Putin says Russia is 'not in a crisis' but here's why you should be worried

Earlier this week, Russia made its last-ditch effort to save its economy and its currency from collapsing. The country’s central bank hiked the interest rates from 10.5 percent to 17 percent, the biggest hike since Russia’s ruble crisis in 1998, to prevent the ruble from crashing in value for the sixth time this year even though the currency has hit its record low, sparking worries of an economic and political instability. On the streets of Moscow, panicky consumers rushed out to buy home appliances before they became even more expensive. The logic? Buy anything that seems as if it might hold value better than paper money, whose worth is evaporating in real time.

On Wednesday, however, the rouble gained 12 percent as the Russian government and central bank revealed measures to support the currency. But on Thursday again the currency weakened again as offered no remedy for a deepening financial crisis. Defiant and confident at a three-hour news conference, Putin blamed the economic problems on external factors and said the crisis over Ukraine was caused by the West, which he accused of building a “virtual” Berlin Wall to contain Russia.

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The rouble has fallen about 45 percent against the dollar this year, and suffered particularly steep falls on Monday and Tuesday, but Putin refused to call it a crisis and said it would eventually rise again. As this Vox article argues, " By playing up the role of outside hostility in Russia’s economic crisis, Putin would shift the blame and, just as important, promote the idea that Russians have to come together and endure the downturn as a matter of national mission against a foreign enemy."

Why is the ruble crashing

Russia’s currency is collapsing primarily because of the falling price of oil. Russia gets around half of its budget revenue from taxes on oil and natural gas, and as long as the price of oil is plummeting, its economy is likely to continue sinking.Russia’s 2015 spending plans had assumed that oil would remain over $100. The country can only balance its budget with the oil price around that mark.

Secondly, sanctions imposed by the US and the European Union in response to Russia’s involvement in the conflict in Ukraine are putting pressure on the ruble. Even Russian companies are having trouble refinancing their dollar and euro debts in Western capital markets because of the sanctions. In other words, they’re scrounging for dollars and selling rubles to get them - sending the ruble down farther. To make matters worse, the behemoth Russian energy companies led by Rosneft and Gazprom cannot get long term financing from Western banks due to sanctions imposed in late June.

Sometimes, a less-valuable currency can help a country by making its products cheaper abroad, increasing exports. But Russia doesn’t have much domestic manufacturing, so it can’t take advantage of the ruble’s decline that way. But as this Bloomberg article points out, “What we’re seeing in recent days resembles full-blown panic. There’s nothing really new. At this point, it’s about psychology: Fear has taken over, and there’s clearly a rush on the part of traders and investors to get their money out of Russian assets. We’re seeing a run on the entire country.”

What Putin really needs to do right now is move away from excess dependence on oil and natural gasto improve the competitiveness of manufacturing and high-tech industries.

Did the interest rate hike work ?
The idea of increasing the interest rate is that people will keep their money in rubles. If you offer people higher interest rates, they’re more likely to keep their money in rubles. It could persuade investors to stop betting against it, and let the central bank cut rates again in the near future. But analysts said the measure was already insufficient because banks and companies could earn much bigger yields by buying hard currency. Meanwhile, higher rates could hurt the economy. If the panic ruble-selling continues, the Russian authorities could be forced to impose capital controls. That would be bad news for any foreign investors who still haven’t pulled their money out of Russia. Already the central bank has reportedly been intervening to try to short-circuit the sell-off, buying roubles to try to arrest the declines.

“The problem is that if you try to defend your currency and lose, you are essentially throwing your money at currency traders for nothing. As Russia has deployed its reserves to (so far unsuccessfully) stop the currency collapse, it has made traders betting against the rouble richer while leaving the Russian government poorer. Poorer by $80 billion, to be precise,” says this NewYork Times article.

Why India should care

Russian turmoil is spreading to other markets. When Russia defaulted in 1998, it set off a global financial crisis and many emerging markets suffered. So far, Russia’s problems are mainly confined to home but a weaker ruble makes it harder for Russian businesses to repay any dollars or euros they borrowed. Some businesses might not be able to pay anything back at all. Moreover, if Russia defaults, most foreign investors will panic and take money out of emerging markets like India and invest it back in safer assets like the US treasury bonds.

[caption id=“attachment_113814” align=“alignleft” width=“380”]  Ruble. Reuters[/caption]

The weaker rouble and higher inflation are limiting consumer spending and hitting sales of non-essential goods like cars. Our exports to Russia could be in trouble. We largely export Pharmaceutical, mobile phones and Tea.

“All companies that have export deals with Russia are bound to be impacted as long as this phenomenon continues. A weaker rouble pushes the cost of imports for Russia and, hence, impacts demand. Indian companies would need to have risk-mitigation models in place to counter this development. The pharma companies should have been hedging their risk on their exports as the Russian phenomenon has been brewing for some time, since the Ukraine imbroglio,” D R Dogra, chief executive officer and managing director of CARE Ratings was quoted as saying by the Business Standard.

Secondly, tourism will be hurt. Goa is flush with Russian tourists and with the ruble collapsing, the numbers of Russians visiting Goa is sure to fall.

With inputs from Reuters