Russia Can’t Escape Historical Retrospection in Crisis

File Photo of Cash, Coins, Line Graph

(Blooomberg – bloomberg.com – Ye Xie and Elena Popina – October 9, 2014) As Russia starts burning through foreign reserves in a bid to defend the ruble, flashbacks to the country’s 1998 devaluation and default are inevitable.

While the government is in a much stronger position today to fend off the crisis than it was then — foreign reserves are 57 times bigger and the price of oil, Russia’s top export, is nine times higher — the underlying mechanism is the same.

Russians and foreign investors are losing confidence in the slumping economy, pulling rubles from banks and cashing them in for dollars and euros. The central bank has stepped in to meet some of that demand for hard currency and stem the ruble’s losses, spending $1.85 billion in just four days this month. In all, international reserves have dropped $55 billion this year to a four-year low of $454 billion. The ruble has still plunged 15 percent over the past three months, the worst selloff in the world, to a record-low 40 per dollar.

Even Paul McNamara, a bond fund manager at GAM U.K. Ltd. who calls any comparisons between now and 1998 “misplaced,” sees enough trouble to steer clear of most Russian assets. There’s “no reason to catch the ruble falling knife,” McNamara, who manages $6.5 billion, said in a phone interview.

The crisis today has largely been fueled by President Vladimir Putin’s incursion into Ukraine, which triggered international sanctions, and compounded by a drop in oil prices to below $90 for the first time since April 2013.

Debt Default

In 1998, a tumble in oil — to as low as $10.72 a barrel — in the wake of Asia’s currency crisis preceded the Russian economic collapse just seven years after the end of communism. That year, central bankers drained reserves to less than $10 billion before abandoning their defense of the ruble. The government defaulted on $40 billion of local debt and the ruble was down 71 percent by year end, saddling a U.S. hedge fund with losses so big that Wall Street banks had to bail it out and sparking outflows from emerging markets that led Brazil to devalue the real in 1999.

“Russia in 1998 and 2014 is two different countries,” Michael Ganske, who oversees $8 billion in bonds and foreign exchange as head of emerging markets at Rogge Global Partners Plc in London, said in a phone interview yesterday. “More concerning is the refinancing problems” for companies “but they are well prepared.”

Russian companies have $158 billion of foreign-denominated debt and the government has $42 billion outstanding. Standard & Poor’s lowered the government’s credit rating in April to BBB-, one level above junk, as the Ukraine conflict began to strain Russia’s $2.1 trillion economy.

Emerging Stagflation

The extra yield investors demand to hold Russian dollar-denominated bonds instead of U.S. Treasuries reached a one-month high of 340 basis points yesterday, according to data compiled by JPMorgan Chase & Co. While far below the spread of about 1,800 basis points reached on the eve of the 1998 default, the rise in borrowing costs reflects concern credit ratings could be cut further.

Stagflation is now emerging, with growth stalling while inflation soars to a three-year high of 8 percent as the weaker ruble drives up import prices. The International Monetary Fund predicts the economy will expand 0.2 percent this year, the slowest pace since Russia’s 2009 recession.

“The worst combination we can have is a weaker ruble and significant growth deterioration, which is exactly what’s happening at the moment,” Lars Christensen, chief emerging-market analyst at Danske Bank A/S in Copenhagen, said by phone yesterday. Russia could see more ratings reductions, and “that it is going to have global implications,” he said.

Financial Defenses

Still, there are no signs that investors are concerned that Russia could struggle again to meet debt payments. At an annual rate of 2.53 percent, the cost to insure the government’s bonds from default implies a 16 percent chance of a halt in payments over the next five years.

Even with the recent declines, Russia’s foreign reserves remain the world’s sixth largest. In the 2008-2009 global financial crisis, the central bank spent $200 billion of its then $598 billion of reserves to slow the ruble’s slide.

This week, the Bank of Russia stepped up its intervention after the ruble crossed the upper limit of the trading band set by the central bank. Policy makers shifted the boundary by 20 kopeks to 44.85 yesterday versus the dollar-euro basket, also used to manage the currency, a threshold that requires the authority to sell $350 million. The ruble strengthened 0.2 percent today to 40.05 per dollar after closing weaker than 40 for the first time yesterday.

While Russia probably won’t see a repeat of the 1998 debacle, the economic costs of the current crisis may eventually force Putin to dial back Russian aggression in Ukraine, according to Steffen Reichold, an emerging-markets economist at Stone Harbor Investment Partners LP in New York.

“I very much doubt the global markets will be impacted the same way they were in 1998,” said Reichold by phone yesterday. “Right now, Putin can afford it, but sooner or later, it will have more impact, and things will change. That limits how aggressive he can be.”

Article ©2014 Bloomberg L.P. All Rights Reserved. Article also appeared at bloomberg.com/news/2014-10-09/russia-can-t-escape-historical-retrospection-in-crisis.html

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