The Russian rouble has been in trouble of late. The value of the currency crashed from 55 roubles to a dollar as on December 11, 2014, to nearly 73 roubles to a dollar as on December 16, 2014. Since then the currency has recovered a little and as I write this around 67 roubles are worth a dollar.
What caused this? A major reason for this has been the fall in the price of oil by 50% in the last six months. As I write this the Brent Crude Oil quotes at slightly less than $60 to a barrel. The Brent Crude price dropped below $60 per barrel only this week.
The Russian government is majorly dependant on revenues from oil to meet its expenditure. The money that comes in from oil contributes around half of the revenues of the government and makes up for two-thirds of the exports.
As The Economist points out: “The state owns big stakes in many energy firms, as well as indirect links via the state-supported banks that fund them.” Given this excessive dependence on oil, Russia needs the price of oil to be in excess of $100 per barrel, for the government expenditure and income to be balanced.
As Javed Mian writes in the Stray Reflections newsletter dated November 2014: “Today, Russia needs an oil price in excess of $100 a barrel to support the state and preserve its national security.” The Citigroup in a report puts the break-even cost of the Russian government budget at an oil price of $105 per barrel. The oil price, as we know, is nowhere near that level.
The rouble lost 10% against the dollar on December 15 and another 11% on December 16. Why did this happen? Foreign investors are exiting Russia lock, stock and barrel. The Russian central bank recently estimated that capital flight could touch $130 billion this year.
The foreign investors are selling their investments in roubles and buying dollars, leading to an increase in demand for dollars vis a vis roubles. This has led to the value of the rouble crashing against the dollar.
The Russian central bank has tried to stem this flow by buying the “excess” roubles being dumped on to the foreign exchange market and selling dollars. It is estimated that on December 15, 2014, it sold around $2 billion to buy roubles.
But even this did not help prevent the worse rouble crash since 1998. This forced the Russian central bank to raise the interest rate by 650 basis points (one basis point is one hundredth of a percentage) to 17%. Despite this overnight manoeuvre, the rouble continued to crash against the dollar and fell by 11% on December 16.
The Russian central bank has spent more than $80 billion in trying to defend the rouble against the dollar this year and is now left with reserves of around $416 billion. The question is will these reserves turn out to be enough?
Russian companies and banks have an external debt of close to $700 billion. Of this around $30 billion is due this month and another $100 billion over the course of next year, writes Ambrose Evans-Pritchard in The Telegraph.
He also quotes Lubomir Mitov, from the Institute of International Finance, as saying that any fall in reserves below $330bn could prove dangerous, given the scale of foreign debt and a confluence of pressures. “It is a perfect storm. Each $10 fall in the price of oil reduces export revenues by some 2 percent of GDP. A decline of this magnitude could shift the current account to a 3.5 deficit,” Mitov told Evans-Pritchard.
This has implications for Russia on multiple fronts. With oil revenues falling, the Russian economy will contract in 2015. Before raising the interest rates to 17%, the Russian central bank had said that the economy could contract by 4.7% because of oil prices falling to $60 per barrel.
Also, inflation which before this week’s currency crisis was at 9.1%, could go up further. As The Economist points out: “Russian shopkeepers have started to re-price their goods daily. Less than two weeks ago one dollar could be bought with 52 roubles; on December 16th between 70 and 80 were needed. Shops defending their dollar income need a price rise of 50% to offset this.”
Further, so much money leaving Russia in such quick time, the country may also have to think of implementing capital controls.
The revenue projections of the Russian government have gone totally out of whack. The Financial Times reports that two weeks back, the Russian president Vladmir Putin, “ signed the federal budget for 2015-17 — which is still based on forecasts of 2.5 per cent annual gross domestic product growth, 5.5 per cent inflation and oil at $96 a barrel.” These assumptions will have to junked.
Putin might also might have to go slow on the aggressive military strategy that he has been following for a while now As Mian points out: “Russia is the world’s 8th-largest economy, but its military spending trails only the US and China. Putin increased the military budget 31% from 2008 to 2013, overtaking UK and Saudi Arabia, as reported by the International Institute of Strategic Studies.”
Whether this happens remains to be seen. Nevertheless, the Russian crisis has led to financial markets falling in large parts of the world. As I write this the BSE Sensex is quoting at around 26,700 points having fallen by around 1800 points over the last two weeks.
So, what are the lessons in this for India? The first and foremost is that foreign investors can exit an economy at any point of time, once they finally start feeling that the economy is in trouble. They may not exit the equity market all at once but they can exit the debt market very quickly.
This is something that India needs to keep in mind. From December 2013 up to December 15, 2014, the foreign institutional investors have invested Rs 1,63,523.08 crore (around $25.7 billion assuming$1=Rs63.6) in the Indian debt market. This is Rs 44,443 crore more than what they have invested in the stock market.
Even if a part of the money invested the debt market starts to leave the country, the rupee will crash against the dollar. This is precisely what happened between June and November 2013 when foreign institutional investors sold debt worth Rs 78,382.2 crore.
When they converted these rupees into dollars, the demand for dollars went up, leading to the rupee crashing and touching almost 70 to a dollar. It was at this point of time that Raghuram Rajan in various capacities, first as officer on special duty at the Reserve Bank of India (RBI) and later as RBI governor, helped stop the crash.
This is a point that the finance minister Arun Jaitley needs to keep in mind and drop the habit of asking Rajan to cut interest rates, almost every time that he speaks in public. Rajan knows his job and its best to allow him and the RBI to do things as they deems fit. Further, Rajan and RBI are more cued into what is happening internationally than perhaps any of the politicians can ever be.
Also, one reason that foreign institutional investors have invested so much money in the Indian debt market is because the returns on government debt are on the higher side vis a vis other countries. If the RBI were to cut the repo rate (or the rate at which it lends to banks) these returns will come down and this could possibly lead to the exit of some money invested by foreign investors in India’s debt market. And that would not be good news on the rupee front.
The article originally appeared on www.FirstBiz.com on Dec 17, 2014
(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)