Thread: Russia: Facing a Massive Economic Crash

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Fred

Stratfor:

Russia: Facing a Massive Economic Crash

January 22, 2009 | 1743 GMT

Summary
Russian currency reserves dropped $30.3 billion in the week ending Jan. 17, according to new economic data. Though Russia so far has done a respectable job of mitigating the effects of the global financial crisis, it now faces the specter of a currency crash.

Analysis
According to data released Jan. 22 by the Central Bank of the Russian Federation, Russian currency reserves dropped by $30.3 billion in the week ending Jan. 17, a decline of roughly 9 percent. While the Russian economy may have entered the current global recession in a better position than most, it is now staring down the maw of a massive crash.

When the global recession began biting in earnest in mid- to late 2008, Russia was the most stable it has been in generations. High energy and grain prices combined with strict state controls on spending had created reserve funds of approximately $750 billion. But Russia’s economy is neither diversified nor dynamic, and the underdeveloped Russian banking system was wholly dependent upon access to foreign capital markets to function. Between Russian disregard for the rule of law regarding foreign and domestic investments, its August 2008 invasion of Georgia and the plunge in global energy prices, investors of all types have pulled their money out of the country. Even the country’s once-mighty oligarchs have found their holdings eviscerated by the flows, and the government has been working overtime to use its coffers to prevent a meltdown.

In that, Moscow has done a respectable job. The Russian government aggressively bought out the banks’ exposure to foreign markets. This protects the banks from currency risk, and gives them credit lifelines to replace now-disinterested foreigners. It also de facto nationalizes decision-making for the entire financial industry. Russia is even having to pay out for guarantees it has made on interbank lending; to our knowledge, it is the only country in the world to have a financial system in such poor shape.

Targeted bailouts have extended beyond the banks to other major sectors of critical importance to the Kremlin’s long-term plans of making Russia the world’s primary commodity provider, propping up metals, refining and energy firms as well. Other reserve funds have been tapped to pay for the budget which has flipped within four months from a surplus the likes of which developing countries have never seen to a deficit that would even grab Zimbabwe’s attention (briefly).

But all this costs money. A lot of money. Plugging the deficit hole alone is now estimated to cost $120 billion.

And in the background, investors of all stripes — including both the oligarchs and the controllers of state companies, as well as your average Russian citizen — have been voting with their money, moving resources out of Russia generally and out of the ruble specifically.

One of the great latent Russian fears is that of the 1998 ruble crash, in which all of the hopes and dreams of the post-Soviet period were brutally and with finality crushed. Russia overnight turned from a country with a recent memory of absolute strength to despair and destitution. Russian Prime Minister Vladimir Putin’s primary achievement in the Russian mind is dragging Russia out of that despair and making Russians feel secure and strong again. Avoiding another ruble crash is thus very near the top — if not at the top — of Putin’s to-do list.

But that may well be unavoidable at this point.

At first, the government strategy was aggressively to defend the ruble, selling currency reserves to buy up the rubles that no one wanted. But once it realized it was spending roughly $6 billion a week — twice the amount a day that the United States spent on the Iraq war — Moscow realized that it needed to change track. And so the government — via the Central Bank of the Russian Federation — has allowed the narrow band that the ruble is allowed to trade in every day to slowly widen, and numerous small devaluations have taken place. The ruble has dropped about 40 percent from its peak just before the war with Georgia, and in the past two weeks it has dropped by an average of 1 percent per day.

Putin is hoping that continuing with the policy of steady, small devaluations will eventually deliver ruble to a value that the market agrees with, but the strategy of having a controlled devaluation in a series of small steps is failing. The big drop in reserves last week — the $30.3 billion mentioned earlier — was split between $18.3 billion for bank bailouts and $12.0 billion for currency defense. That’s double the weekly cost of just one month ago. Put simply, the cost of defending the ruble has increased even though the government is allowing the ruble to fall faster. Russia still has a fair amount of cash — $396.2 billion in currency reserves alone — but it simply cannot continue to burn cash at these rates.

