Up until last week, it looked as though the Russian economy was coasting along, with little reason for immediate worry, writes Professor Stefan Hedlund.
The rouble was sliding in line with the price of oil and Central Bank reserves appeared to offer ample protection against default on foreign debt. Then, it was as if the roof caved in. What happened?
Rumours in the market claim the trigger was a backstage operation to bail out the state-controlled oil giant Rosneft. It was well-known that Rosneft had borrowed heavily to take over the TNK-BP oil joint venture, when BP was finally forced to sell its stake.
Igor Sechin, CEO at Rosneft, approached the Kremlin a few weeks ago with a request for a US$40 billion bailout from the country’s National Wealth Fund. Although that fund was set up to support the pension system, it has over recent months been seen by the Kremlin as a source of funds for bailing out banks and companies hit by Western sanctions.
But granting Mr Sechin’s request would have drained half its capital in one go, leaving little for others in need. The request was denied.
What appears to have happened instead is that just before the fatal weekend, Rosneft issued some 625 billion in rouble bonds (about US$10 billion at the time). These were bought by a group of state banks at very low rates of interest. The Central Bank then added the Rosneft securities to a list which banks could use as collateral for loans, and at the same time it announced a 700 billion rouble liquidity auction. The rumour was that the bank in practice had printed roubles to bail out Rosneft.
Rosneft denies its rouble bond issue had any link to the parallel decision by the Central Bank to issue roughly the same amount in liquidity. But suspicion will linger.
It could have worked, but it did not. Markets caught wind of the action, and reacted swiftly by selling roubles. Given the pressure of expectations which had been building as the price of oil slumped, the sell-off morphed into panic. The bank reacted by hiking its rate to 17 per cent. And still the bleeding would not stop.
On Wednesday morning, December 17, 2014, both the rouble and the Russian market recovered from tailspin, buoyed by expectations that the Central Bank stands ready to spend some US$70 billion of its reserves to shore up the currency.
This may give temporary relief, but at the cost of draining remaining reserves and choking off all prospects for productive investment.
What is really troubling is that the ploy to rescue Rosneft brings back memories of how the Central Bank acted in the aftermath of the rouble collapse in August 1998.
Then it allowed insiders access to ‘informal credits’ such as that requested by Rosneft, while letting others take the hit of default. The government bonds which went into default then were worth US$40 billion.
Looking towards the future, markets will now believe that the Kremlin is not really interested in stabilising the rouble or in saving the country’s economic future, but merely in bailing out its friends.
This lesson will end up costing the Kremlin dearly, but Mr Putin is likely to remain in denial. In the words of exiled Russian economist Sergei Guriev, we are looking at a ‘full-blown economic disaster’.