Russia's central bank is trying to resist a brutal assault on the ruble, but any respite is bound to be short-lived.
The Central Bank of Russia waded into currency markets Monday as the ruble plunged to levels not seen since the 1998 financial crisis that triggered a devaluation and government debt default.
Like the Canadian dollar and the Norwegian krone, the Russian currency has been under extreme pressure amid the collapse in oil prices.
The ruble plunged as much as 6.5 per cent Monday, hitting a record low against the U.S. dollar before retracing some its lost ground to close down 4 per cent, which traders attributed to central bank intervention. The ruble has lost close to 60 per cent of its value against the greenback so far this year.
But if there's any relief in Russia's case, it promises to be temporary as a combination of falling oil prices, Western sanctions, capital flight and a string of policy mistakes threaten to drive an already stumbling economy off a cliff, carrying the currency with it.
"What we are seeing is a perfect storm," said Anders Aslund, a senior fellow with the Peterson Institute for International Economics in Washington.
On Tuesday, the ruble sank for a sixth day, as crude resumed declines and the Economy Ministry said Russia may enter its first recession since 2009 next year. Gross domestic product may shrink 0.8 per cent next year, compared with an earlier estimate of 1.2 per cent growth, Deputy Economy Minister Alexei Vedev said in Moscow.
Despite the Kremlin's best efforts to deride Western sanctions as little more than an irritant, they are taking a heavy toll on Russia's financial sector and other parts of the economy.
Gazprom axed a $40-billion (U.S.) pipeline project on Monday that would have carried natural gas to southern Europe while bypassing Ukraine.
As for the ruble, the central bank had largely maintained a hands-off policy in recent weeks while hoping in vain that tighter monetary policy – four rate hikes so far this year, topped by a stunning 150-basis-point jump to 9.5 per cent in October – would do the trick. But the currency continued weakening.
Analysts expect the central bank to raise its key rate again by 100 basis points at its next meeting Dec. 11, despite pressure from lawmakers to loosen policy in response to worsening economic conditions. Several have called for an investigation of the bank's manoeuvres and are urging more aggressive use of foreign-exchange reserves to prop up the ruble.
But those reserves are eroding more rapidly than many observers realize, Mr. Aslund said, warning that Russia will face a serious financial squeeze in 2015. "The situation is far worse than the Kremlin says."
Central bank reserves total what appear to be a comfortable $420-billion. But that's down more than $100-billion in just one year and will probably shrink by a similar amount in the coming year. What's more, $172-billion of the total is controlled by the Finance Ministry, another $45-billion or so sits in gold and $12-billion is parked with the International Monetary Fund. Another $150-billion is likely to be needed to cover foreign debt repayments over the next year, because the country has been cut off from normal U.S.-dollar refinancing channels by the sanctions.
So actual liquid reserves available to defend the ruble are rapidly shrinking. And the government takes a direct hit from a narrowing oil revenue stream, because of its heavy reliance on its take from high marginal tax rates on the industry to finance its budget.
Still, for all its self-inflicted woes, there are no signs that the Russian economy is mirroring the steep drop in the ruble or facing a rerun of the 1998 collapse, said Neil Shearing, chief emerging markets economist with Capital Economics in London. "The economy's stagnating, but it's certainly not collapsing."
And there may even be a silver lining to the oil slide, if it shakes policy makers out of their complacency and forces them to tackle the structural problems weighing down the economy. Low oil prices were the trigger for previous reform efforts, Mr. Shearing notes. But he acknowledges that the Putin government has shown no inclination to pursue major economic changes.
His forecast puts Russia in recession territory for most of the coming year with a contraction of 1 to 1.5 per cent, which is in line with Moscow-based predictions. "Clearly, the risks lie to the downside."
Mr. Aslund does not do such crystal-ball gazing, but suspects the slump could be much greater, perhaps as deep as 4 to 6 per cent. Mr. Putin, he said, "has made every economic mistake in the book. We are reaching a tipping point."