Sharp rises in interest rates can defend a currency against negative sentiment by hiking the carrying cost of short positions. They cannot alter a currency slide caused by more fundamental factors. For that reason, the Central Bank of Russia’s 650 basis point rate hike in December 2014 seemed to suggest the country is running out of options.
Russian companies have been frozen out of international capital markets by sanctions, and are forced to refinance upcoming maturities on almost $700bn in external debt by borrowing in roubles and then using the proceeds to buy dollars. That weakens the exchange rate. Throw in rising inflation due to Russian restrictions on Western food and pharmaceuticals imports, a Republican-controlled US Congress calling for more sanctions, plus the sudden fall in the price of oil that accounts for much of Russia’s exports and economic output, and you have the fundamental ingredients for a weak rouble.
Companies and local governments with dollar debts and rouble revenues face an increasingly painful asset/liability mismatch. Borrowing in roubles has now become much more expensive as well. The healthiest players in Russia are the government and households. Household debt remains mostly rouble-denominated and low, although some new entrants into the country’s recent consumer lending boom picked up marginal portfolios that are now suffering. Established players such as Home Credit and Russian Standard Bank successfully navigated a deep recession in 2009 and should be better prepared.
The central government’s debt is less than 15% of gross domestic product and the central bank has $374bn in foreign exchange reserves. But that is $100bn less than a year ago and some unpleasant choices are looming. Strategic companies such as oil company Rosneft are already being refinanced by the government, but reserves could be depleted rapidly if that bail-out is extended more widely. Meanwhile, Russian citizens who lost their savings during the 1998 crisis will not be slow to convert roubles into dollars and withdraw them from the banking system – or from the country. As the UK discovered with Northern Rock in 2007, heavy withdrawals from banks can quickly escalate in the internet era, requiring a swift and decisive government response.
In 1998, it was central government bonds that laid Russia low. This time, contingent liabilities from the corporate and banking sectors are the main threat. Reserves will not run dry imminently, but there are growing signs that financial stability could be impaired well before that point. If diplomatic conditions do not improve, the Russian economy will be walking a tightrope in 2015.
