World

Evan Horowitz

Why cheap gas prices are ruining Russia’s economy

Cheap gasoline may be a blessing for drivers and a boon to the US economy, but it is wreaking havoc with oil-producing countries around the world.

Perhaps none has struggled as much as Russia, where the fall in oil prices has set off a cascade of economic crises and left the country flirting with a prolonged recession. One way to understand the current situation, and Russia’s uncertain future, is to take it one crisis at a time.

Budget crisis

To pay for education, the military, pensions, and other core government services, Russia doesn’t just rely on taxes. A huge amount of revenue comes direct from state-controlled oil companies. So as the price of oil drops, government revenues collapse and budget deficits pile up.

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Oil has to be priced around $100 a barrel for Russia to balance its budget. At the current price of roughly $50, the government simply isn’t taking in enough money to pay for promised services.

Currency crisis

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Oil is bought and sold in dollars. So after Russian companies sell their oil on the international market, one of the first things they do is convert those dollars to rubles. That way they can pay local salaries and conduct business inside of Russia.

When the price of oil falls, those companies earn fewer dollars, which means they have less money to convert into rubles. And rubles obey the same laws of supply and demand that govern everything else you might buy or sell: If companies have fewer dollars to convert, that means there’s less demand for rubles, and the value of the ruble goes down.

Since the summer, the price of oil has fallen over 50 percent.

Source: Nasdaq.

And the ruble has fallen about the same amount.

Source: XE.com

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The Central Bank of Russia has taken some steps to try to stop this currency slide. Most notably, they hiked interest rates, which makes it more profitable for people to keep their money in rubles and thus should increase demand. The only trouble is that it also stifles spending, which hurts the economy.

Inflation crisis

A big drop in the value of a currency isn’t bad for everyone. Exporters tend to do really well, because the stuff they make becomes cheaper for overseas buyers. The tourism industry profits too, as travelers with dollars learn they can buy many more rubles for their vacation enjoyment.

Trouble comes when people need to purchase imported goods, or when they have mortgages or others debts in euros and dollars. In those cases, a decline in the value of the ruble means more expensive goods and heavier debts.

One reason the currency crisis in Russia is so dire is that Russian consumers rely heavily on imports, including for food and clothing. The decline of the ruble has driven up the cost of these items, leading to an increase in inflation and even spurring people to snatch up luxury items in an attempt to rid themsevles of rubles.

Banking crisis

This storm of crises is putting new pressure on Russian banks. To begin with, as the economy contracts there’s likely to be an uptick in defaults, which means the banks will have less money coming in. At the same time, the banks have their own debts to pay back — often in dollars — and the falling ruble is making those debts more costly. Finally, with western sanctions still in place from the Ukraine crisis, Russian banks have limited access to international financing and can’t easily renegotiate their obligations.

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For a period in mid-December, banks in Russia were basically refusing to lend money to one another — an essential practice of functioning banking systems. The Russian government has had to bail out one mid-sized bank and it’s not impossible that we’ll see a rash of further bailouts in the future.

Geopolitical crisis

All of this together means the Russian economy is headed for a recession, and possibly something worse. Early on, the Central Bank had estimated that the economy would shrink 4.7 percent if oil stayed at $60. That’s already far worse than the contraction the United States experienced during the “Great Recession,” and now that oil has fallen to $50 and interest rates have increased, it may be optimistic.

Entering a severe recession is the kind of thing that might bring down a Western government, but Putin has remained defiant and polling suggests that his popularity is largely unharmed.

Source: Levada Center.

In mid-December, when the ruble was at its most volatile, Putin partly blamed the sanctions for crippling Russia, comparing his country to a bear that Western powers were trying to put “on a leash.”

If the economy craters, and Putin continues to cling to power, one fear is that he’ll turn this anti-Western rhetoric in a more belligerent direction, using nationalist rhetoric or military activity to distract from the economic situation.

What can Russia do?

At this point, Russia doesn’t have a lot of good options. It can hope that the price of oil rebounds. It can use some of the dollars it keeps in reserve to buy up rubles and perhaps stabilize the currency. It could even impose more dramatic “capital controls” to prevent Russians from trading their rubles into other currencies.

Perhaps most dramatic, and most unlikely, Russia could appeal to the International Monetary Fund for assistance. After all, that’s what the IMF is for, to help countries escape from a downward economic spiral. But there are two reason to think an international bailout is extremely unlikely. First, the IMF would have to agree to help a government still under intense sanctions for its annexation of Crimea. Seocnd, Putin would have to accept the terms of an IMF leash.

Evan Horowitz digs through data to find information that illuminates the policy issues facing Massachusetts and the United States. He can be reached at evan.horowitz@globe.com. Follow him on Twitter @GlobeHorowitz