We have shown so far that all ruble crises were accompanied by a strong
U.S. dollar and low oil prices.
We have concluded that Russia's current problems resemble those from 1998,
though possibly even more severe than seventeen years ago, because the
biggest country in the world is cut off from the international funding. But
what about the following banking crisis in Russia?
Let’s begin by explaining why the next full-blow financial crisis is
coming, even though Russian public debt is very small (less than 10% of GDP).
We have to remember that what really counts is future
fiscal balance. It involves the role of expectations of the future
stance of public finance and explains why governments in crises often have
surprisingly large foreign currency reserves and run small or no deficits at
all. The best example was the Asian countries in 1997. According to
Eichenbaum et al., the Asian crises was caused by “large prospective
deficits associated with implicit bailout guarantees to failing banks”. The
same mechanism operated in Russia. Investors simply noticed that the oil and
gas industry generates about half of Russia’s revenues, so the government,
unable or unwilling to raise taxes or cut spending, will run deficits in the
future. These expectations were enhanced by the implicit bailout guarantees of
Putin’s cronies.
This is why Russian bond yields and credit defaults swaps with measuring
bankruptcy risk for Russia and have already hiked (Russia’s government
10-year local bond yield jumped from 10% in November, 2014 to 14% in January,
2015, while CDS spiked in January, 2015 by 100 basis points to 630).
This issue of prospective deficits is strongly linked with the credibility
of monetary policy. Investors fear that the Central Bank of Russia will not
withstand political pressure (remember: it is an authoritarian country which
is cut off from the external funding) and will start printing money to
monetize deficits. Anticipating future inflation, investors sell rubles
today. On December 15, 2014 the central bank gave Rosneft, owned by Putin’s friend, 625 billion newly
printed rubles. That supply of new money immediately appeared on the currency
market, and the exchange rate collapsed, despite oil bouncing back that same
day.
What about the possible default on private debt? The ultra-low interest
rates in developed economies resulted in the search for yields in the
emerging markets. This led to a rise in Russian corporate debt denominated in
foreign currencies
from $325 billion at the end of 2007 to $502 billion in June 2014. The weaker
the ruble, the higher costs for Russian companies to pay debts issued in
other currencies. They need liquidity to pay interest and roll over debts,
but sanctions cut off Russian businesses (and banks) from foreign financial
markets where Russians used to get half of their capital. Therefore, they
have to buy U.S. dollars in the market, which further weakens the ruble
exchange rate.
The rise in the U.S. dollar caused the reverse of emerging markets carry
trade - investors started to outflow their capital from them, including
Russia which is additionally suffering from the Western sanctions. Although investors
have been taking their capital out of Russia for a few years, a sharp rise in
2014 (around $150 billion in a full year compared to $63 billion in 2013 and
$134 billion in 2008, during the global financial crisis) augmented the
downward pressure on the ruble, which further decreased the confidence in the
Russian economy and next entailed outflows of capital.
Non-financial companies are not the only ones that suffer from the ruble’s
weakening. Banks, who borrowed in foreign currencies, make a close second.
Banks have $192 billion of external debt (about 10% of GDP), up from $170bn
in 2008, and from $18bn in 1998, while having few dollar assets to balance
against their dollar debts. About $130 billion of bank and corporate debt
will be due this year.
Three more factors aggravate the banks’ situation. First, companies’
insolvency means more bad loans and losses for the banks. For example,
overdue unsecured consumer debt of Russian banking sector rose by 2
percentage points between April and September 2014, to 11.3%, while Sberbank,
the country's biggest lender, has reported a 25% slump in third-quarter net
profit on rising provisions for bad loans.
Second, depositors no longer trust the ruble and began withdrawing their
money from the banking deposits. The share of Sberbank’s deposits held in
foreign-currency increased from 13 percent to 17 percent in the second half
of the year. Russians also started flying into real values, i.e. they are
getting rid of rubles and buying foreign currencies, durable goods and
obviously gold. Such behavior typically indicates the loss of trust in the
domestic currency and entails high inflation.
Third, in response to hike of the CBR key rate (see graph 3), the interest
rate on Russian three-month interbank loans rose to 28.3%, higher that it was
even during the 2008 crisis. Consequently, Russian banks will need support in
the near future. Actually, the first banks (Trust Bank, VTB, Gazprombank)
have already been bailed out at a level of a few billion U.S. dollars. However,
bearing in mind that banks and companies (whose operation must be financed by
banks) will need to repay almost $100 billion of foreign debt this year, we
may next expect more bailouts.
Graph 3: Russian benchmark interest rate from March to December, 2014
Source: tradingeconomics.com
It is just a logical step during the currency crisis experienced by the
developing country with large foreign-currency debt. According the Krugman, “…the initial effect of a drop in
export prices is a fall in the currency, this creates balance sheet problems
for private debtors whose debts suddenly grow in domestic value, this further
weakens the economy and undermines confidence, and so on”.
Did you enjoy reading the above article and would you like to know what
the Russian crisis could mean to the global economy and gold market? We
analyze this issue in our latest gold Market
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Arkadiusz Sieron
Sunshine Profits‘ Gold News
Monitor and Market Overview Editor
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