emirates and Saudi Arabia both have taken a hit. The same scenario is happening in Latin America and in the emerging markets in Europe that are outside the Euro-zone.
The contagion of declining confidence in equities and stocks by investors is continuing to spread. Concern among central bankers is heightening, as a result of further disconcerting news coming in from around the globe.
The fear in Russia is that the interest rate hikes and reassurances by government officials, will only temporarily stem the lack of confidence in the ruble. The Russian Central Bank had already intervened in October, with the equivalent of $30 billion USD. A hike in the interest rate during the same month failed to stem the decline. Last month, the Russian government was forced to abandon the policy of buying rubles whenever the currency dropped below a certain level.
The volatility in the ruble over the last few months is at it’s highest level since 2005.
At the beginning of this month, the Central Bank was selling $700 million USD in foreign exchange markets, as the price of oil started to collapse. Putin has been moving to punish currency speculators inside Russia, but this will do little to stops speculators outside the country. Indeed some currency brokers have abandoned the trade in the ruble, but this has not become widespread at this point. The ruble has already lost 14% of its value this week alone with a plunge of 27% for the month so far. This is the worst situation for the country, since the currency devaluation and government default that both occurred in 1998.
The plunge in the currency market was worsened by the cash infusion of major conglomerates in Russia by officials . A mostly nationalized oil company Rosneft for example, borrowed 625 billion rubles this month. The company is claiming it has no interest in converting this money into a western currency, but the loan is adding to the anxiety over the ruble. Money is being poured into the economy by the central bank in order to keep the credit market afloat inside Russia. Trillions of rubles are being injected into the system by a variety of methods.
Interest rates have risen 11.5 percentage points this year to date. It is not clear if further increases will save the ruble from further decline. A total of $80 billion USD has already been spent in the foreign exchange markets to prop up the ruble. Reserves are rapidly being drained. They are already at a 5 year low. An additional $60 billion USD has been spent, in propping up companies that are in need of dollar and Euro liquidity.
As Russia falls into recession the country is not being spared inflation. Prices are now rising rapidly and the official inflation rate is at a 3 year high. The increase is running at an even higher rate for everyday consumers. It is deemed possible that 30% of the cost of goods in Russia today, is due to various types of corruption. At the beginning of 2014, inflation for food was between the 5% to 6% range. By the summer it was over 9%. Now it is running in excess of 12.5% from 11.5% last month.
Stagflation (higher inflation and higher unemployment at the same time) is now setting in, caused by the the collapsing oil prices, sanctions, rising military expenditures, massive corruption and poor government directed economic policy.
Some analysts are already predicting that the economy in Russia may contract up to 5% or even higher, if oil prices do not rebound with Brent selling above $60.00 USD again.
Net cash flows are bleeding from Russia at an enormous rate. The amount may reach well over $130 billion USD, more than twice the sum from last year.
The question at this point is how will Russia finance its internal needs as well as meeting the foreign debt obligations of the country? The central governmental budget relies on oil income for 50% of it’s revenues. The money owed to outside creditors is between $675 and $680 billion USD. It was over $700 billion last year. Russia still has close to $375 billion in foreign reserves. However, it cannot continue to deplete these resources indefinitely. The national budget of Russia is depending on the price of Brent oil to be $96.00 USD. This is the only way that the 8 million barrels that Russia exports daily, will be sufficient to meet the needs of the government.
Foreign investment in Russia is drying up. Emerging market funds that were invested in corporate and bonds inside the country, have been particularly hard hit. The losses are escalating and many international investment houses are divesting their interests and assets in Russia.
Tuesday was a dark day for Russian monetary policy. Yesterday, the country did what was needed to stave off the impending collapse of the ruble. The country pledged another emergency $7 billion USD in reserves, to help support the currency. The government also continued to insist, that Russia will be more than able to meet all financial obligations. It is hoped that this will help calm fears. In addition, the Central Bank has promised more liquidity and a recapitalization of the banks if it becomes necessary. The ruble has responded somewhat to these actions, with a rebound of 12%. This brought the currency back to a ratio of 60 rubles to $1.00 USD from the previous rate of 70.
These steps although accommodating, will not solve the underlining problems now facing Russia. Eventually Russia will need to change course in foreign policy to get the sanctions lifted. The collapse in oil prices if it continues, will be more than enough of a problem to deal with by the leaders of the country. If not, the crisis will continue as the economy worsens and stagflation accelerates. Devaluation of the ruble and debt defaults under those circumstances, will then become much more likely. Very difficult times are ahead for Russia, under the present government preferences in politics, economics and foreign policy.