Russia faces currency crisis and a hard landing

published 21 November 2008

Russia is facing the worst turmoil since its 1998 crisis. Since May, the RTS index has slid by over 70% as unease over political interference in the stockmarket has been compounded by the plunging price of oil, Russia's chief export. The flight of capital, due to the darkening local outlook and mounting global risk aversion, has caused a crisis of confidence in the rouble and left the central bank in "a fixed-exchange-rate trap", says Ambrose Evans-Pritchard in The Daily Telegraph.

Russia used to peg the rouble in a narrow trading band against a basket comprising dollars and euros. This was designed to temper the appreciation of the currency. Now, due to plunging oil and an end to capital inflows, it is defending "an overvalued exchange rate", says Rory MacFarquhar of Goldman Sachs. Last week, having already spent around a fifth of its foreign-exchange reserves shoring up the currency, it raised interest rates and allowed a 1% slide of the rouble against its basket a small move likely to tempt traders to launch further speculative attacks on the currency.

A bigger devaluation to a more realistic rouble level, on the other hand, would raise the cost of the foreign debt to be paid off next year and undermine local confidence in the currency; there are already reports of depositors frantically switching their roubles into dollars. Meanwhile, the broader economy is deteriorating fast, with falling oil prices set to wipe out the budget as well as the current-account surplus next year, external demand weakening and the rate hike making scarce credit even dearer, says Neil Shearing of Capital Economics. Growth will tumble to just 3% in 2009. "That will feel like a very hard landing."