With oil prices plummeting and the USD holding onto strength built up over the past six months, many market participants have waited and wondered about which EM economy would crack first. It has been popular to assume that the Saudis would be the first to bow to the pressure of falling oil prices. After all, Saudi Arabia’s main natural resources are oil and sand. However, there is another one-trick-pony economy (OK, there are several, but this one happens to be a global power), Russia.
Without oil and gas, Russia is a clawless bear. Mr. Putin is in serious trouble. Russian economic trouble may be reaching a crescendo. Last night (1 AM Moscow time), Russia’s central bank raised its overnight lending rate to 17% from 10%. It also raised its repo rate to 18% from 11.50%. This is a bid to defend the ruble. This has, thus far, proved unsuccessful.
From Russia with Love
The ruble has lost more than half its value versus the dollar, from 32 rubles to the dollar to an exchange rate of about 72. Basically, if you are a Russian company and were purchasing goods services denominated in USD, your costs more than doubled. If you are a Russian company that issued bonds in USD and you must convert Rubles to dollars to pay your bonds, your debt load and interest expense has also more than doubled.
If you are a Russian company seeking to borrow in rubles, there are few lenders/investors willing to provide credit. This could put some Russian corporate debt (both bonds and loans) under pressure. The problem with dollar denominated foreign corporate debt is not unique to Russia. As we have said before, even dollar denominated foreign debt is not immune to currency volatility.
Last summer, we discussed EM and we specifically pointed to Russia as a trouble spot (and not just because of sanctions). Investing in a non-diverse economy that is centrally-planned and manipulated can have significant risks. Such economies are like the little girl with the curl. When they are good they are very, very good, but when they are bad, they are horrid. Russia is horrid now that oil prices are falling and the Fed is moving closer to tightening. Energy was a kind of paint that allowed Russia to effectively paint over economic rust. The thing about painting over rust is the rust eventually bubbles through.
If the sharp rate increase does not stabilize the ruble (and we have good reason to think it will not), the next step is probably capital controls. This is where the Russian government limits the amount of capital that can leave the country at a given time. This would be an act of desperation as it would destroy what little confidence is left in Russia from around the globe. However, it could stabilize the ruble and quell any internal unrest that might arise in Russia. However, large interest rate hikes and capital controls can only buy an economy time to cure what ails it or enable a broken economy to heal via animal spirits. Thus far, the only animal spirits that appear to exist in Russia belong to the shirtless man on a horse. No, not Taras Bulba, Vladimir Putin.