We have shown so far that all ruble crises were accompanied by a strong U.S. dollar and low oil prices. We have concluded that Russia's current problems resemble those from 1998, though possibly even more severe than seventeen years ago, because the biggest country in the world is cut off from the international funding. But what about the following banking crisis in Russia?
Let's begin by explaining why the next full-blow financial crisis is coming, even though Russian public debt is very small (less than 10% of GDP). We have to remember that what really counts is future fiscal balance. It involves the role of expectations of the future stance of public finance and explains why governments in crises often have surprisingly large foreign currency reserves and run small or no deficits at all. The best example was the Asian countries in 1997. According to Eichenbaum et al., the Asian crises was caused by "large prospective deficits associated with implicit bailout guarantees to failing banks". The same mechanism operated in Russia. Investors simply noticed that the oil and gas industry generates about half of Russia's revenues, so the government, unable or unwilling to raise taxes or cut spending, will run deficits in the future. These expectations were enhanced by the implicit bailout guarantees of Putin's cronies.
This is why Russian bond yields and credit defaults swaps with measuring bankruptcy risk for Russia and have already hiked (Russia's government 10-year local bond yield jumped from 10% in November, 2014 to 14% in January, 2015, while CDS spiked in January, 2015 by 100 basis points to 630).
This issue of prospective deficits is strongly linked with the credibility of monetary policy. Investors fear that the Central Bank of Russia will not withstand political pressure (remember: it is an authoritarian country which is cut off from the external funding) and will start printing money to monetize deficits. Anticipating future inflation, investors sell rubles today. On December 15, 2014 the central bank gave Rosneft, owned by Putin's friend, 625 billion newly printed rubles. That supply of new money immediately appeared on the currency market, and the exchange rate collapsed, despite oil bouncing back that same day.
What about the possible default on private debt? The ultra-low interest rates in developed economies resulted in the search for yields in the emerging markets. This led to a rise in Russian corporate debt denominated in foreign currencies from $325 billion at the end of 2007 to $502 billion in June 2014. The weaker the ruble, the higher costs for Russian companies to pay debts issued in other currencies. They need liquidity to pay interest and roll over debts, but sanctions cut off Russian businesses (and banks) from foreign financial markets where Russians used to get half of their capital. Therefore, they have to buy U.S. dollars in the market, which further weakens the ruble exchange rate.
The rise in the U.S. dollar caused the reverse of emerging markets carry trade - investors started to outflow their capital from them, including Russia which is additionally suffering from the Western sanctions. Although investors have been taking their capital out of Russia for a few years, a sharp rise in 2014 (around $150 billion in a full year compared to $63 billion in 2013 and $134 billion in 2008, during the global financial crisis) augmented the downward pressure on the ruble, which further decreased the confidence in the Russian economy and next entailed outflows of capital.
Non-financial companies are not the only ones that suffer from the ruble's weakening. Banks, who borrowed in foreign currencies, make a close second. Banks have $192 billion of external debt (about 10% of GDP), up from $170bn in 2008, and from $18bn in 1998, while having few dollar assets to balance against their dollar debts. About $130 billion of bank and corporate debt will be due this year.
Three more factors aggravate the banks' situation. First, companies' insolvency means more bad loans and losses for the banks. For example, overdue unsecured consumer debt of Russian banking sector rose by 2 percentage points between April and September 2014, to 11.3%, while Sberbank, the country's biggest lender, has reported a 25% slump in third-quarter net profit on rising provisions for bad loans.
Second, depositors no longer trust the ruble and began withdrawing their money from the banking deposits. The share of Sberbank's deposits held in foreign-currency increased from 13 percent to 17 percent in the second half of the year. Russians also started flying into real values, i.e. they are getting rid of rubles and buying foreign currencies, durable goods and obviously gold. Such behavior typically indicates the loss of trust in the domestic currency and entails high inflation.
Third, in response to hike of the CBR key rate (see graph 3), the interest rate on Russian three-month interbank loans rose to 28.3%, higher that it was even during the 2008 crisis. Consequently, Russian banks will need support in the near future. Actually, the first banks (Trust Bank, VTB, Gazprombank) have already been bailed out at a level of a few billion U.S. dollars. However, bearing in mind that banks and companies (whose operation must be financed by banks) will need to repay almost $100 billion of foreign debt this year, we may next expect more bailouts.
Graph 3: Russian benchmark interest rate from March to December, 2014
It is just a logical step during the currency crisis experienced by the developing country with large foreign-currency debt. According the Krugman, "…the initial effect of a drop in export prices is a fall in the currency, this creates balance sheet problems for private debtors whose debts suddenly grow in domestic value, this further weakens the economy and undermines confidence, and so on".
Sunshine Profits' Gold News Monitor and Market Overview Editor