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- Buffeted by Western sanctions and lower oil prices, Russia has suffered a significant decline in net foreign earnings. Capital is fleeing the country, and corporations and households are looking to switch out of rubles and into dollars and other \u201chard\u201d currencies. The result has been a sharp fall in both international reserves and the value of the ruble, contributing to a rising threat of domestic financial turmoil.<\/li>\n
- At the same time, it is only a matter of time until the country\u2019s economy has to deal with an even stronger stagflationary wind. The currency\u2019s sharp depreciation is sure to fuel inflation, while the drop in foreign income will curtail domestic economic activity.<\/li>\n
- The central bank\u2019s retreat from propping up the ruble highlights the fix the country is in. The authorities\u2019 initial response was to use ample international reserves to counter the impact of sanctions imposed by the West.\u00a0 They backed this up by intervening in the foreign-exchange and repo markets, which readily exchange securities for cash,\u00a0 and by raising interest rates.\u00a0 This moderated what would have been more disorderly pressures on the ruble and an even faster loss of confidence. But the subsequent collapse in oil prices and the pickup in capital flight overwhelmed this strategy, forcing the central bank last week to retreat from its policy and fully float the currency.<\/li>\n
- The country\u2019s foreign-exchange situation could spin further out of control, at one extreme, or the Russian authorities might respond strongly with higher interest rates and spending cuts.\u00a0 Either approach would risk depressing economic activity even more in the short run. The most likely outcome is somewhere in between — some interest-rate increases and the use of controls to try to buy time by limiting dollar use and channeling more foreign exchange to the government.<\/li>\n
- While Russia\u2019s creditworthiness is under significant pressure, with international reserves still above $400 billion, the country\u2019s debt-servicing capacity isn\u2019t exhausted, provided the authorities can better manage the movement from rubles into dollars. Yet even then, it is probably only a matter of time until the country loses its investment-grade credit rating, raising its borrowing costs and narrowing further its creditor base. The situation will be acute for companies and banks whose balance-sheet positioning requires them to pay more rubles to obtain the dollars needed to meet their foreign obligations.<\/li>\n
- The negative spillover effects of Russia\u2019s financial turmoil are a lot less than they were in 1998. While some Western banks and investors still have notable exposures, quite a few responded to Western sanctions in the last few months by reducing their holdings and preparing for further turmoil.<\/li>\n
- President Vladimir Putin, whose popularity surged when he acted in Ukraine earlier this year, faces one of two choices:\u00a0 He can moderate Russia\u2019s involvement in Ukraine as a means of relaxing Western sanctions. Or he can press even harder in Ukraine to distract attention at home away from the economy but risk another round of sanctions and countersanctions that would aggravate the economic and financial turmoil in Russia, and potentially tip Europe into recession.\u00a0 The market implications of the two courses are polar opposites.<\/li>\n<\/ol>\n
Aggravated by lower oil prices, the recent financial turmoil reflects the geopolitical tensions and Russia\u2019s decision to favor regional adventures over internal economic and financial stability. The sovereign analysis that the vast majority of investors use isn\u2019t often comprehensive enough to easily and effectively capture this reality.<\/p>\n
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<\/a><\/p>\n<\/div>\n<\/article>\n<\/div>\n","protected":false},"excerpt":{"rendered":"Mohamed A. El_Erian writes:\u00a0 The central bank of Russia appears to be losing control of its currency market.\u00a0 Here are the seven things to know about what\u2019s going on in Russia now. Buffeted by Western sanctions and lower oil prices, … Continue reading