No end in sight for Russian crisis

Russian currency Ruble has been under pressure with a sharp decline in crude oil prices trading at a 5.5-year low

Russia has become the first victim of falling crude oil prices. The country’s central bank, in a bid to stem a sharp decline of the ruble, raised its key interest rate on Tuesday to 17% from 10.5%. In a midnight release, Bank of Russia said it is also raising its repo rate to 18% from 11.5% and increasing the volume of foreign currency it offers banks at the repo auctions to $5 billion from $1.5 billion.

The reason for doing this drastic increase was aimed at limiting substantially increased ruble depreciation risks and inflation risks.

Russian currency Ruble has been under pressure with a sharp decline in crude oil prices which are trading at a 5.5-year low. Oil accounts for 60% of all exports from the country. On Monday ruble saw its biggest drop of nearly 12% since 1998 when the country had devalued its currency sharply. The currency is already depreciated by around 50% in the present calendar year.

For President Vladimir Putin, 2014 was not a good year since his country has not only been hit by falling oil prices but his policy on Ukraine has resulted in Russia being hit economically on account of sanctions, a sluggish economic growth and flight of capital.

In order to stem the further flight of capital, Bank of Russia took the harsh step. However, the move might be a stop gap arrangement till oil prices stabalise. But if interest rates remain high, economic activity in the country will be badly affected.

Some analysts have termed Russia’s central bank as a brave one, especially since a 100 basis point increase interest rates the previous week did not help to contain ruble’s fall. According to UBS the central bank likely took strong action after Russian households began shifting their domestic deposits into other currencies. Shares of retail forex deposits rose from 19.8% to 23.8% in the past two months. Russians have pulled out more than $100 billion from the country in 2014.

Not everyone is as sympathetic of Bank of Russia’s move. According to a New York Times article Russia has a new enemy: the currency markets. The surprise rate increase, says the article, underscores the limited options for Russian policy makers. The central bank has spent at least $75 billion this year to prop up the ruble, with little effect.

The central bank is not too hopeful of the economy if oil prices are low. On Monday, Russia’s central bank said that it expected the country’s economy to contract 4.5 percent in 2015 if oil prices averaged $60 a barrel. Morgan Stanley says that Russian economy will slip by six% if oil stays at $50 per barrel. Oil is presently trading at 54.5 levels.

So how does the move affect world markets?

Asian markets including India seem to have reacted adversely to the development. But the European markets, which are the biggest trading partners of Russia are all moving higher. European markets are trading higher on account of better than expected economic data. Further a strong ruble would bring down Russia’s competitive strength in the Eurozone.

In emerging markets however, analysts feel that despite the troubles Russia has one of the strongest balance sheets. Interest rate parity will result in flight of capital from other emerging markets to Russian markets. Indian rupee fell to a 13 month low, helped by global events and the high trade deficit number. Rupee’s strength has a strong relationship with equity markets.

To make matters worse Russia’s ruble continues to fall against the dollar on Tuesday and has slipped by another 5.4% despite the interest rate hike. This now leaves very few options with Bank of Russia. Chatter in analysts circles is that the country will now have to impose capital controls.

We are nowhere close to end of the crisis in fact, it’s the beginning of a new one.