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OPINION

Russia’s economy: The new world order

Western governments hope Russian citizens will blame the regime of president Vladimir Putin and seek change. That is a gamble.

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“The conditions for the Russian economy have altered dramatically.” Elvira Nabiullina, governor of the Central Bank of Russia (CBR), made no attempt to downplay the effectiveness of Western sanctions in a speech on Monday explaining the decision to raise interest rates to 20% to protect the value of the rouble.

But even trying to tell it straight sounds like an understatement.

The CBR had been buttressing its defences ever since the annexation of Crimea in 2014. It increased foreign currency reserves from $356 billion that year to $630 billion on the eve of the invasion of Ukraine, while being careful to cut holdings of US Treasuries and to build the domestic Mir card network as a hedge against the country being cut off from Mastercard and Visa.

But within days, Western governments halted transactions with the CBR and shut off its access to the large portion of those reserves that are held outside Russia. The CBR spent $1 billion defending the rouble on February 24, slightly less on February 25 and then stopped even trying as the currency fell 38% against the US dollar.

A financial system collapse is playing out at high speed in a country with one of the lowest government debt-to-GDP ratios in the world

The government instead required exporters immediately to sell 80% of hard currency earnings for roubles in an effort to forestall further collapse for as long as Western governments allow energy exports.

As depositors queued to take their cash from Russia’s banks, Nabiullina announced emergency measures to keep them afloat, expanding the collateral the CBR will accept in return for liquidity, allowing them to mark securities held as balance-sheet assets as at February 18, before the invasion, as well as foreign currency liabilities and even encouraging forbearance against unpaid loans.

But a financial system collapse is playing out at high speed in a country with one of the lowest government debt-to-GDP ratios in the world, at a mere 18%. As Euromoney went to press on Wednesday, the Moscow Exchange remained closed.

Western governments hope Russian citizens will blame the regime of president Vladimir Putin and seek change. That is a gamble. They might rally behind the strong man in the face of this financial attack.

Facing the consequences

Meanwhile, Swift awaits the list of Russian banks it must cut off from its messaging service, saying it will disconnect them as soon as it receives legal notification to do so.

To be effective, sanctions must be airtight and long-lived. But the West will face consequences. Fears are mounting of stagflation. Russia is a leading exporter not just of oil and natural gas, but also, along with Ukraine, of wheat as well as rare metals and gases required for the manufacture of chips.

US and European bank stocks are falling as rate markets price in lower likelihood of aggressive rates hikes to combat this inflation, as war in Europe threatens slower growth and rising defaults.

Higher rates would help banks. But on Tuesday, yields on 10-year US Treasuries fell to 1.72%, while 10-year bund yields fell back into negative territory. The next day, 10-year Treasury yields shot back up to 1.88% after US Federal Reserve chair Jerome Powell all but confirmed a 25-basis point hike in March. But markets remain volatile and liquidity is poor.

On Wednesday, the oil price hit $112.

Bjarne Schieldrop, chief commodities analyst at SEB, says the global economy faces “energy starvation”.

Russia did a good job of isolating itself before the invasion, but the West still can't hurt Russia without hurting itself.

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