It doesn’t seem like it rains in Russia but it pours. Russia continues to teeter on the brink of an economic crisis with its government hopping from one intervention to the next in the hope of avoiding the worst.
IN THE MONEY WITH Nesbert Ruwo & Jotham Jakarudze
Despite decades of political strife with Western powers, Russia has been on a steady growth path supported by the liberalisation of its oil sector in the 1990s. This growth trajectory saw it included as one of the four original BRIC countries touted as being the new centres of growth and economic dominance.
The most recent debacle all started with the Russia-Ukraine conflict which resulted in Russia’s renewed fall-out with Western nations, particularly the USA.
A series of sanctions combined with a dramatic fall in crude oil prices, a slowing economy and Russia’s aggressive monetary policy is somewhat of a perfect storm.
Russia’s crisis, epitomised by the crush of the ruble, something reminiscent of the 1998 Russian financial crisis, is much more than of its own making. Russia is energy commodity-dependent with over 50% of federal budget coming from oil and gas.
Crude oil price has been on a tailspin since mid-2014, and has declined by more than half to the current levels of close to US$50. Russia’s currency has weakened as a result, from RUB 33,98/US$ at end of June 2014 to the current levels of RUB 63 per US$. It briefly touched its record-low of 80,10 per dollar on December 16 forcing Central Bank of Russia (CBR) intervention.
The CBR increased its key interest rate by 650 basis points to 17% in order to limit “substantially increased ruble depreciation risks and inflation risks”. Yields on dollar-denominated debt have also risen.
While this move is likely to backfire down the line as it serves to squeeze investment and push the ailing Russian economy deeper into recession in 2015, it is probably the lesser of two evils, the other being the collapse of the financial system caused by a fall in the ruble.
Weaker fundamentals will likely move ratings agencies to downgrade the country’s rating possibly to “junk” status, further exacerbating disinvestment in the country by international investors, making it more expensive for the country to borrow much-needed assistance. This remains an unlikely scenario for Russia though. With an oil price of US$60/barrel, the CBR estimates economic shrinkage of between 4,5% and 4,7% in 2015. CBR only sees a chance of recovery in economy activity in 2017.
The current crisis demonstrates the risks facing any petro-state, which is always vulnerable to external factors. Sustained low oil prices and sanctions pressure on Russia could pose a serious threat to the stability of the regime and would most likely open the possibility of political and economic change in Russia.
The nagging question however in all of this is; are Russia’s BRICS counterparts up to the task to assist? Or is it an issue of “each man for himself, the bloc for all us”?
The grouping recently agreed to form its own BRICS bank, to be headquartered in Shanghai China, in an effort to reduce reliance on the World Bank and IMF.
The approvals by the different local legislatures and finer detail of how the bank will operate, including its risk appetite are still in the works. However, the new bank will comprise two parts taking the form of the two World Bank and IMF.
The New Development Bank, as the one part is called, will be the infrastructure development and project finance arm to be initially capitalised by US$50 billion, split into equal contributions from the members.
The second arm and so-called Contingent Reserve Arrangement (CRA), with US$100 billion in initial capital, will work as a coordinated central bank fund to provide assistance to members in financial difficulty such as the currency crisis that Russia finds itself in. China will contribute the bulk of this with US$41 billion, South Africa US$5 billion and the other BRICS US$18 billion apiece.
It is evident that the combined strength of the BRICS through the CRA allows the resolution of issues such as the Russian currency crisis, which also pose regional or global systemic risks.
The benefit for Russia, or any other nation requiring assistance, would be that there would be policy conditionality that is typical with IMF assistance. However, it may be argued that the lack of policy conditionality in and of itself will serve to undermine the probability of achieving a successful turnaround and will be to the detriment of the fund’s long term sustainability.
The removal of policy conditionality is considered important by member countries, and particularly China as this does not interfere with the political systems of other countries in the way that the IMF has done.
In most instances however, there remain close linkages between the political systems and financial systems and it will be interesting to see how the finer details are set out given that all five of the BRICS continue to battle rampant domestic corruption.
Overall, the notion of the proposed bank is a noble one provided all the parties involved agree on how the bank will operate and in what instances it will intervene.
Furthermore, how it will guard against the member countries using the bank to promote own national interests at the expense of others.
Individually, however, or outside of such a formalised structure, the BRICS grouping is likely to be of little or no help at all to Russia in light of its current woes.
It can be argued that BRICS is increasingly becoming a disparate group with three of the five economies (Russia, Brazil and South Africa) either experiencing or on the verge of weak or negative growth while China remains in a relatively much stronger shape. China will however likely form the core of the group and play a key part in decision making much as the USA does for the Western alliance.
l Nesbert Ruwo and Jotham Makarudze are investment professionals based in South Africa. They can be contacted on email@example.com