Thursday, 18 December 2014

Russia's collapse was only a matter of time

While the extent of damage of Russia’s financial week-from-hell is still unclear, the country has been struggling with deep structural economic problems all year. Wednesday’s currency crash is simply the next step in Russia’s regress to recession.

The Russian rouble had already lost about half its value this year due to an effective mix of Western sanctions, collapsing oil prices and diminishing market confidence in the ailing economy. But Russians are used to hardship and understand, although aren’t happy about it, that the good times often come to an end when least expected.

In a mysterious series of events, the Russian central bank tried putting a tourniquet on the sliding rouble earlier this week raising baseline interest rates from 10.5% to 17%. 

That desperate measure worked for a few hours before the currency slipped into free fall, at one point losing more 20% of its value. The currency finally stabilised and then slightly strengthened later in the day indicating potentially two monetary interventions from the Russian central bank, which if confirmed will be interesting to analyse in themselves.

The world’s eighth largest economy has had a tough year. At the beginning of the fourth quarter, Russia estimated its growth for 2014 would be close to 0.5%. This estimate took into account that foreign direct investment had dropped, according to the government, by 50% year-on-year compared with 2013 and capital flight was expected to reach $US100 billion by December.

So while this year’s expectations are now in shambles, Moscow is also reassessing its once optimistic growth forecast for 2015. In September the government predicted 2015 growth would reach 1.2%, followed by 2.3% in 2016 and 3% in 2017. That’s now entirely out of the question and unless the situation drastically improves a recession seems likely.

The context of Russia’s currency and economic woes is the story of a country playing with a losing hand trying to make the most of the time it has left. While it might have thought the worst of its troubles were over (Moscow had made some expensive domestic investments recently), that assumption has proven devastatingly wrong.

Since the final months of last year, Ukraine has been a thorn in Moscow’s side. The country at one point threatened to side entirely with Europe and the West. From Russia’s point of view, that was unacceptable and it intervened in Ukraine’s politics to wrench the country back under Moscow’s orbit. 

The ideological battle spilled into a low-level hot war between “patriotic Russian citizens” living in Crimea and Eastern Ukraine and the government in Kiev. Thousands have since been killed as Russia and Ukraine slowly traded control over the eastern regions of the country throughout the year. Russia’s ultimate goal, if it couldn’t win, was to leave Ukraine at minimum operating in neutrality between Brussels and Moscow.

However the battle for Ukraine hasn’t gone to plan for Russia at all. Kiev responded to Russian aggression with far more ferocity than Moscow expected, isolating the separatism in the east and working through its political issues with minimal interference from Moscow’s antagonists. Russian President Vladimir Putin cannot possibly think he is in control of the situation in Ukraine.

In response to Russian revanchist actions in Ukraine, Europe and the United States created a gradually tightening series of sanctions aimed at Russian energy industry and politically-affiliated oligarchs. The sanctions, according to Western leaders, were only meant to hurt the powerful in Russia, not the general populace.

Nevertheless, the sanctions meant that access to Western financial institutions was cut off for most of middle Russia and its market has suffered under the added weight. 

A fresh tranche of sanctions was announced by US President Barack Obama this week, coincidentally or not, just as the rouble’s free fall was taking place. The message to Moscow that the West has plenty more tools to inflict economic pain on Russia was read loud and clear.

The final, but by no means the last, piece of the current puzzle is dynamics of the Russian oligarchical system. Before the currency failure, Russia boasted a deep rainy-day fund of $US641 billion in reserves: $US467.2 billion in currency reserves, $US87.32 billion in the National Wealth Fund and $US87.13 in the Reserve Fund. That was supposed to act as a buffer if the oil price temporarily fell below $US100 per barrel.

But Russia is chewing through those reserves quickly. Moscow has already spent $US80 billion of this money to shore up its failing currency. That money went to traders betting against the rouble and away from the Russian government. Who are those traders getting rich off Russia’s pain? Western investors and the mega-rich handful of Russians who have sucked the life out of the country over the last two decades.

Perhaps the best way to describe Russia is not to view it as a country or a federation at all. It is a colony. Russia’s oligarchs after the fall of the Berlin Wall treated the country as if it were owned by them. All the wealth that the country produced was siphoned away and stored offshore in European bank accounts in exactly the same way as the British, French and Spanish empires once operated.

Add to this mess the crippling corruption and graft endemic in Russia, and it is no mystery why the country constantly struggles to develop even while it sits on enormous natural resources and energy reserves.

Now it is those very energy reserves which until a few months ago supplied powerful leverage over Western Europe which are now Russia’s Achilles heel. But everybody is feeling the pain. Moscow and the oligarchs each sunk hundreds of billions of dollars into the oil and gas companies Gazprom and Rozneft (and others) in a fairly solid prediction that energy prices would only rise in the future.

That prediction has come spectacularly undone in the past six months as global oil prices sliced 49% of its value. Oil prices hit a low not seen since June of 2000 this week of $US59 per barrel. Russia pegged its 2015 national budget on a $US114 price per barrel. No matter which way it’s cut, the system Russia relied on for strength has been shredded. 

What will happen next is anyone’s guess. But the last time something similarly economically drastic occurred in the Russian Federation, the government of former President Boris Yeltsin was overturned in 1998. Current President Vladimir Putin took Mr Yetsin’s place, and many Russia-watchers don’t consider that a trade-up. 

After the events of this week, the constantly scheming factions of Moscow’s political class will surely be wondering whether the current structure of leadership is beneficial for their own interests. Mr Putin and his spook allies will be locking their doors at night while they sort out their next moves.

Greater Russia is accustomed to upheaval and will probably survive this drama, but even a marginal implosion of a country this size could have ripple effects across the world. Many countries still rely on Russia for energy and other resources and the administrative system Moscow has created with its Former Soviet Union neighbours relies on a cohesive central body. 

Thus avoiding a larger crisis could be difficult if the Russian economy cannot be brought under control soon. Despite what the Europeans and the United States proclaim about corralling Russia, the standoff in Ukraine may not be worth the stress if the unintended consequences of a failed Russia endanger the wider region.

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