Russia is the first casualty of the oil price crash – it won’t be the last

Russia's drastic interest-rate hike is a sure sign the country's in trouble. But as John Stepek explains, it's not the only market that's feeling the pain.


Falling oil prices are a major headache for Vladimir Putin

How would you feel if you woke up one morning and the Bank of England had nearly doubled interest rates in the middle of the night?

There's a range of answers here, no doubt. But I'm betting the main one is "a little bit panicky".

That's what the people of Russia have woken up to today. The Russian Central Bank raised its main interest rate from 10.5% to 17% last night.

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That's pretty drastic.

Unfortunately for Russia, it's not going to be enough.

Russia's big problem oil

Russia has two main problems. Firstly, it invaded Ukraine. It might have got away with that. But then a passenger airliner was caught up in the crossfire. That couldn't be ignored. So sanctions were imposed, making it difficult or impossible for many Russian companies to raise money from overseas investors.

That's made life tricky. But the biggest problem is the collapsing oil price. During the commodity boom, Russia did very little to diversify its economy. Instead, it just came to rely on ever-higher oil prices to fuel public spending and to shore up its geopolitical power.

That's the commodity curse, and very few countries are able to cope with it. Even an advanced, wealthy, forward-thinking democracy like Norway will struggle to cope with diving oil prices. So you can see why a brittle autocracy like Russia would have an even harder time.

With the outlook for the economy grim, the rouble has fallen hard. That's perfectly normal. A weakening currency can sometimes be part of the solution to a downturn as Britain knows only too well.

And to the Russian central bank's credit, it hasn't acted particularly aggressively to defend any specific line in the sand. Emerging markets (and our own Bank of England, in 1992) have learned the hard way that when central banks try to defend a falling currency against evil speculators', the evil speculators generally win.

But a central bank can only stand by for so long. The rouble's slide has driven inflation higher (imports become more expensive when a currency falls). And there are some signs of a rising risk of dollarisation' where consumers start to abandon a local currency in favour of using dollars instead.

That's an ugly sign for an economy. When faith in the local currency vanishes, you're on the road to full-blown crisis.

The central bank had already lifted interest rates sharply, just last week. But yesterday the rouble slid a whopping 13% against the dollar. Hence the midnight rate hike to try to stem the panic.

This isn't a buying opportunity not yet at least

The big risk is capital controls. Your money goes in. Then it gets stuck there. And because you're just some rich foreigner, no one gives a flying monkey's about whether you've been ripped off or not.

But let's assume that you're not as worried about that. Will this central bank rate hike do the trick? Unfortunately, it doesn't look like it. The rouble bounced by around 10% against the dollar just after the rate hike, but it's plunged right back down this morning.

The big issue is this: if you're going to take radical action as a central banker, it has to solve the problem. You have to draw a line under it. If it doesn't solve the problem, then you just look as though you're panicking. And that makes things worse.

And higher interest rates don't solve Russia's fundamental problem. The real problem is the oil price. And that's still falling Brent crude is now below $60 a barrel, having been as high as $115 earlier this year.

As one wealth manager in Moscow told Bloomberg: "The rouble has erased gains because oil is falling. Right now it's very hard to stop the panic since everyone is betting against the rouble. The central bank was too late with its move. Without oil and the economy stabilising, the rouble won't rise."

We'll be looking in more detail at previous emerging market currency crises and what they suggest about timing buying opportunities in the next issue of MoneyWeek magazine (out on Friday).

When a critical market like oil crashes, you get collateral damage

Lots of people invested lots of money on the assumption that oil would stay at around $100 a barrel. Lots of those investments are now going to turn bad. Where is the exposure to all of those bad investments? Who is going to blow up?

We can't be sure yet. But what we can be sure of is that some investments will get undeservedly hammered along the way. This is one reason why it's always a good idea to keep a portion of your portfolio in cash at all times. It gives you the opportunity to act when bargains come your way.

One area I'll be looking to top up is the investment trusts in the MoneyWeek portfolio. We've been following this six-trust portfolio for a bit more than two years now and it's done very well in that time. If you're not a subscriber, you can get hold of the details of the portfolio and get your first four MoneyWeek issues free by signing up here.

John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.