Russia's long night is only just beginning

A massive central bank interest rate hike failed to support the rouble. This crisis is slipping out of Moscow’s control, says Ben Chu

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Midnight on Monday at the headquarters of the Central Bank of Russia was less the witching hour than the desperate hour.

The Moscow monetary authority chose the dead of night to hike its short-term rate to an agonising 17 per cent, up from an already painful 10.5 per cent.

The bank’s board, which is chaired by Governor Elvira Nabiullina, knew that making money so expensive would be very hard to swallow for the Russian economy, where growth rates have been tumbling this year thanks, in large part, to economic sanctions imposed by Western nations in response to Moscow’s military intervention in Ukraine. But these central bankers had a still greater peril in mind: a full-blown financial crisis.

The bank hiked rates to emergency levels in order to support the value of the rouble, which had shed a full tenth of its value in just 24 hours. And that was merely the latest plunge. The Russian currency has been sliding since the summer.

Yesterday morning it took 62 roubles to buy one US dollar. In the summer it required just 33. The purchasing power of the Russian currency has thus halved in only six months.


This currency collapse has made Russian imports much more expensive, helping to push domestic inflation above 9 per cent. Moreover, the risk of a domestic financial crisis, with banks and other big borrowers unable to roll over their foreign currency debts, has been growing with every percentage point slide in the value of the currency.

Yet despite the emergency rate hike the rouble continued to fall yesterday morning, the exchange rate climbing as high as 79 to the dollar before finally recovering some ground.

Beyond the Western sanctions, the root cause of Russia’s emergency lies in its undiversified economy, which is dominated by the energy sector. Oil and gas account for two thirds of the value of all Russia’s exports. The rouble is a classic petro-currency. As the global price of a barrel of oil has plummeted since June, so has the value of the rouble.

More than half of the Kremlin’s budget revenues come from oil and gas. For many years – when the oil price was high – the Kremlin’s coffers were bulging with dollars. The state also managed to build up a huge foreign exchange treasure chest, worth $580bn at its peak.

Those foreign exchange stockpiles ought, in theory, to be providing protection now that the cycle has turned. But in practice, to date they do not seem to have done so. Earlier this year the central bank sold $75bn to help support the currency but failed to stem the bleeding. Some $374bn of reserves remain and many analysts expect they will be called into service before this crisis is over.

Some analysts have also suggested Moscow may need to resort to capital controls, preventing investors taking money out of Russia. There were hints of this kind of official intervention earlier this week as the central bank ordered the Moscow stock exchange to stop trading in certain financial derivatives, citing “possible market manipulations”. Capital outflows are forecast by the central bank to hit $120bn this year.

How bad could things get? Few are predicting a repeat of 1998 when Moscow sent a colossal shockwave through global capital markets by defaulting on its sovereign debt in the wake of a similar currency crisis. Its national debt is considerably lower now than it was 16 years ago, at about 15 per cent of GDP. “Russia has one of the strongest sovereign debt profiles of any country globally,” according to Alexander Moseley  of Schroders.

Yet the country’s total external debt – which includes private sector borrowing – is far from negligible. It stands at $715bn, according to the most recent World Bank figures. About $550bn of that is foreign currency debt, equating to more than a quarter of the country’s $2trn economy. And those ratios, of course, get worse every time the rouble falls.

An added headache for Moscow is that US and European sanctions make it hard for Russian borrowers to refinance this debt. Western banks with assets in Russia were punished by stock markets yesterday. Shares in Austria’s Raiffeisen Bank, which generates most of its profits in the country, were down 7.75 per cent. Other Western firms with sizeable retail sales in Russia also fell sharply. Carlsberg slumped 4 per cent, while the German retailer Metro lost 3.5 per cent.

The Kremlin was trying to put on a confident face yesterday, but the crisis is showing signs of slipping beyond Moscow’s control. Markets appear to doubt Ms Nabiullina’s resolve. Her argument on Russian TV yesterday that the rouble was undevalued made little impact.

Moreover, the central bank has warned that the domestic economy could contract by as much as 4.7 per cent in 2015 if the oil price remains at $60 a barrel, regardless of any currency interventions. That would mean Russia’s worst recession since the global financial crisis.

Yesterday, Brent crude went below $60 for the first time in five and half years. And some analysts are predicting it could go even lower in the months ahead. If that forecast proves correct, Russia’s petro-economy seems likely to be headed the same way.