The Kremlin must make the tough choice between its increasingly costly rearguard defense of the ruble, which could land it with no reserves and a ruble crash later, or between simply walking away now. The crash would be just as hard, maybe even harder, but at least Russia would still have a few hundred billion in reserves to deal with the aftermath. At present, it appears the Russians are opting for the latter option. At the time of this posting, Sergei Ignatiev, the head of the Central Bank of the Russian Federation — and Finance Minister Alexei Kudrin’s right-hand man — announced that Moscow is “finished protecting” the ruble.

The one bright spot in all of this is that some aspects of Russia’s lack of economic development and sophistication actually work in its favor. A new ruble crash would still be very painful, sending inflation through the roof and destroying what savings have been clawed back in the past decade, but Russia’s is not a free-market system. Its internal stability is based on control, not the free flow of capital. Its foreign policy is based on energy leverage, military might and a terrifyingly competent intelligence capability — not economic strength. Russia’s primary income sources — oil, natural gas, metals, weapons — are all dollar-denominated despite years of rhetoric talking up the ruble as a superior currency. And a ruble crash could actually be a breath of life to Russia’s manufacturing industry, assuming that the riptide of capital leaving the country does not leave the sector destitute.

So while a ruble crash would destroy some of Russia’s more esoteric dreams — becoming a global financial hub, for example — it would not adversely impact its ability to project power in its immediate neighborhood. Still, that is small comfort for a government and its people who thought Russia finally had “made it.”

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Russia: Letting the Ruble Drop

January 22, 2009 | 1945 GMT

Summary
The Bank of Russia has announced that it is finished with its gradual devaluation of the Russian ruble. The move represents a bid to maintain Moscow’s ability to act as a strong country beyond its financial system.

Analysis
The Bank of Russia announced Jan. 22 that it is “finished” with its gradual devaluation of the Russian ruble, and will now allow “market factors” to guide the rate. The announcement comes after Russia’s central bank said that the country’s currency reserves had dropped 9 percent within a week, with ruble dropping 40 percent since August 2008. Russia has widened the country’s currency trading band 20 times since mid-November 2008, and the ruble has been steadily declining an average of 1 percent a day for the past two weeks.

Also since November, the Russian government has been spending approximately $6 billion a week from its large currency reserves in defending the ruble, a figure that has doubled in the past week. Stratfor had first heard rumors in early December 2008 that the Kremlin could allow the ruble to crash. But the Kremlin waited to let the ruble go until the ruble no longer struck it or its accountants’ as worth defending anymore.

Now, beginning Jan. 23, the ruble will start at 36 rubles per dollar and will be allowed to float without government intervention with the market determining its rate. Tomorrow and beyond could go two ways.

First, the government could allow the currency to float, but will not let the Russian currency rise or fall more than a small amount in any given day (at present that trading band is limited to between 1-1.5 percent). Should the ruble change in value more than that amount, trading would be suspended. Such suspensions have been seen before in the Russian stock markets; the government occasionally has simply halted trading whenever stock values plunged too far. The idea behind a halt in this case is that eventually the ruble would stabilize, though this could take weeks or even months. In the interim, there would be an explosion of black-market currency trading by businesses, the government and average Russians as the ruble’s “real” rate would be much weaker than the state’s “official” rate.

The second, and more unsettling option, would be if the Kremlin simply allowed the ruble to fall freely. There is no dispute that the Russian government, or anyone in the world, presently has zero confidence in the ruble. Letting the ruble fall without intervention could see the ruble crash in a matter of weeks. This happened in 1998, when the ruble lost 70 percent of its value in a matter of months. The Russian people saw their savings and investments wiped out in just a few days as panic broke out in the system.

Today’s announcement came from Finance Minister Alexei Kudrin’s right-hand man, Sergei Ignatiev, chief of the Bank of Russia. Kudrin and Ignatiev are both considered some of the more adept accountants inside the country; moreover, they are both highly trusted by Russian Prime Minister Vladimir Putin. The fact that Kudrin believes Russia’s best option to overcome its ruble woes is abandoning its defense of the ruble is very telling: The Kremlin is thus apparently willing to destroy the credibility Russia has built in the past 10 years as a financially competent country. It is doing so, however, to hold onto what is left of the cash it has accumulated over those 10 years rather than letting it bleed away in defense of an indefensible currency. By allowing the ruble to fall, Russia hopes it can maintain its ability to act as a strong country beyond its financial system.