Tuesday, December 16, 2014

Is Russia's Economy Doomed?

It's been one heck of a year for Vladimir Putin, who did the unthinkable in remaining one strategic step ahead of President Obama and the U.S. throughout some of the year's most newsworthy events: the annexation of Crimea, continued efforts to subdue the Syrian government, Iranian nuclear talks. For a while, it seemed as though President Putin held all of the cards, and that the U.S. was walking on thin ice by flaring up tensions with increased sanctions and other diplomatic tools. Unfortunately for Russia, it appears that President Putin has finally run out of leverage - Western sanctions are finally taking their toll. It was an economic collapse in the late 1980s, brought on by decades of Communism wreaking havoc on the Soviet Union's financial system, that finally brought the Union to its knees. Will history now repeat itself? And what will the implications be for the U.S., and the global economy as a whole?

Consumers buying up electronics. Courtesy of NYT

As global oil prices have continued to slide, so has Russian currency. In fact, Russia was poised to shut off natural gas supplies to Ukraine through the entire winter earlier this year, as retaliation for Western sanctions. Such a move would have likely thrust Europe back into a recession, as the European Union struggled to find natural gas supplies from elsewhere. However, that plan did not pan out as Putin had initially intended - during the last few days of October, Russia signed a deal with the Ukraine and the E.U. that effectively resumed natural gas supplies flowing to Ukraine in exchange for an agreed-upon payment (much of which was coming from the E.U). Obviously there were numerous benefits - for both sides - to this deal. However, the deal is indicative of a Russian economy that was already uneasy at the prospect of missing out on a major energy export deal for so many months.

30-day look at value of ruble vs. Brent crude. Copyright Bloomberg LP

Up until yesterday, the ruble had slid approximately 11 percent against the U.S. dollar so far this year. The Brent crude oil index was at a multi-year low, trading at less than $80 per barrel. And then, overnight, things got much worse for Russia. After Russia's Central Bank minted more than 600 billion new rubles in part of a bond-selling deal with Russia's state-owned oil giant, Rosneft, the effect that new currency had on global markets was devastating. With the ruble in free-fall and oil nearing a 5 1/2 year low, Russian finance ministers convened overnight and raised interest rates a whopping 6.5 percent, from the benchmark 10.5 percent to 17 percent in an effort to stanch the flow of capital. Unfortunately, this was not enough, and it appears that Russians don't see 17 percent interest as incentive enough to hold on to their currency. News outlets have reported a run on electronic and other high-end consumer stores, as citizens take advantage of the record-weak currency. Oil continue to trades low, and now Russia is stuck with commodities it can only export for cheap, a rapidly depreciating currency, and now, high interest rates that will make it harder to borrow. Earlier today the ruble's depreciation doubled, from its 11 percent on the year against the dollar to 22 percent. While reserves and general finances are better in Russia today than they were decades ago when they underwent their last economic downturn, it's safe to say Russia is on the brink of a catastrophic currency crisis.

Falling oil prices may be great for consumers in the short-term, but they are indicative of a downturn in the global economy, which is never a good thing. The instability that can result from the OPEC countries struggling to maintain their exports is something to be afraid of. And while relations have been icy in recent months between the United States and Russia, there are significant economic ties between the two nations that could prove to be costly for U.S. interests should Russia's economy collapse. Russia's currency needs to stabilize, and fast, before the damage spreads outside of their borders.

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