Streetwise Professor

November 12, 2008

Worser and Worser

Filed under: Economics,Energy,Russia — The Professor @ 8:27 pm

From America’s financial problems, to Russia’s. Hard as it is to believe, given the depth of our miseries, that is not an improvement. To the contrary.

Where to begin?

How about the Ruble. It is widely recognized that Ignatyev’s waffling on the Ruble was a blunder. Not that statements that Russia was preparing to defend the Ruble to the last ditch would have been credible, but the attempt to be a little bit pregnant won’t have any effect on the course of the currency, and calls into serious question the competence of the central bank, and the government. Hopes that the currency will decline gradually are pipe dreams. If speculators are convinced that (a) Russia will not put its reserves behind a defense of the Ruble, and (b) the government is reconciled to a decline in the Ruble in the future, they will make the future now and mount an attack on the Ruble. If the central bank tries to stem a speculative attack and slow the rate of decline by selling dollars and euros and buying Rubles, it will burn through reserves, and for nothing–because sooner or later the fundamentals of capital flight and a current account deficit will prevail and drive the currency lower.

What’s more, if those dollars and euros are spent attempting to slow–but not stop–a Ruble decline, that’s fewer dollars available to pay back dollar and euro denominated debt. Now this is primarily private debt secured by equity in Russian firms, but as has been discussed often on SWP by me and Michel, Putin et al are loath to let the collateral fall into Western hands. But if the reserves are frittered away in a futile attempt to defend the currency against registering the reality of bad fundamentals, they won’t have a choice, and there will be widespread defaults. One can only imagine the extralegal means and judicial legendermain that the oligarchs and the government will use to keep their paws on the collateral. This would turn into a diplomatic and political catastrophe, rather than merely an economic one. And who knows what hard, desperate men will do when their backs are against the wall?

The market is sending signals that the worsening situation has substantially increased the prospect of default by the government and big corporations. From Bloomberg (article linked above):

Credit-default swaps on Russian government bonds jumped to 7.82 percent of the amount insured from 6.14 percent yesterday, according to CMA Datavision prices. The yield on its 30-year dollar bonds increased to 10.47 percent from 9.1 percent, according to Bloomberg prices.

. . . .

The cost of protecting against a default by OAO Sberbank, Russia’s largest lender, surged to 8 percent from 5.65 percent, while credit-default swaps on OAO Gazprom, the largest company, increased to 11.5 percent from 9 percent.

Credit-default swaps, conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. An increase indicates deterioration in the perception of credit quality.

Sberbank bonds plunged, sending the yield on five-year notes due 2013 up 210 basis points to 16.69 percent, Bloomberg prices show.

Sberbank’s stock fell 8.5 percent on the RTS today, and closed at $.92–not at its recent low, but damned close. And remember Sberbank is one of the banks that the government has favored, and pumped full of money. Another favored bank, VTB, was down over 22 percent.

The only other tool available to fight the Ruble decline is a sharp rise in interest rates. And the central bank pulled that tool out of the shed today. The problem is that it is a very costly tool to use. It will make it costlier for Russian firms and individuals to borrow, and cause a slowdown in the economy.

The stock market continued its slide, with the RTS down 13 percent today, 15 percent on the week. It was worse on the RIOB index of Russian stocks in London (which is not affected by the now-we’re-open-now-we’re-not shenanigans of the Moscow markets). This index was down 17.5 percent today, and 36.51 percent since 11/6/08.

And oil? Urals Med was down to $51.28/bbl. Kudrin is reconciled to oil $60/bbl or below for 2009-2011 ($50/bbl for 2009, $55/bbl for 2010, $60 for 2011.) That prospect, of course, is a major driver of all of the bleak news discussed earlier.

