Friday, December 19, 2014

Putin jumps the shark

Amid the occasionally rambling and bizarre comments from Vladimir Putin's annual press conference yesterday, a couple of critical points are rather obvious. 

Firstly, Putin accepts no responsibility for the crisis that has hit Russia, continuing to believe his own paranoid fantasy of Western economic destabilization.  

Secondly, he intends to double down and continue his aggressive and disastrous policies.

However, despite the current dead cat bounce in the Rouble, there are two things that could rapidly make the economic situation for Russia irretrievable. The first is in the small print of the Rosneft placement that triggered the deep crash in the currency. Essentially the Bank of Russia underwrote the placement of RUR 625 billion at 150 b.p. below Russian sovereign risk price- and since Rosneft had $7 billion to pay on 21st December, the whole placement went into the forex market. The implication is clear: The Russian central bank, in addition to being the lender of last resort to the banks- which are already under strain as a result of sanctions- is now being asked to take the burden of Rosneft debt too. 

The combined outstanding debt is over $300 billion- which commits substantially all of the Russian reserves to rescuing Putin's cronies- especially Sechin at Rosneft. That the Rouble crash has come despite the gigantic reserves nominally available to the Central Bank shows that the market totally understands the implications of the placement- the Rouble is not backed by anything like the reserves on paper. I think that never in human history has the reserves of such a large state been captured to support such a small group of individuals- it is Kleptocracy on an undreamed of scale.

The second problem is the banking sector. 

The spike in inter-bank rates shows that the Russian banks already scent the blood in the water- one or more of them is facing terminal levels of losses as a result of the market turmoil, breakdown of the oil price, liquidity strike, sanctions or all of the above. The Central Bank will be urgently trying to find the problem, but a systemic breakdown is now more than possible: the CBR is facing too many leaks in the dam and not enough fingers to plug them all. The liquidity crunch is exacerbated by the fact that it is the end of the quarterly tax period- and the reduced liquidity of this short run credit crunch could quickly lead to a credit shut down. The Russian banking system is now in a more dangerous state that it was in 2008-9.

So the Russian financial system is coming under severe pressure- the external Rouble crisis is rapidly turning into a domestic banking crisis- and the central bank, by being forced to bail out Rosneft does not have the firepower to stabilize the crisis. As the MICEX falls, and interbank rates rocket, the intervention to support the Rouble will peter out and the currency can only weaken again. The current mild winter may yet leave the demand for oil and gas at 2013/4 levels over the coming winter, meaning that from the demand side, the situation remains lacklustre- so there is no reason for any sustained increase in energy prices, given current supply. Therefore no help from the Rouble seems likely from that quarter, and if forecasts of $40/bbl for oil by the spring are born out, then the recession in Russia will be in double figures, not the c.5% fall currently forecast. 

So Mr. Putin's blithe assurance that Russia will recover in two years is -as usual with his statements- not supported by the facts. In fact for Russia, the economic crisis is set to take a step downwards within a pretty short order of time.

For as long as Russia has a President that listens more to the voices in his head than to his economic advisers, the economic position will continue to get drastically worse. The Russians are already voting with their feet or their pocket books and where they can they are getting themselves out of Russia and their money out of Roubles.

Meanwhile, almost unnoticed, the United States has authorized military assistance to Ukraine. Should the Ukrainians use this to begin to push back the Russian troops in Eastern Ukraine, then Putin will face a perfect storm of military defeat and economic collapse.

In the press conference he suggested that the bear would not "sit quiet", but "chase wild piglets", but what he may now discover is that some of these piglets are in fact wild boar, with some very sharp tusks. Now even Belarus is taking steps to protect itself from the Russian crisis. Should the Belarusian election go peacefully and political prisoners be released, then Lukashenka will have played a very subtle game indeed- and will be far less dependent on Moscow.  

In the summer, the cliche was that Putin was playing chess and the West was not responding. Now it looks like Putin is being forced to play in the Hunger Games- with an increasingly high risk of defeat. 

His performance yesterday gives no sign that he will back down, and his repeated references to nuclear weapons show how dangerous the situation is- and how detached from reality the Russian tyrant has become. Nevertheless, Putin himself remains responsible for the crisis and unless he deescalates, the game will continue to its logical and potentially grim conclusion.

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