Tuesday, December 16, 2014

The Dark Night of Russian markets

Yesterday the dam finally broke in the Russian markets: the Rouble had a heart attack and fell over 10%. The continued erosion of the price of oil down to $61 is placing Russian government finances in considerable jeopardy at a time when even a relatively small deficit is unlikely to be financed by Western lenders, and the increasing refinance risk on the existing debts of Rossneft and the banking sector is creating still further demands on the Russian public purse.

At 1 am the Russian central bank raised rates by 6.5% to 17%.

Moscow has made a choice to attempt to defend the Rouble from collapse, but the price of that choice will be a deep recession as the economy digests the rate rise shock.

In fact this could prove to be a catastrophic decision.

Russia urgently needs investment capital in order to modernize and diversify its economy: this has been true for some time. It is also recognized by the authorities as a strategic goal. Indeed the decision to impose sanctions on foreign food imports was explicitly in order to promote import substitution. Unfortunately, even in basic agriculture the historic lack of investment has created significant capacity problems, and so the result of these sanctions has been a sharp rise in inflation. At every level, even agriculture, the Russian economy lacks capacity to fill the demand of their own internal market, still less to export.

The economic illiterate in the Kremlin believes that by squeezing demand he can strengthen the domestic economy. In fact this attempt at North Korean autarky is more likely to cause a final economic breakdown. Failing to use the competitive advantage offered by imports will make the already inefficient Russian economy even more unable to deploy investments in a timely and efficient manner. Inflation will take off and with it the final death of the hard earned credibility of the Rouble. The return to dollarization is the only logical response - and the authorities are trying hard to stop this. Yet without the effective safety valve of "equivalent units" it is quite likely that the Rouble will go into hyperinflation- again.

The meltdown in the Rouble on Monday was matched by similar falls in the Russian markets. Tim Ash called it "Red Monday", but despite the drastic falls in asset prices, there remain few buyers. The buyers strike continues and from the market perspective only the end of Russian aggression and a complete U-turn in the Kremlin is likely to change things.

The bond market may yet claim another political victim.

However in this emerging economic death spiral, the Putinist lie machine is still searching for a way out that can allow Russia to make a judo throw. We are entering even more dangerous ground.

The next few days will see of economic stability can be recovered. However as yet another civilian jet had a near miss with a Russian military plane with its transponder switched off over the Baltic sea, and as green men are rumoured to be gathering in Belarus, there is as yet no sign that Russia is changing its course of confrontation with the West.

Putin seems determined to consign Russia to an economic and political Gotterdammerung. 

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