Whichever way Medvedev or Putin or Kudrin or Ignatyev turn, they face stark choices. Protect the Ruble–burn through the reserves or throw an already wobbly economy into a tailspin by jacking interest rates. Let the Ruble fall–serious potential for political unrest and the almost certain destruction of Putin’s credibility and reputation as the man who restored Russia from its last default. Bail out the oligarchs–say goodbye to dollars and euros. Let the oligarchs default–say goodbye to Russian control over the “crown jewels” of Russian industry, or keep control of them by repudiating foreign commitments and forget about foreign capital for a long time to come.

I think that the likely outcome is that Russia will not try to fight fundamentals, and will let the currency drop. Even if it drops like a stone. That would be the smart thing to do. As painful as the devaluation of 1998 was, it was a necessary condition for the economy to recover, and it did so in the 2000s.

But this will put tremendous domestic pressure on Putin and Medvedev. It will make them liars in the eyes of Russians across 11 time zones. But the problem they face is that attempting to defend the currency will only delay the day of reckoning, and leave them in a weaker position to deal with the fury.

And that is the danger of demanding and obtaining near absolute power, and depriving the citizenry of any meaningful political safety valve. When things go bad, everybody knows exactly whom to blame. That’s what makes a political system brittle.   And that is why there is a much greater potential for a political explosion in Russia than in the US or Europe.

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  1. […] Professor posts a detailed update on Russia's financial problems: “Whichever way Medvedev or Putin […] turn, they face stark choices. Protect the Ruble […]

    Pingback by Global Voices Online » Russia: Financial Problems — November 12, 2008 @ 8:49 pm

  2. And the price of the Urals Blend is now trading at less than $50 per barrel. According to “Нефть Urals упала ниже $50 за баррель
    Спотовые котировки российской нефти марки Urals впервые в этом году упали в ходе торгов четверга ниже отметки $50 за баррель – уровня, который Минфин прогнозирует как средний на весь 2009 год. К 13.12 мск котировки «покупать» упали до $49,83 против уровня закрытия предыдущего дня – $50,77. На мировых торгах нефтяные котировки снизились до 22-месячного минимума, поскольку страх перед рецессией в мировой экономике превысил эффект от намерения ОПЕК вновь снизить объемы добычи уже в конце ноября.”

    The OPEC cuts and other declines in production can’t match the decline in demand, so prices are going down. Just as the Russian Minister of Finance acknowledges the likelihood of oil averaging $50 a barrel next year, prices go done some more.

    I have to say that I don’t understand the Russian government’s logic in trying to defend the ruble at all costs. All they are doing is spending billions of dollars that could be better spent elsewhere. How much did they spend yesterday after drawing a new line in the sand? Six billion dollars? Imagine if they had taken that money and spent in on building hospitals, launching a massive HIV/AIDS awareness campaign, and otherwise improving infrastructure. In the long run, that would have been more beneficial and would have done more for Russia than by spending billions to delay by eventual devaluation of the ruble by a few weeks or a few months.

    Comment by Michel — November 13, 2008 @ 9:04 am

  3. I can never figure out which price the Russian government is “reconciled” too — is it the world price, or the much-lower price for Urals blend?

    Whichever, their attempt to send the message that they don’t care how low the price drops because Russia is so well managed that it doesn’t matter is wholly neo-Soviet in character and truly terrifying.

    Comment by La Russophobe — November 15, 2008 @ 5:15 am

  4. The budget is based in the Urals Blend price. You are right, it is sometimes ambiguous as to what price is being referred to, but this is often likely due to press ignorance. When Kudrin and others in the Russian government speak of oil prices, implicitly or explicitly they are referring to UB.

    Even the concept of a “world price” is dubious. The most commonly quoted benchmarks are Brent and West Texas Intermediate. Brent usually sells at a discount to WTI. Increasingly the world’s oil output is heavier and more sour than the “light, sweet” Brent and WTI, so most world oil sells at a discount to the most commonly quoted benchmarks.

    The ProfessorComment by The Professor — November 15, 2008 @ 9:21 am

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