Reasonable observers can disagree about the impact of Western sanctions on the Russian economy this year. However, no one questions the sledgehammer blow delivered by the Saudis who are determined to force oil prices lower.
The Russian economy is hugely dependent on oil, which accounts for some 70% of all exports. The Guardian reports that $100 per barrel for Brent crude is the minimum price for Moscow to achieve a balanced budget. Brent crude last saw $100 per barrel in September, and is continuing on a steep decline – closing at $61.38 on December 20.
The reason for this precipitous fall? Saudi Arabia’s unwillingness to reign in oil production — despite a global glut — in a bold attack on surging US production levels. Apparently, the Saudi’s will endure near-term pain to force reductions in the costly extraction of US shale oil, and the Russians are getting wounded in the crossfire.
One of the most stunning effects of the oil price collapse is the fall of the ruble. Coming into the middle of December the ruble had lost 40% of its January 1st value against the U.S. dollar. On December 15th, the ruble lost approximately 10% of its remaining value; on December 16th, the ruble fell another 20% to 80 rubles on the dollar before recovering and ending the day down only 10%.
The Russian central bank stemmed the crisis temporarily with a $16.5 billion bailout of the banks, but that may not be enough in the end.
Much was made of the Russian central bank sharply raising interest rates to 17% from 10.5%, but a more telling change was the change in Russia’s interbank lending rate (the three-month “mosprime”). It shot up to 28.3%, topping the values from the 2009 crisis. Russian banks are clearly concerned about their ability to repay each other.
According to a Washington Post article, the Russian banking system is in such tenuous shape that the central bank is allowing other banks to ignore the market value and use older (more favorable) exchange rates to assess the value of their assets on their books. In other words, we will just pretend this isn’t happening, and eventually things will get better and the exchange rates will return to normal.
Multiple sources have used the phrase “perfect storm” to summarize Russia’s current situation, including Putin’s own economic minister. Western sanctions, a slowdown in the global economy, plunging oil prices, and the subsequent effect on the ruble have put Russia’s firms in a difficult position.
The Economist reports Russian businesses have approximately $100 billion in foreign debt due in 2015. With the drop in the ruble, that debt becomes increasingly difficult to pay back. Bailouts from the Russian government can only go so far.
President Putin acknowledges that times will be difficult in the short term, but that Russia has enough foreign exchange reserves to weather the presumably short-term drop in oil prices. That is debatable. Current reserves have an official value of $370 billion, but the real value is considered to be much lower – given the banking skullduggery listed above, the actual value is hard to predict.
Russia runs a significant chance of a run on banks by citizens combined with multiple defaults by Russian companies, leaving Russian banks with bad loans and an increasing currency crisis.
Putin also suggested that the central bank might have avoided the large interest rate hike via controlling foreign exchange interventions – effectively imposing indirect capital controls to keep dollars within Russian borders. The mere mention of that seems likely to send more capital fleeing the country in the short term.
Putin’s popularity remains stratospherically high – around 80% since the Crimean takeover. In addition, he seems unlikely to take action that will soften Western sanctions until that number falls sharply. What’s more, most Russians attach more blame to the West than to Putin for their problems.
As bad as things may be in Russia at the moment, it seems likely to get worse before it gets better. Falling oil prices were the main trigger for the crisis, and ultimately, rising oil prices will be what resolves it.
Western sanctions continue to have an effect by cutting off access to international credit markets, increasing the chances of Russian defaults before oil starts its eventual rise. Nothing suggests that sanctions will be lifted anytime soon.
Consequently, for the average investor, it appears unwise to indulge in anything Russian – energy stocks, currency, ETFs – until the situation begins to stabilize.
Oil prices will surely rise once the Saudis have sufficiently squeezed the market, and as the rise begins, savvy investors may be able to find Russian bargains. The emphasis here is on “savvy” – Russian investing is not for the novice. Research any purchases carefully, and remember to treat them as risky emerging market components in your portfolio.