K.S. Rajan (28 Dec 2014)

Russia is heading into an economic storm with no captain

Sergei Guriev
Moscow’s worst fears have come true. Comparisons with 2008-09 look wishful, says Sergei Guriev

On Tuesday afternoon, the value of the rouble was one euro cent, about 30 per cent less than on Monday morning. Russian stock prices registered a similar collapse. In recent weeks, rouble and stock prices have been falling in line with oil prices. This week, however, oil prices remained stable at about $60 dollars per barrel.
So what led to these events — and why the disparity between the currency, oil and stocks?
What seems to have triggered the chaos was an unusual deal involving the bonds of Russia’s biggest oil company, Rosneft. Last year, in the era of three-digit oil prices, the state-owned group borrowed about $40bn from leading international and Russian banks to acquire its former competitor, Moscow-based joint venture TNK-BP. Given low oil prices and the impact of western sanctions in response to Russia’s actions in Ukraine, it is no longer clear how this debt will be repaid or refinanced.
This is why Rosneft has asked several times this year to borrow $40bn from Russia’s sovereign wealth fund. But, since the money was unavailable, at the end of last week Rosneft issued rouble-denominated bonds worth $11bn. The speculation is that these were bought by the largest state banks. The interest that investors are charging Rosneft on these bonds is substantially below even that of Russian sovereign debt of similar maturity — which is unprecedented for a company, especially one under international sanctions. Coincidentally, the buyers of these bonds were then permitted by the central bank to use them as collateral to borrow directly from the bank itself.
This deal has sent a strong message to the market. First, it showed Moscow’s priority is not fighting inflation or stabilising the rouble but supporting Rosneft. Second, it demonstrated that the central bank is ready to use highly questionable tools. The Rosneft deal has increased the risks in the banking system. The state lenders already have large exposure to the oil group — and any purchase of overpriced rouble bonds would erode their capital further.
Third, it became clear that the government and the central bank have neither strategy nor a clear understanding of how to deal with the present predicament, and certainly not in concert with a poor investment climate and resulting record capital flight.
The markets see a gathering storm but no captain. In recent weeks, Russia’s worst fears have become reality: the oil price has fallen; Asian markets have declined to bail out the nation’s banks and companies; hopes for lifting sanctions have become even more illusory.
Unless sanctions are lifted and the oil price rebounds, the Russian economy will grow much worse in 2015
In response Moscow has made one policy mistake after another — both by commission and by omission. The retaliatory ban on western food imports is proving counterproductive; and has in effect led to the destruction of the prized customs union with Belarus, a close ally that has hitherto provided a transit route for European food imports.
Moscow and the central bank have failed to make clear how they plan to solve the huge foreign debts of the country’s banks and businesses. And, just two weeks ago, Vladimir Putin, Russia’s president, signed the federal budget for 2015-17 — which is still based on forecasts of 2.5 per cent annual gross domestic product growth, 5.5 per cent inflation and oil at $96 a barrel. These assumptions were completely unrealistic then; they are even more ridiculous now.
What will happen next? A month ago, the central bank described an “un­likely” scenario with oil at $60 a barrel and a 4 per cent fall in GDP in 2015. Now, with the oil price actually at $60, a mild recession sounds like a pipe dream. The financial disruption and the interest rate rise in the middle of Tuesday night point to a full-blown economic disaster. Comparisons with the 2008-09 crisis already look like wishful thinking. In early 2009, the central bank stopped the financial chaos by raising interest rates to 13 per cent — an act that was followed by an 8 per cent GDP drop. Yesterday, the central bank raised interest rates to 17 per cent yet failed to stop the fallout.
There are only two remaining certainties. First, unless sanctions are lifted and the oil price rebounds, the Russian economy will grow much worse in 2015. Second, we can predict that Moscow’s response — in both economic and foreign policy — will be unpredictable.

The writer, a former rector of the New Economic School in Moscow, is professor of economics at Sciences Po in Paris
Copyright The Financial Times Limited 2014.
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